Transferring the farm business from one generation to the next can take several years. This is due, in part, to the large amount of capital involved, explain Gary Hachfeld, former extension educator; David Bau, extension educator, and C. Robert Holcomb, extension educator, University of Minnesota Extension.
This time of transfer can also be used to share knowledge, shift management responsibilities of the business and educate the entering generation.
During this beginning period, parents can step back a bit from the farm business. The generation taking over can determine if farming is really what they want to do as a career.
Here are some options you have when transferring a farm operation.
Sole Proprietorships
There are three ways to move forward: Farming together as a trial period, farming together but apart and multi-owner/joint ventures. Let’s look at the pros and cons of each one.
Farming together as a trial period: This may be the best way to begin testing compatibility and commitment. With this approach, parents hire the aspiring entering generation on a simple wage or incentive plan for a year or two. During this period, serious consideration should be given to the entering generation’s ability to contribute to the business and its management, personal compatibility and the skill level of participants. It is also a great opportunity for the retiring generation to see if they are truly ready and willing to give up control and management of the business. This period should give both parties the ability to review the farm situation and withdraw, if necessary, before becoming involved in a complicated joint operating agreement.
Farming together but apart. Farming together but still maintaining a separate entity may be another approach. This may provide a good training ground for a young farm operator. An entering son/daughter might rent some additional land. He/she might use the parent’s machinery in exchange for contributing labor to the parent’s farm business. The son/daughter may or may not pay for their fuel and repairs depending on the agreement. Perhaps they can also rent existing livestock facilities from a neighbor. In any case, they should take over the total management of their enterprises. Management includes establishing a business account and records system, developing a credit relationship with a lender, ordering and making decisions on inputs and procedures, and taking total charge of marketing decisions. As time progresses, the son/daughter can eventually take over more of the crop land or livestock enterprises. As machinery needs replacement, the son/daughter should begin to purchase the new items as they can. Eventually, the parents won’t purchase any new machinery as they approach retirement. This method provides a way for a son/daughter to buy the machinery gradually and for the parents to phase out of the farm business. This method avoids the problems associated with the joint decision-making required in most complex business arrangements. It also gives the younger generation pride in ownership and the incentive for gain.
Multi-owner/joint ventures. Multi-owner operations can get very complicated. Many farmers begin the transfer process by bringing in a son or daughter. They purchase assets together and own some individually. Later, another son or daughter may come into the business. Invariably, they end up with a record keeping nightmare with many different ownership levels: some assets owned 50-50-0; some 33-33-33; others are 0-50-50 or 100-0-0 or some other percentage mix. In most cases, where there is multiple ownership with more than two individuals involved, some other business structure may be a best.
Partnerships and Corporations
The huge challenge for sole proprietorship is dealing with many individuals and specific assets during the transfer process. One solution to this is to form a business entity for the purposes of business transfer. In forming a partnership or corporation, you issue ownership units or shares which can be easily sold, gifted or passed through your estate as a means of transferring the assets. This eliminates the need for transferring specific assets such as machinery or land. You effectively transfer those assets over time through the transfer of the ownership units or shares rather than specific assets.
Forming another business entity should not be done without thorough investigation of the ramifications. These entities are complex and require legal and tax advice. For more specific information, see utilizing partnerships and corporations to transfer farm assets.
When establishing another ownership entity, the entity must establish its own checking account. The account serves as the main vehicle for operations. Organizers contribute assets or cash to the new entity in exchange for ownership units or stock shares. The business entity then begins operation with the assets. It deposits income and pays expenses out of the entity checking account. Expenses may include wages to workers or a wage draw to partners. It may also include rent payments to all parties for rent of machinery, livestock, buildings or land. At year’s end, excess profits are used to reduce debt or to pay dividends to shareholders. Ownership units or stock shares provide a convenient way to transfer ownership through sale, gifting or passing them through an estate. Younger shareholders can buy shares or sell shares to one another. This is very useful if an individual wants to enter or leave the business entity.
Many times, it is desirable for owners to keep many of their assets out of the business entity. It makes it much easier to do tax planning and liquidation of the entity and may be less of a tax problem. Often land is kept out, as is machinery and breeding livestock. The new entity sometimes contains only “operating” assets. Again, seek legal and tax advice on which approach is best for you.
Farming together in one of these business entities can be a very rewarding experience if all parties remain focused and committed. However, if inequities exist or are perceived to exist, it can be difficult. It also requires patience, good communication, tolerance, division of responsibility, delegation of authority, sacrifice and trust.
Iowa State University Extension also discusses farm transfer strategies in this resource.