Farm Succession Planning - What About the Other Children?
THE COUNSELOR
Volume 9 • Issue 11 • November 2019
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. In this month’s issue, we will discuss planning for non-participating children in family farm or ranch ownership transition. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
In 1978, Renato Tagiuri, a senior professor at the Harvard Business School, and John Davis, a doctoral student, were looking for a way to categorize the issues, interests, and concerns of family companies. At the time, the norm was to refer to two overlapping circles. One for the family and one for the business. They found this model lacking as it didn’t account for the fact that some family members were owners and some were not. From these discussions, Tagiuri and Davis added a third circle for ownership. This new diagram allowed for the development of their definition of family companies:
A family company is one whose ownership is controlled by a single family and where two or more family members significantly influence the direction and policies of the business, through their management positions, ownership rights, or family roles.
Now known as the “Three-Circle Model of the Family Business System” it shows three interdependent and overlapping groups: family, ownership, and business.
Each individual will fall into one of the seven sectors formed by the overlapping circles. Owners are in the top circle. Family members are in the left-hand circle. Employees are in the right-hand circle. If you fill more than one role, you will be in an overlapping sector, sitting within two circles at one time.
In the transition of any family farm or ranch, there is often the need to address those individuals who sit in the bottom right (non-employee family members with no ownership) or bottom center (employee family members with no ownership) sector of the three circles model. Rarely does a situation arise where all of the children desire to work in the farm or ranch operation. This is often referred to as the fair vs. equal problem.
When discussing succession planning in the context of a family farm or ranch, a good working definition is: a process of decision making that:
Protects the ongoing viability of the agricultural operation
Provides for the orderly transition of the agricultural operation to new ownership
Preserves family harmony
An attempt to make things “equal” by bringing the non-participating family members into ownership of the family farm or ranch can be a recipe for disaster.
The Basic Problem
A farm or ranch family usually involves a child (or children) working in the farm or ranch operation who want to continue as the operator after the retirement or death of the parents, and children living away from the farm or ranch who are not interested in working in the farm or ranch operation. The non-participating children may desire to have an ongoing ownership interest generated from nostalgia, but more often prefer “their share” of the inheritance in the form of money or land. The participating child is primarily concerned with securing ownership of the land and production assets necessary in running the farm or ranch operation and participating in the growth that takes place. Participating children will want to see capital re-invested in the operation, while non-participating owners will want to see a realization of the value of the asset owned through distributions of cash. Keeping both participating and non-participating children in ownership sets the family up for conflict.
Fair vs. Equal
Often the departing generation will express a desire to be “fair” with their children. In the parent’s mind this equates to an “equal” distribution to each child. For example, Blake and Gwen have the following assets:
Farm Operation: $3,000,000.00
Home: $175,000.00
Other Investments: $500,000.00
Blake and Gwen have four children: Adam, Kelly, John, and Carson. Kelly loves the rural lifestyle. She and her husband, Brandon, have stayed and worked on the family farm for twenty years. Adam, John, and Carson all have jobs and spouses that have taken them away from the farm. While they love and miss the farm, none of them has a real intention of coming back to live or work. If Blake and Gwen give the farm to Kelly she will inherit $3,000,000 while Adam, John, and Carson will each receive $225,000.00. This may be difficult for those three non-participating children to accept when each person would receive an inheritance valued at $918,750.00 if the assets are divided equally.
While this may appear more “equal” at first glance, is it really? First, while Kelly is being given a substantial asset, she has likely invested in the farm operation during the preceding 20 years. Is it fair to gift her share of the equity to her siblings? Second, what Kelly is really being given is an opportunity to work and generate an income for her and Brandon. This is not the same thing as being given a parcel of land that will just be sold or developed. If we split the assets equally, but Kelly is given control of the farming operation, the value of this asset is really illusory to the others. Adam, John, and Carson can never realize its value. It just looks good on paper. In fact, now that the non-farm assets are being split four ways instead of three they actually receive less in assets that could be re-invested. Finally, equal doesn’t take into account the sweat equity Kelly and Brandon have put into the farm. Nor does it consider her lost opportunities or lower wages received. In dealing with this issue, the goal should really be fair – not equal.
What Are Your Options?
Because the cash flow of the farm or ranch is often insufficient to fund a fully proportionate inheritance to the non-participating children, you will be forced to make difficult decisions if you want the operation to pass successfully to the next generation. However, remember, cash to the non-participating child in an amount much less than the proportionate value of the farm or ranch may in fact produce more income than the participating child will receive from the operation.
In the first instance, the inheritance to the non-participating children should come from assets that are not central to the farm or ranch operation and/or from the purchase of the farm operation by the participating child at a predetermined price. A common way of providing an inheritance for the non-participating children is through the purchase of life insurance on the parent’s life. In the case of a sale to the participating child, the premiums paid on the life insurance may involve a smaller outlay of cash by the successor child than installment payments on a promissory note. The policy should be of a permanent nature as opposed to a term policy to ensure it will be there when needed. Consideration should be given to a joint life policy on both parents as premiums can be substantially less than on a single life policy. A joint policy can also be more forgiving when it comes to health issues. A major concern with life insurance is the considerations of age and health in determining the premium. Therefore, there is no time like the present to look into the availability and cost of life insurance.
Conclusion
As with most complex problems there is rarely a simple solution. However, changing your mindset from one of equal to equitable will open doors that have previously been closed. It will also create a framework for success in your farm or ranch succession planning.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.