February 15, 2016
Farming Succession: Beating Time to the Punch
By Carol Lea Spence, University of Kentucky The mAGazine
In the mid-1970s, the extended Strode family, farming on Ohio River bottomland west of Owensboro, suffered a setback when the great grandfathers of the family passed away in quick succession. One man had two children; the other had one. The men assumed everything would just be split among their heirs.
In other words, they had no plan.
Assistant professor Jennifer Hunter, Department of Family Sciences, would say this is a perfect illustration of "what if."
What if the Big Certainty happens—a farmer dies. What if the spouse or a son or daughter is left to manage things? What if a farmer becomes incapacitated? Or less direly, what if a farmer wants to retire, relax, and enjoy life?
The question should really be what happens when, because Time ignores no one, and not planning for the future could mean there is no viable future on the family farm for the next generation. Considering that the average age of farmers in Kentucky is 58, Time seems to be winning. For every farmer under the age of 25, there are 44 older than 70. Over the next decade half of the state's farmers will retire, and 70 percent of farms will change hands. The question for farmers to ask themselves is, do you want to have a say in how that change occurs or do you want to toss the decisions into the wind and hope they land right? Because every farm business will experience transition, with or without planning.
“It's not really a problem,” said Steve Isaacs, professor in theDepartment of Agricultural Economics. “It's an opportunity.”
Isaacs and Hunter offer workshops around the state, during which participants learn from the experts about what goes into a successful transition.
One of the ideas the team shares with workshop participants is that, without a plan, they're really transitioning a set of assets versus transitioning the business. And if management of the business isn't transitioned, it is probable that the business will not succeed much past the retirement or death of the elder generation.
“Transferring the human capital is harder to do than transferring the assets. That's why we call it transition planning or succession planning and not estate planning,” Isaacs said. “Estate planning implies that we're just going to transfer the physical assets and the money. Succession or transition implies that we are going to try to transition the community goodwill, the leadership roles that the family has had in commodity organizations or local communities, and the relationships with vendors. Those make up the human side of the business, and those need to be transferred as well.”
I'll let the kids sort it out.
“Don't worry, I'll take care of you.”
Isaacs said that is the worst thing a parent can say to the children.
“It sounds good, but what it really means is ‘Don't ask me about this again,’” he said. “They should be saying ‘Here's how we're going to take care of things.’”
In the case of the Strodes, the original assets did split among the next generation in the 1970s, but it left the family with a sizable tax bill that took 10 to 12 years to pay off.
“Our business didn’t grow much in those years,” said Jason Strode, part of the third generation since his great-grandfathers passed.
Having a plan and following that plan rests on whether or not there is communication between the generations.
“It's a hard conversation to start,” Isaacs admitted.
He throws out to workshop participants that perhaps they could follow the path his wife took with her mother.
“She just sat down and said, ‘Well, let's start at the end. What songs do you want at your funeral?’” He laughed. “That's funny, but it is hard for the younger generation to start the conversation, because it makes it look like they're greedy. So the parents and grandparents need to start the conversation. They have an obligation to do that.”
Jason Strode's grandfather took to heart the lessons learned from his own father's passing. He contacted an estate attorney and they, together with Strode's father, drew up a plan to avoid exorbitant capital gains and estate taxes in the future. They set up multiple entities, corporations, LLCs, and partnerships from all the interests that they had in different properties and farms.
“My granddad did a lot of gifting at first, but then later, we got to where the third generation—my generation—decided that we wanted to farm, and we have been purchasing shares of different entities over the last 15 years,” Strode said. “Every year we look at it to make sure we're doing the best we can to minimize future taxes and keep up with the current law.”
The hard lesson the Strode family learned motivated an ongoing conversation between the generations, but for families who have yet to go through such transitions, it can be a hard talk to have.
“I used to say these family discussions were kitchen table discussions. They're not,” Isaacs said. “It's very difficult separating family and business in farms. Mom's kitchen table is not a neutral site, because everything that has happened in that family, good and bad, is sitting around that table.”
Neutrality can come in the form of a transition team made up of an attorney, an accountant, a financial planner, a farm analysis specialist, and the lender—it's important for the family to build the team based on its vision for the future of their farm.
When should I show them the books?
Sometimes the elder generation is unwilling to let go.
“If Dad is still signing off on the notes when he's 85, and the son doesn't even know what notes are out there, then that's a problem,” Isaacs said.
They must be willing to share the books, they must be able to share expectations, and make sure everyone involved is on the same page.
“If they (the heirs) don't have a clue what's going on, then they will be shocked one day when something happens,” Strode said.
A gradual transition that allows someone to step into new roles over time is ideal, so when the exiting generation does choose to reduce their role on the farm, the entering generation is well prepared and the business won't suffer.
The plans should include how the family intends to transition the management and make cropping, livestock, and personnel decisions.
This also applies to couples. When a transition plan has not been created before a spouse passes away, it can be difficult for the surviving spouse to put all the pieces in place.
Ensuring that assets are properly titled can help answer some of the "what if" questions. Unfortunately, Hunter has seen widows left struggling to pay bills while their husbands' estates were in probate, simply because their names weren't on the bank accounts. For that reason, many of the workshops the UKAg team offers are aimed toward women.
“We are helping them understand the process of transitioning their farm to the next stage, whether that is bringing on an on-farm heir, helping them have more of a role in the farm management, or planning to orderly dissolve the business,” Hunter said.
The lessons the Strode family learned in the 1970s paid off when the oldest generation passed away about 18 months ago.
“We had a very peaceful transition; it was about the most seamless transition you could imagine, because my grandfathers really didn’t own anything by that time, farmwise,” Strode said. “They were still realizing the income from rentals of different properties, but it flowed through, and within a month we had everything buttoned down. Nothing has changed and nothing will change. And everybody’s expectations in the family were met.”
The result: Family and business survive and thrive.
Fair doesn’t mean equal
Isaacs and Hunter try to help workshop participants think about what the implications are for the next generation. What type of plan might they want to put in place? There are strategies that the younger generation or the on-farm heir can take to be able to preserve that farm, but without knowing what Mom and Dad are planning, they're often caught off-guard later.
If a son or a daughter stays on the farm, builds the equity, and takes the risk, Isaacs said they probably deserve more than an equal share. One of the ways to start is with something like a 2:1 or 3:1 ratio, so the child who stayed and took the risk has a bigger share.
“But that’s up to every parent,” he said. “There’s not a right or wrong answer to that.”
Can the family afford the transition?
It's not all about death and inheritance. If the elder generation is thinking about retiring and is going to continue to need an income, the question must be asked: is there adequate income to also support a son or daughter's family who come back to the farm?
One of the biggest mistakes the specialists say the younger generation makes is thinking they need to increase the farm's gross income by $50,000 or $100,000 to support a second family. In fact, it's the net income that has to increase by at least that much. In its overview of 2014, Kentucky Farm Business Management estimated that the average farm family living expense was $108,550, which included taxes, medical expenses, life insurance, capital, and expendables. A retired couple might not need this much, but they might need more if they plan to travel or if they run into medical issues and long term care needs.
“We encourage parents to think about what other sources of income they have,” Isaacs said. “Maybe some retirement, maybe some investments, maybe some social security.”
If a family is considering growth to make up the difference, it should be a controlled growth, and the lender should be part of the transition team. The Strode farm currently supports two generations.
“We don't try to add acres every year,” Strode said. “We try to add acres that make sense for us and the equipment we have. It's all about efficiency.”
It's all about efficiency, communication, and being prepared to beat Time to the punch. When it comes to farm succession, the best answer to the question “What happens when?” is “Now, before it’s too late.”