A recent webcast to agriculture producers generated a question concerning farm business transition. The question presented was, “With many intergenerational business transitions happening these days, do you have any tips for valuing assets to be fair to both the younger and older generations?” Valuing assets is a sensitive subject, particularly for family businesses with numerous generations and individuals involved in the business transition.
First, a third-party evaluation of the assets is highly recommended to maintain objectivity. If numerous parties are involved, each can select an appraiser or evaluator and the values can be compared. Often specialized assets or sentimental assets, such as registered cows or the old John Deere 4020, may have a different value perspective depending upon the generations. These third-party individuals can be more objective when placing a value on assets that have an extended life.
One of the issues for the younger generation is taking over a business that has a machinery line or facilities that are not up-to-date or are technically obsolete. This, in turn, can require significant investment and upgrades which can choke cash flows if considerable money is being borrowed.
In valuing a farm, one has to examine the financial performance of the business. A suggestion is to take a five-year trend of EBITDA, which is net farm income before interest expense, income taxes, and depreciation. (The “A” in this case is amortization or goodwill, which is generally not applicable to agriculture.) In an ongoing business, three to five times EBITDA is the value of the farm from an earnings standpoint. It is suggested that accrual adjusted earnings be utilized to account for payables, inventory, prepaid expenses, receivables, and accrued expense adjustments. For example, if the EBITDA averages $400,000, the business would have a worth ranging from $1.2 million to $2 million from an earnings standpoint. Debt levels of the business usually need to be considered. With a higher debt level, the EBITDA multiple would actually decline.
If non-farm family members are involved, remember that the generation remaining on the farm very seldom can afford to pay full price to be competitive with the non-farm family members. Non-farm family members usually receive cash from life insurance or bank accounts, which comes with no risk. The on-farm family member may receive the farm assets which come with considerable business risk ranging from environmental to overall competitiveness. A rule of thumb is to divide the assets “equitably,” which may mean that they are not necessarily divided “equally.”
In transition, a buy-sell agreement process needs to be established upfront and periodically revised. If not, the lucky winners will be Uncle Sam and high-priced lawyers and accountants.
Want to catch Kohl in action? Join us for the Farm Futures Summit, January 23 and 24, 2020. Learn more at FarmFuturesSummit.com.
The opinions of Dr. David Kohl are not necessarily those of Farm Progress.