By Blake Knickelbein
Farm succession planning revolves around the goal of ensuring that the farm stays in the family for another generation. Our office takes pride in working with families to create a structure that maximizes the possibility that a farm remains in the family for multiple generations. One tool used to help farms succeed to the next generation is a buy-sell agreement.
A buy-sell agreement may be a separate agreement signed by owners of a business, or the same terms may be included in a limited liability company’s operating agreement. Either way, I think of these transferability provisions as a “safety net” to protect the farm in case certain unfortunate events happen. While it can be uncomfortable to discuss these issues, agreeing on a fair method at the beginning, while there are no hard feelings, can minimize disputes later that can lead to family tension.
One possibility that should be discussed is what should happen if an owner dies. Let’s take the example of a dad and mom and their adult son and daughter on a farm. If the daughter dies, it is safe to assume her estate plan says everything she owns goes to her husband. If the husband is not involved in the family farm, should he have the right to retain the daughter’s ownership in the farm?
The buy-sell agreement can provide that the remaining owners in the farm have the right to purchase the daughter’s ownership from her estate to allow the ownership of the farm to remain in the immediate family.
Many farm transfers are facilitated through gifts of earned equity to the next generation. The expectation is usually that if Dad and Mom are gifting this ownership and not receiving money in return, the next generation should be dedicating their full-time employment to this farm. A buy-sell agreement should also address what will happen if the son or daughter leaves the farm. Because Dad and Mom gifted the ownership, they probably will not want to buy it back at full value. It is common for significant discounts to be placed on the buyback of ownership from an owner who was gifted ownership and then leaves the farm.
Also, the remaining owners routinely have the option to purchase that ownership back, but it’s not the requirement. In this situation, the son or daughter who left the farm may be allowed to retain ownership, but because farms usually do not pay out dividends, he or she is not receiving significant financial benefit from that ownership.
A major aspect of the buy-sell agreement is agreeing on how the price of the ownership interest will be established and the payment terms of the purchase price. In many other industries, businesses are valued using a multiplier of the earnings of the business. However, because farms are asset-rich and cash-poor, and because in most situations families want to set a buyout price the farm can afford, the buy-sell agreement usually sets the value of the farm as the assets minus the liabilities. It is also common for there to be a discount applied to the purchase price of an owner’s units.
With the high value of farmland and other farm assets, a farm can hardly afford to carry on its normal debt load and then buy part of itself back if an owner leaves or dies. Therefore, this discount can be agreed upon at the beginning, which can be fair to the owner being bought out but can also allow the farm to continue. Further, rather than forcing the farm to get a loan from a bank to pay the entire purchase price at once, a buy-sell agreement can allow for the purchase price to be paid over an installment sale.
There is no one-size-fits-all solution for transferability provisions, especially in the agricultural industry. Every farm family situation is unique, and what works for one farm may not work for another. Also, there may be different provisions included in the buy-sell agreement for each owner. For example, the son may have a wife who is actively involved in the farm, and the family may want the daughter-in-law to have the ability to keep the son’s ownership if he passed away.
Again, these buy-sell agreement provisions are viewed as a safety net to help the farm continue for another generation and protect the farm in case certain unfortunate events happen. These transferability provisions should be a major part of your farm succession plan, and you should meet with your trusted advisers to assist you in structuring these in a way that maximizes the possibility your farm succeeds to another generation.
Knickelbein is an attorney at the Chilton, Wis., ag law firm Twohig, Reitbrock, Schneider and Halbach S.C. Call him at 920-849-4999.