Farmers and ranchers work incredibly hard over many decades to build their businesses. In order to pass along the full value of all they have achieved to the next generation, it is imperative they also focus on creating a succession plan to protect their assets and maintain family harmony.
In America, only 30 percent of all family businesses survive into the second generation, 12 percent will survive into the third, and only 3 percent into the fourth. While many American farm families have far beaten these odds to date, taking the important steps of creating a comprehensive succession plan will increase the likelihood of success.
Succession planning is often associated with retirement and is therefore put off as a task for the future. It is important to recognize, though, that not all succession comes at retirement: death, disability, disaster, divorce and disagreements can also lead to the need to transition an operation, and all five of these “Ds” should be addressed in the plan. For example, if brothers co-operate a business and have an irreconcilable difference, how will the business be divided? For these unexpected reasons, succession planning should start early, even as soon as operation begins.
There are five key considerations to creating an effective plan:
All Stakeholders Participate
The first and most important is to make sure all the stakeholders, regardless of whether they are an active part of the operation, are aware of the plan and buy into it. These conversations can be challenging, as siblings may have different ideas than each other and their parents about who should have what responsibilities, and how assets should be divided fairly; including accounting for children who are not involved in the farming operation. In some cases, for example, it may be deemed fair that a child working his whole life on the operation would inherit the farm assets, and a non-farming sibling would inherit some of the land, or a life insurance payout. Having a mediator involved in these family discussions can help immensely in arriving at acceptance of the plan while retaining family relationships.
Define Business Plan
The second step is to develop, in writing, the business objectives and the specifics of the plan: who will be the production manager or the financial manager, do you want to continue the same crops, and are you working toward growth or stability? The plan also needs to ensure the senior generation is taken care of and has enough money for retirement and elder care when that time comes.
Gather Financial Information
Next, the operator should compile comprehensive and accurate financial information, especially a balance sheet that identifies assets, liabilities and owner’s equity. You should determine your level of profitability, and make an informed decision as to whether the business can realistically continue in the face of the succession plan. Ideally, you should examine five years of financial reports to recognize important trends, such as increasing or decreasing equity. At this point, some hard calls may need to be made about whether the operation is viable for the next generation.
The fourth important consideration, and one that is sometimes challenging, is to seek and pay for the necessary professional advice. These advisers may include the aforementioned mediator, or a consultant to measure the aptitudes of the children coming in to run the farm. The consultant can provide an independent assessment of the appropriate role for each to ensure they are able and positioned well to fill the new roles. At the very least, you should retain an attorney and a tax adviser: the attorney to advise on the best business structure and other estate decisions, and the tax adviser to ensure neither the senior nor the younger generation pays more income taxes than necessary. As an example, a parent selling equipment to a child will need to pay income tax on the gain using ordinary tax rates because of depreciation recapture, but if the equipment is gifted, neither party incurs income taxes on the transfer. Land purchased 40 years ago at $400 an acre and now worth $6,000 an acre can represent significant capital gains tax for the senior generation, but if sold over time can eliminate jumping a tax bracket. Farming enterprises are complex, having an advisory team to help you navigate the process will benefit all involved.
The fifth and final step is ongoing: once the succession plan is established, it needs to be revisited periodically as things change: children may go to college and decide they do not want to return to the farm as expected, or the opposite, they planned off-farm careers but then realize they want to return. Children may marry and start families, you will need to continually evaluate whether the operation that once supported one family will be able to support multiple families. Any of the 5 Ds occurring – death, disability, disaster, divorce and disagreements – also necessitates updates to the plan.
With the plan in place and kept current, the time eventually comes to start implementing it. Outside of an unexpected event, we recommend beginning to transfer management responsibilities at least 10 years before a planned transition, allowing the next generation the opportunity to experience the full cycle of the sector – good times, bad times, economic cycles, possibly even natural disasters – and learn from the experts in the family how to respond. That way, both the senior and the younger generation can have confidence in the operation’s continuation. During this period, the transfer of assets and creation of business entities, following the plan devised with support from your legal and tax advisers, should also be initiated.
At GreenStone, we have assisted many of our customers in their succession planning process, specifically helping them evaluate the tax consequences of transferring assets. We are here to serve as an integral part of the succession planning team to help you, our customers, successfully transition your hard-earned success to the next generation!