For your farm business to successfully transfer to the next generation, you will need enough cash flow to support two family units at least for a time.
Commodity harvest is in full swing across the Corn Belt. Prices are low, as usual this time of year, but also about half what they were three harvest seasons ago. Most operations will be challenged to show any true profit in this crop year.
Does that mean you scrap your plans to transition the business to the next generation? Maybe, but maybe not. Depending on the senior generation's priorities, it might just be time to get serious about running the numbers to see just how the transition needs to work. Even if this is NOT the time to start the active transition process, it could be a good time to work out some plans.
One of the core challenges of transitioning the operation from one generation to the next is that the farm business needs to be healthy enough to survive into the next generation. The mathematical fact is that in order to successfully transition, the farm business has to be able to support two family units for some period of time.
If things seem tight, it might be a great time to sharpen some processes like reducing expenses or increasing marketing returns. You can also begin to evaluate your strategies to see if there are opportunities in spite of commodity prices. Can you:
- Reduce monthly expenses for the senior generation?
- Increase the size of the operation with sweat equity added by the junior generation?
- Leverage other assets of the operation to smooth the transition?
For example, think of the farm business enterprise having several separate units like:
- The traditional farmstead, usually the current residence of the senior generation.
- Productive crop land, often owned free and clear in the name of the senior generation.
- Productive resources (grain storage complex, grain handling equipment, breeding livestock, buildings, vehicles or machinery).
- Liquid assets like insurance, IRAs, CDs and bank accounts owned by the senior generation.
Choices to consider:
- The traditional farmstead – The senior generation can live in the traditional residence as long as possible OR sell it to the junior generation, or an outsider, and use the proceeds to move to town if it lowers overall living expenses.
- Crop land – The senior generation can hold the land and live off rental income until death. Rental rate might be reduced to subsidize the junior generation during a transition period. Rates will likely increase over time to accommodate the senior generation's increasing health care expenses as needed. Land can be mortgaged to finance expansion for the junior generation, but often the senior generation doesn't love the exposure since they would still hold title to this land.
- Productive resources – These can be owned by a family business entity.
- Provides a chance for non-farming heirs to participate in the value of the enterprise by having some shares in the enterprise;
- Assets may be valuable enough to serve as collateral for a loan; and
- The structure of the entity can provide income to the senior generation AND manage the tax liability also.
- Liquid assets – These can be used by the senior generation to meet expenses during the transition phase and reduce the burden on the junior generation.
If you wonder if your operation is suited to some of these ideas, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with new people. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.