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7 tips for a drama-free farm transition

Progressive Dairyman Editor Peggy Coffeen Published on 18 January 2018

The transition of a farm can make or break not only the future of a business, but also the relationships among family members involved. A banker, an attorney and an accountant recently shared their advice on how to minimize drama when dealing with the transfer of farm assets.

The three consultants served on a panel at the Farming Forward: Planning Your Farm’s Future workshop hosted on Nov. 30, 2017, by the University of Wisconsin Extension, Outagamie County. Brad Guse from BMO Harris Bank represented the lending sector; Nancy Immel spoke on behalf of All-Ways Accounting; and Troy Schneider contributed from his experience working with farm and business succession as an attorney with Twohig Rietbrock Schneider Halbach S.C. The panel offered seven key tips for making transitions go as smoothly as possible.

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1. Start early

When it comes to having conversations among family members regarding the future of the farm, Guse said, “You can’t start early enough.” He and Immel identified five years as a realistic timeline from start to finish for putting a plan in place, but noted that every situation is different. A good starting point can be establishing a will, estate plan and business continuity plan.

2. Communicate expectations and understand differences

Generational differences often surface in discussions of farm transition, which is why initiating conversations surrounding needs and goals of all parties is important. It takes mutual respect between generations to talk about what each really wants and to reach an understanding of how assets are not the only thing being transitioned; decision-making and management will also be transferred.

“Here’s a tip for the older generation: Act like a mentor, not like a boss. Mentoring is empowering, not belittling,” Schneider said. “As for the younger generation, be prepared to take constructive criticism, and remember that experience is just as important as education.”

The timeline for transition completion can be a contentious topic. When one party drags their feet in making decisions, the other may get frustrated to the point of giving up. Guse has seen family transfers fall apart when the older generation fails to give enough reign to the child, and when the child has unrealistic expectations for how quickly they will assume ownership. “In one case, the son decided to leave and get a job somewhere else,” he said.

3. Get the ducks in a row

In preparation for discussing a farm transition, be sure to have key documents in order. “Come in with good bookkeeping, wills and power of attorney,” Immel suggested. Schneider added balance sheets and historical income statements to that list.

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An important conversation to have ahead of time is how much incoming family members expect to be paid. “What do parties anticipate taking for family living draws?” Schneider said. “That is sometimes one of the controversies between parties.”

Guse recommended the “70/20/10” rule as a baseline to follow when discussing adding family members to the operation. He explained, it takes 70 cents to generate a dollar of income (operating expenses); 20 cents of capital cost to generate a dollar of income (combination of debt payment and actual capital purchases); and 10 cents of family labor and management to generate a dollar of income (family living expense).

For example, an incoming family member wants to be paid $40,000.

Using this concept, $40,000 divided by 10 percent equals $400,000 of gross farm income that needs to increase in order for the operation to afford the additional owner (unless the other categories are more efficient).

4. Consider corporations and other entities for risk management

Immel has created entities such as corporations, S corporations and limited liability corporations (LLC). “To set up the correct entity, you need lots of planning,” she said. “The tax part may indicate which type of entity you might need.”

Regardless of the type, Guse advised to “keep entities separate and identifiable,” with separate checkbooks and accounting. It may take a little creativity, such as setting up different capital accounts for cattle and machinery and starting out the contributions in the checkbooks at a 30 percent/70 percent split between partners that may change over time to transition majority ownership.

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Separation also allows parties to distinguish risks associated with each aspect of the business. “There’s not a lot of liability in owning land, but there is a lot of liability risk in hauling manure,” Schneider explained. “Try to separate out different risks into high- and low-risk activities from a legal perspective.”

5. Think about tax implications

A good farm accountant is a key partner in tax planning during a farm transfer to prevent adverse effects down the road. “How you transition assets makes a difference because different taxation levels apply. There are things you can do with some assets that you can’t do with other assets,” Immel said. “For example, when transferring land, Mom and Dad pay the taxes as they get payments. But you can’t do that with tractors.”

6. Know the ratios

According to Guse, the most important ratio to know when going into a transition is the debt coverage ratio. “A good number is 125,” he said. This figure tells the parties what they can turn into cash in a year, and how much they can sell in a year to fund a period of losses.

Other key numbers to keep close at hand are equity, which “allows you to manage long-term stress,” and return on assets (ROA), which should be higher than the cost of interest on the farm. “If you are paying 5 percent interest, the ROA should be 6,” he said. “Otherwise, you are borrowing money and investing in the operation and not getting a return on it.”

7. Establish the operating agreement

It’s the “divorce decree up front,” Guse said. “The operating agreement is a necessity, and both sides need to understand it, front to back, so there’s no pain or emotions on the back end,” Guse said.

Schneider noted this agreement should cover three areas: How things work tax-wise (with transferring assets), how things work management-wise (who calls the shots), and what happens upon different transfer events (death, disability, disaster, divorce, disagreement).

Working with reputable and experienced consultants and keeping these seven tips in mind can open up necessary dialogue for a successful transition that meets the needs of the farming operation and the family members involved.  end mark

Peggy Coffeen
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