Through good times and bad in agriculture, farmers generally cherish the idea of passing their family farm on to the next generation. The farm community’s practice is to celebrate and even commemorate the moment the family farm reaches the century mark. However, according to the PWC 2016 US Family Business Survey, only slightly over half of family businesses planning to transition their business from 2016 to 2021 intended to keep it in the family. It is a staggering statistic that underscores how important transitioning the farm from one generation to the next is compared to non-farm family businesses. With this in mind, we thought it would be worthwhile to take a moment to discuss business succession planning and highlight the essential elements of a successful farm business succession event.
As retirement comes into view for business owners, they should begin to consider their exit strategy. Generally, the senior generation has the following exit options.
- Transition the farm to a family member(s) to own and operate
- Transition the farm to a family member(s) to own and an outside professional to operate
- Transition the farm to a non-family member to own and operate
- Liquidate farm assets
Due to the moderate size and scale of most family farms, it is uncommon to attract outside professionals to operate the family farm business. Nearly all family farm owners see their succession opportunities as options 1 or 3 above. Absent an individual interested in continuing the farm operation, liquidation of the assets (not the operations) captures the least value and is likely the last resort.
Business succession is a process. The farm’s senior generation has spent a lifetime building the business’s assets and operations. Instead of relying on traditional tax deferred retirement plans, the senior generation farmer has typically invested the profits of the farm back into the farm business. In most cases, they are counting on the revenue from the farm or the farm assets to be their retirement vehicle.
As a result, the retiring generation commonly approaches their succession event by transitioning the following business elements in the following order:
- Management – responsibility for managing day-to-day business operations and making operational decisions
- Leadership – responsibility for setting business’ strategic direction and making strategic decisions
- Ownership – ownership and control of business assets
The chronology of this list is important. The next generation can prove its resolve to successfully operate the family business with the reward being the transition of assets. As the senior generation becomes more comfortable that their assets and business are safe and in good hands and that their retirement vehicle (the farm) is at limited risk under new management and leadership, they are willing to transition farm ownership. There are basic and creative ways to transition asset ownership to accomplish a tax efficient transition. It is important to assemble a transition team to identify the strategy that will work best for you.
An effective farm business succession event should include 6 essential elements.
Eligible Business
Profit and Assets – The farm business should be profitable and employ business assets that are relevant to today’s industry. Without either of these attributes in play, the next generation should question why they are interested in investing in the family farm business.
Cash Flow – The regular cash flow created from the business’ operating activities should at a minimum be adequate to operate the business, invest in new assets, service the debt obligations and owner draws. Unless the senior generation is willing to gift ownership, the business needs to be scaled ahead of time to satisfy the owner draw requirements of both generations.
Common Vision – A common business purpose and goals should be shared by the incoming and outgoing generations minimally during the timeline of the succession event. A successful business has value when the stakeholders in the business are aligned and the business of business is clear. When not aligned, stakeholders (especially the lender) tend to become uneasy.
Communication – Communication within a business can be the glue that holds it together. Clear, regular, and transparent communication lends itself to effective business operations. It is also important that communication exists between all stakeholders. For example, a lack of communication with lenders or non-farm children may impact the farm’s future access to capital for growth.
Decision Support – With the availability of information and the power of technology, the next generation is often very data driven and comfortable making decisions based on information. Conversely, the retiring generation is comfortable making complex decisions based on gut instinct supported by years of experience. Improving financial and managerial systems to provide valuable information could be a critical factor to the next generation making the right decisions in your absence.
Willing Predecessor
Timing – The regular cash flow created from the business’ operating activities should at a minimum be adequate to operate the business, invest in new assets, service the debt obligations and owner draws. Unless the senior generation is willing to gift ownership, the business needs to be scaled ahead of time to satisfy the owner draw requirements of both generations.
First Steps – As mentioned earlier, the senior generation’s willingness to transition will happen in stages. They will start with handing over the reins to day-to-day management. When management has been successfully transitioned, assuming the leadership role and an opportunity to own the assets will follow as the retiree’s confidence builds.
Qualified Successor
Family Acceptance – Successful successors often have the trust and respect of the family prior to the succession event. They may also have close and durable relationships with their parents and siblings. These attributes prove to be important as the senior generation gains confidence that their successor can take control of the business and manage the family dynamics that almost always exist.
Traits – The personal traits of the successful successor include descriptive words like motivated, creative, decisive, strategic, operational, independent, confident, and aggressive. As the successor progresses from management to leadership, it takes a unique combination of these attributes to be seen as the leader empowered to drive the team toward the business’ vision.
Competencies – Qualified successors usually leave the farm to gain knowledge through formal education and outside work experience. While away, they develop valuable skills, experiences and a record of success that should be transferable to the farm.
Determined Facilitator
Accountable – Without a facilitator, business succession planning frequently becomes a one-time event instead of a dynamic process. The facilitator role is focused on outcomes and results that builds consensus among stakeholders. They also advocate for the business on an impartial and objective basis as well as holds stakeholders accountable throughout the process.
Advocate – Successful facilitators are skilled communicators, active listeners, and diligent schedule keepers. They are direct and tactful while remaining unbiased and objective. They listen for the words being suppressed and confirm a common understanding to create clarity for the family. They will bring an inclusive approach that allows even the quiet voices to be heard in the process.
Experienced Technical Team
Techniques – Once ownership transition becomes possible in a succession event, the techniques to execute significant financial transactions requires the sophistication and experience of a technical team.
Team – The team should include an attorney, accountant, lender, and other trusted advisors who understand the business. This team should provide advice on proper legal structure and tax strategies to efficiently preserve and transition the financial resources.
Realistic Timeline
Beginning – First and foremost, the clock starts on the timeline when the predecessor is ready to begin planning the exit. If the senior generation waits too long to start the clock, they risk the next generation losing interest and pursuing other opportunities.
Pace – The succession timeline is also limited by the successor’s capacity to take over the farm’s management, leadership, and ownership. Cautious predecessors will only proceed when their next generation is ready. The timeline is not a one size fits all!
Ending – Depending on the size and complexity of the organizational and financial structure of the farm business, succession could take as much as 10 years to complete. Be diligent and patient as you follow the process.
Like many life events, most will only participate in a succession event twice, once on the way in and once on the way out. Unfortunately, both perspective and time will cloud the clarity realized from previous experiences. It is important to honor the difficulty of business succession with proper planning and careful consideration.
By: Jim Marzolf Vice President, Pipestone Business Services