March 8, 2016
Splitting a farming operation into two entities is a simple, yet powerful strategy in succession planning. It allows a family to better manage the operation, simplifies the succession planning process, and creates options for the future.
Splitting a farming operation into two separate entities may seem obvious to a few, but it’s easy to get lost in the details and forget why it’s so important. Assume a typical family farming operation — parents working with one child who may co-own some land and coincidentally manages his own small farming operation. At some point in the future one or more of the inactive children may desire an opportunity to join the operation and/or the parents may want to leave an equitable distribution of land to each child as a part of their estate plan.
Recently I visited with a family regarding this exact situation. The parents own a family farming operation that includes grain crops and cattle. One son works in the operation, co-owns some land with dad, and has a small farming operation of his own. At some point in the near future, a second son may join the family farm as an employee and possibly work with both operations as needed.
As of today, dad and oldest son work well together, the operation is profitable, and things run smoothly. However, there are concerns that bringing the second son into the operation may affect the congenial and collaborative environment that exists today.
And, as oldest son’s separate operation continues to grow, they must manage both operations to avoid splintering oldest son’s loyalties and/or kindling some form of undue — read: destructive — competition between the two farming operations.
Additionally, the parents may want to maintain options for the other children not currently working in the operation, and they may anticipate a provision for equitable distributions to all the children in their estate plan. Though logistically not complex, the situation is still subject to the normal and expected run of emotions inherent in any family organization.
Planning appropriately, the operation can be better managed with options built in for the future.
As with any planning effort, clearly defining objectives is the first step to achievement. My recommendations are based on:
• Establishing a business structure that will allow the family to focus on common goals. Eliminate the splintered, or separate, loyalties that may be brewing due to the current situation.
• Enhancing financial security for all active family members, promoting an ownership focus, and providing opportunities for continued growth.
• Preparing the next generation to lead. Facilitating constructive conversations, establishing a more efficient management structure, and focusing on each person’s leadership aptitudes.
First, I recommend splitting the operation into two separate business entities. Using limited liability companies (LLC) or some form of corporate structure (Corp.), the land holdings can be placed in one and the operating entity, including equipment, inventory, land leases, etc., in the other. Separating the land from the operation allows for owning and managing each LLC/Corp. independent of the other.
Starting with the land holding entity, the parents can devise an operating agreement to hold and manage the asset based on farming use. The ownership can be divided and decision-making based on the percentage of land each contributes to the entity. For example: Assume parents contribute 5,500 acres and dad and son contribute 1,500 acres they co-own (60/40 or 900 and 600 respectively). So, the ownership breaks down as: parent’s 5,500 + 900 = 6,400/7,000 total acres or 91 percent and oldest son’s 600/7,000 = 9 percent of total. So, ownership of the land LLC is 91 percent parents and 9 percent son.
The land holding company will lease the land to the farming operation entity, collect a fair rent, and distribute revenues according to each owner’s interest in the entity. The land holding company should be supported by a buy-sell agreement among the owners.
This entity is designed to manage the parents’ properties and any land co-owned by parents and son. It is not designed to preclude the son from buying, selling, or leasing land outside this holding entity.
The farming entity will be managed as per a similarly devised operating agreement. Today, the sole owners of the farming entity are the parents. After establishing an entity, they may invite their son to participate as owner, honoring his contribution to the whole (equal to the level of his sole farming operation), gifting shares based on some level of sweat equity, selling him shares based on a current fair market value, and/or a combination of the options.
Once ownership is granted, the parents should establish a buy-sell agreement to maintain the integrity of the operation and make sure ownership does not pass to a non-active owner.
Separately and independently managing the two facets of an operation allows owners to achieve their goals, establish the foundation for future development, and maintain the option for involving others in either/both entities.
Kevin Spafford and his firm Legacy by Design (Legacy-by-Design.com) serve the succession planning needs of farmers, ranchers, and agribusiness owners. Reach Kevin by email ([email protected]) or phone (877) 523-7411.
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