Business Succession and Estate Planning for the Long Haul
By working through the business succession and estate planning processes, you have taken steps to preserve the long-term health of your business and to plan for the future of the farm and your family members. Your careful planning preserves the farm and its value into the future. It is important work and is a great gift to your family, to Oregon agriculture, and to society.
After getting into the details of each part of the planning process, it is critical to again step back and see how the plan will work for both the family and the farm business. You will also need to be sure that each part is working together. Regular communication and maintenance of the plans over time with your family and your team of legal and financial experts are essential.
You can also evaluate your plan to see how it will help you withstand some common disruptive life events, such as an unexpected death, divorce, or bankruptcy. Your plan can be designed to help you weather these storms, keeping the farm and family intact. In this chapter, we will share some of the lessons learned from years of working with farm families and observing how their business succession and estate plans have worked—or have fallen apart—so that you can benefit from that experience while you are making your own plans. The goal is to create a structure that shelters your family and farm business from some of life’s common storms.
A. Make the Current and Long-Term Farming Decisions, the Succession Plan, and the Estate Distribution Plan Work Together
The succession and estate planning process can feel complex and daunting because you are planning for your farm and family in the present and for the future. The goal, of course, is to make all pieces of the family farm work together. The problem with making the pieces work together is that farm families typically find themselves working with their family concerns and the business concerns separately. The following set of questions can help you think about how the different parts work together:
As you can see from the list, the pieces at the top are purely family oriented, while the pieces at the bottom are pure business concerns. The pieces in the middle tend to be a little of each (figure 17).
A good exercise is to stop and ask yourself these seven questions and then analyze the answers. Then ask your family members to do the same and share your results. You can start at the top and work your way down or you can start at the bottom and work your way up. You should be asking yourself, Is everything working together to achieve roughly the same ends? Are there gaps? Are there loose spots? That will help you identify areas that need some work.
Keep in mind that no family farm can claim perfection here. And this is an iterative process. You will keep coming back to your plans and refining them. You may put some estate distribution plans in place and then later buy some additional life insurance that will go to one of your kids, which means that you have to change your plan to account for the new benefit to one child. Finally, the basic rule is that life happens while you are busy making plans. As with anything related to farming, success or failure should be based not on the achievement of specific goals but on the achievement of positive trends. Is the farm business growing as intended? Did estate tax laws change? Are the kids or any other farming successors satisfied with the plan—have you actually sat down and asked each one individually? Are you satisfied with the plan? Or is there something that still is not right, which will get in the way of Thanksgiving dinners now and in the future?
The different pieces of the business succession plan, including any LLC operating agreements, must address several realities for the farm to pass to the next generation and survive the ups and downs of life. We outline some here and how to guard against them in the succession and estate planning process.
No parent expects a child to die before them. No child expects a sibling to die before them. But these things do happen. When a person dies, their assets become part of their estate. They may have a will or trust in place to govern how their assets are distributed upon death. If one of those assets is membership in a family LLC, that membership becomes a part of that person’s estate and will be transferred to whomever the will or trust may designate.
Any entity used for succession planning needs to take that reality into consideration and include a way to deal with a membership interest ending up in the hands of a spouse or child of a member in a .
If the entity is an LLC, the operating agreement and buy-sell agreements for the LLC should contain provisions to manage a situation like this. This will be a provision indicating that the entity and/or its owners have the right to purchase any ownership interest that might become a part of the deceased member’s estate. It should clearly set out how to determine the purchase price and provide for payment over time with interest at the prevailing rate and with a payout period that is long enough to reduce the payment amounts so as not to interfere with the farm’s cash flow requirements. It should indicate that during the payout period, the heirs of the estate are not owners and do not have a right to vote on business issues.
The unexpected sometimes happens. A member might become involved in a divorce proceeding. A membership interest in a farm family LLC might be assigned to a former spouse as part of the divorce proceeding. An LLC operating agreement or buy-sell agreement should provide that in the case of an owner’s divorce, the entity and/or its owners have the right to purchase that owner’s interest on the same terms as are provided for the purchase of a deceased owner’s interest from his or her estate. If the business structure is established before a child marries, encourage them to get prenuptial agreements in place before they do.
A member might become involved in a bankruptcy proceeding. A membership interest in a farm family LLC might be assigned to a creditor as part of the bankruptcy proceeding. An LLC operating agreement or buy-sell agreement should provide that in the case of an owner’s bankruptcy, the entity and/or its owners have the right to purchase that owner’s interest on the same terms as are provided for the purchase of a deceased owner’s interest from his or her estate.
Most Gen 2s wish the next generation of family would all work well together and enjoy the benefits of the farm operation that was put together over time at sometimes great sacrifice. The reality is that the ability to work well together in a common endeavor is rare. Many times, Gen 3 family members get along well when Gen 2 is present, but once that cohesiveness is gone, the Gen 3 group begins to separate into its own family groups, which need some distance to operate well. For that reason, the best farm succession plans contain elements that allow the ownership to coalesce around certain family groups within the third generation, with preference going to the Gen 3 who has chosen to stay and farm.
The LLCs in their operating agreements and buy-sell agreements need to have provisions that allow owners to sell their ownership interests in a manner that recognizes the true value of the interests and allow for payment to the withdrawing owner over time with appropriate interest rates. Like the buyout provisions in the event of death, divorce, and bankruptcy, the buyout provisions in the event of withdrawal should allow the operation to fund the buyout without jeopardizing cash flow to maintain the viability of the farm. Again, the most important thing here is to allow the farm to be passed onto the next generation intact. That’s why we build the farm business organization to fall apart in a way that does the least damage to the family members if they decide to part ways.
Seldom considered but important in maintaining the fabric of the relationship in a closely held family operation is the ability of a family member who lost or sold an ownership interest to have an opportunity to buy back in and acquire an ownership status once again.
The operating agreement or the buy-sell agreement of a closely held family LLC should have provisions allowing that family member to buy the lost membership interest from the entity or other owners in a businesslike manner by essentially reimbursing the entity or other owners who funded the buyout of the interests of any heirs, divorced spouses, or bankruptcy creditors in the first place with interest. It must be clear that such a right is personal to that individual only and cannot be exercised by the individual’s heirs or assigns who are named in his or her will or contractual relationship.
The first line of defense in a risk-management program is adequate insurance. Liability insurance is relatively inexpensive and should be maintained at levels sufficient to address the increasing levels of judgments being granted for damage that can be caused by the farming operation, including natural resource damage.
Pay careful attention in all of this with respect to who bears the risk of loss. It depends on the circumstances, but in the scenario outlined earlier, Hobson Farms LLC would shoulder most of the risk of loss. Therefore, Hobson Farms LLC would pay for the insurance and would name the other entities as additional loss payees and indemnify the other entities against any risk of loss.
The second line of defense is entity management. The textbook way to promote risk management through entity management is to separate the farming operation from the land and other major assets. That is done by forming at least two separate entities as we have described, with an operating LLC separate from the landholding or other asset-holding LLCs.
The most successful succession plans for agricultural businesses provide Gen 3 with reasonable expectations, a sense of ownership, some certainty, and some sense of security. They also provide protection for Gen 2’s retirement while protecting the core business by paying careful attention to cash flow needs while guarding against disruption.
For example, to take care of both Gen 2 and Gen 3, we often put management agreements in place. Hobson Farms LLC can hire the incoming Gen 3 farmer to be the manager as Gen 2 begins to step back and take a less active role in the day-to-day affairs of the farm. We might also want to hire the outgoing Gen 2 to be a manager as a way of providing an income for retirement that operates as a business expense for the operation. It is wise to have clear management roles and expectations for each manager to maintain a healthy working relationship as Gen 2 steps back into retirement. Gen 2 must be aware of the tax and retirement income implications of their continued active management in the business.
An increasing problem with succession plans these days is the lack of a family member who wants to come into the business as Gen 3. The first step in addressing that issue is to find a nonfamily Gen 3 who you trust, who is committed to the long-term success of the farm, and who respects your desires to include your family in the business succession process. When developing a plan that includes a nonfamily Gen 3, it is important to establish at the outset that a potential nonfamily Gen 3 is not an heir. They could be an employee to start with, then perhaps a manager, and potentially a co-owner, but not an heir. With a nonfamily Gen 3, it is about building a pure workable business relationship. It is not about inheritance. As discussed in the last-person-standing LLC structure, it is important to establish a separate operation involving the nonfamily Gen 3 with new pieces that can be separated out in the event that things don’t work out. The Gen 3 business can be separated from the other family LLCs without disrupting the underlying farming operation and certainly without disrupting inheritance for the family members who are inheriting Mom and Dad’s estate.
With any Gen 3 arrangement, whether Gen 3 is a family member or not, it is critical to be transparent, to manage expectations, and to be clear about ownership interests in the farm businesses so that everyone feels secure and that their expectations are being met in the succession and estate plans.
Getting organized to pass the farm on to the next generation takes careful planning and execution. It is important to remember that the most important thing in all of this is not taxes or equality or ownership; the most important thing is Thanksgiving. These efforts involve families, and you want family members to be able to get together for Thanksgiving when it is all said and done. Equally important is preserving the farm so that the family legacy lives on regardless of who owns and operates it day to day.
To preserve the family, first pay excruciating attention to detail. A common misconception is that because it is family, we don’t need to worry so much about all the details. The thought is that things will just work themselves out. Don’t be fooled into thinking that. Second, be as businesslike as you can. With families, you want to dot the i’s and cross the t’s more carefully than you would with a stranger. Third, don’t think that the members of the family will be able to get along and work together forever through successive generations if you just set it up correctly. No matter what you do to set your business succession plan up, it is generally a very bad idea for cousins to be in business with one another. The LLC organization documents we use provide for the siblings to each buy the other out if there is a death, divorce, or bankruptcy so that over the years, there will be only one family owning the LLCs inherited from Mom and Dad. Then the business succession and estate planning processes begin again on a solid foundation.
The distribution of farm ownership and control can be fair without being equal as long as everyone understands and accepts their role, which is much easier to accomplish if it is done through planning together rather than by decree after Mom and Dad are gone. Proper business succession planning is not a handout; it is a leg up. The associated estate planning should be the same. Everyone in the family has different life goals and trajectories, so they should each get a part of Mom and Dad’s estate that is unique to their goals and needs.
To be successful at maintaining the family and the farm, everyone needs their own things and their own space. The farm needs to be set up with last-person-standing LLCs and elements that are built to fall apart into definable pieces that can be separated out without hurting anything or anyone if disaster strikes. Then people can work together knowing that at any time, they can take their piece, go off, and make a name for themselves. Whether they stay together or go their separate ways, the assurance that they have some independent financial stake allows them to get together for Thanksgiving as a family, not as business partners.
A business entity with a limited number of owners, typically family members in farm businesses. Rules about buying and selling ownership interests ensure that the business cannot be owned by anyone outside of the family (see buy-sell agreements).