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Passing on the family farm: Where not to start

Jon Holthaus Published on 11 March 2015

It seems to be all the hype today. There are as many seminars as there are questions, each bringing a perspective on ways to transition the family business from one generation to the next. Many individuals don’t know who to turn to or even where to begin. There are just too many things to consider.

Putting the cart before the horse

I often find individuals seeking or implementing solutions (revocable trust, irrevocable trust, life estate, will, etc.) before they fully grasp their dilemma. Even though these solutions are intriguing and get your mind going, they really don’t get you started toward your goal. It would be like walking into a doctor’s office and wanting penicillin before you knew what was wrong with you (because that’s what your neighbor did).

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The doctor would first want to go through a process of checking you over before making a recommendation. Maybe we need to take a step back and get our vitals checked before we prescribe our own medication. Those “vitals” are important when considering how different farming is to other industries.

Farming, at times, can be an equity-rich and cash-poor industry. The value of your land and operation may continue to climb through the years, but it may not be fully realized in the cash flow.

And yet, we are faced with this daunting task of trying to figure out how Mom and Dad can generate retirement income, the new operator can make a living, and somehow try to provide some fairness to the non-farm heirs. It’s all a strain on the cash flow of the farm, but many families overlook this aspect and jump straight to the legal planning.

In a different light, let’s pretend that instead of farming, you worked in a factory your entire life and built up a nice 401(k) plan at work. You decide one day to retire – but instead of using your 401(k) to live in your retirement years, you want to pass the full value onto your heirs. Sounds crazy, right? But that’s exactly what farmers are faced with: a financial dilemma.

Start first on the financial planning and feasibility. Mom and Dad should first try to determine what amount of income they want and need in retirement, and what incomes/assets are available to meet their retirement goals.

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This should account for lifestyle expenses and protections needed for each spouse (such as the potential for long-term care, outliving income, premature death, etc.). Don’t forget, inflation will cause all of these expenses to increase over time, so this can have some complexities. With something so important, it would be wise to seek out a financial professional.

Once the foundation is established with Mom and Dad, we can start to address some of the needs of the operator, such as income needs, incentives and measuring “sweat equity.” Unfortunately, there is no set formula for any of these topics because each family dynamic has different goals and circumstances. However, we can start with core concepts and mold the plan to best fit the situation.

Operator dilemma

Farming is always full of surprises, both mentally and physically. You may think there are too many “unknowns” in the daily operations and prices to put a comprehensive plan in place. Start first at the financial basics.

As the operator, ask yourself what income you need to support your family. As your own employer, be sure to provide yourself some working “benefits,” such as protection in the case of a premature death or disability.

Just like with Mom and Dad, some of the costs of living increase over time. Seek out the guidance of a financial professional to help map this out. Once this is accomplished, you can share some of the worries and risks with Mom and Dad.

Sweat equity

The topic of sweat equity is a sure way to spark conversation in any farming operation. Too often, families put off planning because “We just aren’t old enough to start a succession plan yet.” This can be a crucial mistake. The sooner we start, the better. Otherwise, we could find ourselves years down the road at the kitchen table with the operator and non-farm heirs, each pleading their case to an elderly Mom and Dad on how they believe the farm should be split.

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Trying to remember things that occurred over a 40-year time period never ends well. Start the process of measuring your sweat equity from day one and help minimize the potential for tension or hard feelings. There are ways for it to be accomplished, and you probably have heard of some instances.

For example, when a Fortune 500 company brings on a new CEO, how do they get compensated? It’s not always a major salary but instead may come in the form of stock options. Let’s assume a CEO comes aboard a new company. His salary may be $100,000 cash and 1,000,000 shares of the company.

The shares of the company are currently valued at $5 per share. However, the CEO’s contract states he cannot sell his shares for 10 years. What do you think is his incentive? Now that his net worth is directly affected by the value of the company, he will probably want to grow the share price, right?

Compensation with equity is just one concept of many, but it may play a role in some farm succession plans. It doesn’t always have to be a lump sum transition of shares (or equity) but might be more applicable to do a little bit every year. This can help address problems of cash flow out of the operation, a way of actively documenting sweat equity earned through the years and an incentive for the operator to grow the value of the farm.

These tips are not meant to be all-inclusive, but instead a way to get everyone thinking from the beginning. Coming from a family farm, I know some of the conversations and feelings that can arise when starting this journey. Don’t put it off. Seek the advice of a financial professional who has personal experience in this area. Tensions can be lowered tremendously if all parties feel their feelings are heard and understood. PD

Jon Holthaus is a financial planner and owner of Holthaus Financial Group LLC. He can be contacted by email.

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