If your family has been in the farming business for many years, you know the “simple life” on the farm can produce many complexities in the families’ finances that don’t present themselves to the rest of the population. The phrase “land rich and cash poor” is widely used in reference to family farms where land values may have appreciated significantly over the years but liquidity within the family balance sheet is disproportionately low when compared to virtually any other kind of business.
Because farmers that manage their businesses for a generation or more have learned to manage cash flow in a manner that enables them to keep their business and personal interests ongoing in a functional way, the disparity between total assets available and cash on hand doesn’t produce a crisis for most farm families until a major “liquidity event” arises, i.e. the death or disability of the family patriarch or farm manager, the sale of all or part of farm property, or a conversion of the business interest in the property to a use that generates immediate cash.
Another major event, but that does not necessarily generate liquidity for the family, is the split of the interest in the farming business – usually between siblings. It is not unusual in the farming business for the male children to continue to operate the family farm professionally, while the female children pursue raising a family or off-farm careers. But it is also very common for one sibling to take charge of the farming operations after Dad is no longer involved, and to buy or actually squeeze out the other brothers or siblings without first determining the actual market value that reflects the true economic benefit conferred upon the continuing owner-operator in the business.
Quite often an LLC or corporation was set up at some point in time with family members granted units or shares in the business, but with the operating sibling holding a controlling interest, either through actual equity in the entity, through voting rights, or just in a controlling position by proxy from other stakeholders in the operating business entity. At some point, interests get divided further – and in a farming business, that point is usually when one owner dies or becomes incapacitated. When that occurs, his or her descendants then want to pursue their equity shares in the business, but that may be challenging. If another sibling holds a controlling interest in the business responsible for the farm operations and/or the real estate that is farmed, he may make any vote or opportunity to liquidate a share of the family’s interest difficult or virtually impossible to accomplish.
If you hold the controlling interest, this is very much to your advantage. But to all of the other siblings and beneficiaries of the family business, it may be very disenfranchising. The best way to deal with something like this is to address it on the front end, i.e. when the business entity is first established. At that point in time, buy-sell and other liquidation event provisions can be drafted in a way that will be fair to all parties when the time comes. The key in drafting such provisions is to make sure that on the one hand, no heir is left in a position where he or she won’t be able to access what is rightfully his or hers, and on the other hand, that no impediments are created to the continuing operation of the farming business.
Given the nature of farming, however, it is very unlikely that the continuing operations will be jeopardized by protecting the rights of sibling-heirs and other beneficiaries. But the rights of the non-operating heirs can slip away over time if safeguards are not built in to the original framework of the succession plans and operating agreements of the farming business and its governing organizational documents.
Even if the protections are not put into place at the outset, there are always ways to protect the same interests of heirs further down the road. For example, if no operating entity is created, there is no Will or Trust in place and no other governing, operating document, legally, all heirs will maintain their stake in the ultimate distribution of an estate. This may or may not be equitable, however, in the case of an heir who operates and profits from the business of the farm, if entirely equal distributions to siblings is the result upon the death of the founding farm operator, will generally protect those other siblings as their parents would have intended, even without a Will or a Trust.
That statement, however, begs the essential question – what actually is the intent of the senior generation with respect to their own children, i.e. their intended heirs. There are a few common approaches to the issue:
- Complete Equality in Distributions – all income and asset distributions are shared equally by all heirs
- Equal Distributions Adjusted for Income to Child-Farmer
- Child-Farmer Keeps Beneficial Income from Farming (Profits Reaped Approach)
- Reallocate Asset distribution as an Offset to Farm Income (Talents Distribution Approach)
- Greater Distribution for Child-Farmer(s) (Sweat Equity Approach)
- Unique Allocations Approach – parents allocate income and assets to children based on their unique lie positions and their relationship with the parents.
Regardless which approach is employed, a sound valuation of the farm assets (both real property and operational assets) is vital to an efficient and effective transition when the time comes for the property to be distributed among the next generation.
Painful litigation or tedious issues often arise at the time of this transition if comprehensive planning has not been accomplished beforehand.
If you need assistance with planning or addressing issues related to a family farm and its succession to the next family generation, please contact the Thompson Law Office at (317) 564-4976