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Cleaning up sweat equity

It used to show you were committed to farming. Now it’s a dangerous source of controversy on more Canadian farms

At his financial office in Stettler, Alta., Peter Boys reaches for stark language to make his point. “Slavery is alive and well on farms in the Prairies,” Boys says.

Boys is referring to the practice of farmers not paying equitable wages to their children working on their farms, often under the promise of future ownership… someday.

Sometimes that day never comes.

Almost every farm adviser knows a case where a 60-year-old farmer has a 40-year-old son farming with him, and neither can be sure if their 80-year-old father/grandfather is going to leave them ownership of the farm in their will. Not only that, but for decade after decade, as well, the son and grandson got paid minimally (to avoid paying income tax).

Now, it turns out the value of the farm has escalated, and the non-farming members of the family are getting agitated about inheritance equality.

But where will the 60-year-old son be if he doesn’t inherit the farm? And can there be any hope for a farm in the future of the 40-year old grandson, already married with two kids?

Recently, Boys had a client from a very successful farm who was paying his 23-year-old son minimum wage, stringing him along. Boys’ advice was to pay the younger generation a reasonable wage, equivalent to the jobs the son might get locally off the farm. “They need to match what the other businesses are paying for day labour in the area or he’ll be gone,” Boys warns.

In this case, Boys also convinced the older generation to start giving the younger generation some ownership. It’s an imperative step in his view. Being a shareholder, even a minor one, or helping them buy a first quarter allows the next generation to contribute to and participate in any future increase in value. More importantly, it gives them hard equity, which in turn gives them a launching pad for financing.

There’s also another important subtext to such a conversation, showing the next generation that the parents respect their contribution, and showing them how important they are to the success of the farm. The next generation also gets a lesson in how important the farm is to their parents; it’s the family legacy.

By paying the next generation a living wage and giving them a piece of the farm, the parents are beginning to shift the conversation to one between adults instead of parent and child. “The son didn’t know where he stood,” says Boys.

Manitoba-based farm family coach and adviser Elaine Froese thinks the problem is throughout Canada and much more common than we’d like to think. She is currently dealing with a similar case in Ontario, where a client’s parents think $1,000 per month is fair compensation. The son’s working wife is ready to leave the marriage in frustration.

“Many farmers do not cash flow enough money for labour compensation, so I think they use the promise of ‘sweat equity’ to keep labour on the farm, and sometimes they forget (the promise of sweat equity),” says Froese.

On the other hand, Froese has seen gross overcompensation. She knows parents who want to give a multi-million dollar farm to one child just because he worked on the farm since school. This leaves nothing for the other children, and little for the parents to retire on.

Most standard wills leave instructions to pay off any debt and taxes and then split the remaining estate equally among the children, says Boys. In this case, he says parents who want to succeed the farm to one child and want to be somewhat equal to the other children have only a couple of options: The succeeding farmer has to remortgage to buy out the other siblings, or the parents need a large separate savings, investments or joint-last-to-die life insurance policy to divide among them.

Yet it’s also important to recognize that if the farm sells at the time of death, there’s often a huge tax bill to pay. And also that whether it’s a small or large farm, taking away a chunk of equity can damage the operation’s viability.

Having to repurchase land that was already part of the farm operation can be an enormous challenge, says Boys.

And that’s in a relatively civilized situation, which isn’t always the case.

And if the mess does end up in court, one of the areas of potentially heated dispute is the valuation of sweat equity. In the precedent-setting Mountain versus Mountain case, a father verbally promised the son the classic “Someday this will all be yours.” However, the will said something else and it took hundreds of thousands of dollars, a judge that considered sweat equity, and an appeal before the son got to keep the farm he had worked on all his life.

It was a very real, very rural mess that took place in bucolic Cheltenham, Ont. The reality is that it can happen anywhere and to any family.

The problem with these sweat equity understandings is they’re seldom in writing, so it becomes the parents’ responsibility to correct this in some form of differential distribution at transition.

“If it is not written down, it didn’t happen,” says Cedric MacLeod, who operates MacLeod Agronomics and farms in New Brunswick.

A written shareholders’ agreement is a good place to start, including how dividends are to be distributed. “If it’s a profitable business, be like every other successful business. Take out some funds to invest in a nest egg,” says MacLeod. “Don’t be afraid to pay income taxes.”

In a typical scenario, the older generation came home after college, they either inherited or paid minimal amounts for the farm, and then worked for years, taking out only small personal draws. Now closing in on retirement, they have no off-farm investments, so they feel they need to get paid today’s full market value for the farm in order to fund their future.

“Don’t bury it all in the farm,” suggests MacLeod. “Set some aside for retirement.”

The message is clear

The bigger message is clear. If farmers don’t get their wishes and business strategies organized and written down, these problems are just going to continue to get larger and messier.

This is for a number of reasons. Not only are farm assets getting bigger and more valuable, but farm businesses are also getting more complicated and more people are involved.

The “equal versus fair” problem has become a looming issue as farmland values in many parts of Canada have skyrocketed well beyond the productive capacity of the land to pay for itself.

Moreover, the business and technical skills needed to manage farms today have gotten more demanding and the opportunity costs, risks and potential losses more significant.

Not only are estates getting bigger, matrimony, gender equality and the very definition of family has changed. Legal studies show an explosion in cases involving blended, complex or fractured families, where a spouse has remarried or entered into a new common-law relationship and may have children from multiple relationships.

To head off such litigation, familial relationships must be considered in estate and business planning. Parents need to communicate to the whole family so everyone knows ahead of time what’s involved with the farm business and what’s in their wills.

And they mustn’t use it as a threat or a carrot.

And put it in writing. Otherwise, conflicts can lead to failed businesses, broken relationships, lawsuits, and lingering anger, Boys says, warning, “The bigger the dollars get, the bigger the hogs get.”


Check your entitlement at the door

Unless you are a minor or a dependent, your parents are not obligated to leave you anything, whether you are male or female or farming or not. Inheritance is a gift, not something to which you are entitled.

Yet siblings and parents also have to respect the contribution of the next-generation farmer.

It’s very important that everyone in the family knows what their parents’ wishes are and what’s going to happen according to their wills.

“Tell them how this will build and improve on a family legacy,” says Cedric MacLeod of MacLeod Agronomics in New Brunswick. “The family needs to know that their farm is a foundation.”

Jim Snyder, national director for agricultural practice development with BDO Canada, says parental leadership and family communication are imperative to a healthy outcome of estate planning and farm succession. He uses the example of a farm family that recently lost their mother. The father is in good health in his mid-’70s and made it very clear to his four children that his assets will be distributed equally. Each child will get a farm when he passes.

The father also emphatically told his two sons that the reason their two sisters spent more time doing housework was because he had assigned them that responsibility and that their contribution was every bit as valuable as theirs, just as their recently deceased mother’s contribution had been equal and sometimes greater than his. “That ended the conversation and the kids really do love and respect each other,” says Snyder.

Other times the absence of gratitude and respect drives further problems. Snyder knows of a very successful operation with more than enough assets and cash flow to support all family members and employees in a lush lifestyle. Yet, the two brothers are determined to make sure their sister inherits no shares in the farm, as well as not keeping the ones she already owns.

What’s sweat worth these days?

“Sweat equity is worth exactly what you paid for it,” says Jim Snyder, national director for agricultural practice development with BDO Canada.

In other words, if you didn’t get paid for your efforts in dollars or assets, you didn’t get paid at all.

It comes down to separating ownership from management. “If we can compensate each other based on contribution of labour and performance, it avoids so many other issues,” says Snyder.

If you bring skills and knowledge to the farm, you should be paid correspondingly, agrees Cedric MacLeod of MacLeod Agronomics in New Brunswick.

Another way to look at it is earning capacity. Based on a 20 per cent contribution margin, if the additional new generation expects to be paid $50,000 a year, they have to generate $250,000 additional revenues to the farm.

We must track the value of what everyone brings to the farm, and pay them accordingly, says MacLeod.

Beyond straight wages, sweat equity actually has another component of value. This is the contribution of the on-farm family member to increasing the value of the business. If the family member enhances the farm’s viability or brings business skills that make it more efficient or profitable, this needs to be recognized, which then puts a venture-capital twist on sweat equity.

“Treating unequals equally may be the most unfair thing you can do,” says David Goeller, a transition specialist with the department of agriculture economics at the University of Nebraska-Lincoln in his paper, Putting a Value on Sweat Equity.

To value sweat equity, Goeller suggests you set a farm value at the point in time when your child came back to farm and equally divide that number by the number of heirs. Then you need to figure out the net worth increase since that point in time.

Next comes the more subjective part: Goeller says you need to estimate a percentage for how much of that increase was due to the parents’ and how much was due to the successor’s contributions. This can get complicated because you need to articulate and evaluate your reasoning at the time of expansion. Did the farm buy the land next door because the farm was succeeding? Would they have bought or sold quota if the situation was different?

Next Goeller recommends dividing the parents’ portion of the increase by the number of heirs and adding it to the first-step, pre-successor point of value you established earlier.

You might need to consider if the farming child or children received market-value wages for the time they’ve spent working on farm. You also might want to balance that with what the other child or children receive during the parents’ lifetime, such as university tuition, school room and board, or maybe even a vehicle or a house in town.

John Baker, lawyer and founder of Iowa’s Beginning Farmer Centre created a more detailed approach to valuing sweat equity. The centre conducts programs for farmers who want to transition their farm business to the next generation or people who want to get into farming.

Baker’s spreadsheet is a fill-in-the-blank approach that establishes credits for many details, including inputs, liabilities, breeding stock and loan payments. On another sheet it has a valuation for elder care and property maintenance, time investments that are often overlooked and not valued in dollars yet they can be big factors in farm transfers and estates. His detailed fill-in-the-blank asset statement will help everyone understand net worth at various age stages.

Download John Baker’s Excel spreadsheet here for your own use at country-guide.ca.

WESA, what?

A few years ago, after over 30 years of planning, the estate laws of British Columbia received a major overhaul via a new statute called the Wills, Estates and Succession Act (WESA). It replaced and combined several previous stand-alone estate laws.

Basically this law now requires that the proceeds of an estate be distributed equally, which can be problematic if one child is receiving more or if one child is expecting more in consideration of sweat equity.

It’s predicted the definition of the spouse and the powers of the court to rectify and determine a document to be a valid will may potentially result in more litigation. Overall, it’s generally quite favourable for persons who have been disinherited.

Sweaty situations and solutions

More and more often, it can make sense to sell land and get paid partly in labour

“Timing is everything,” says Robin-Lee Norris, partner with Miller Thomson LLP in Guelph, Ont.

Recently Norris was working with a young couple buying a farm in part with cash and in part with sweat equity. With a “sweat equity” purchase, the buyer is paying off all or a portion of the agreed cost of a property through labour.

If the seller is flexibile and recognizes the contribution the buyers have made or will make through their labour, acquiring ownership of land can be accomplished over time, and a sweat equity deal can be negotiated as part of a purchase involving a cash down payment.

These type of transactions are often a combination of purchase agreement and shareholder agreement. “I think it is going to become more and more common for aging farmers to look at this as an option during their lifetime,” says Norris. “It will appeal to farmers who are attached to the land and want it to stay productive farmland. With startup costs so high, it may be the only way we are going to be able to transfer many farms to the next generation.”

Another way to make a sweat equity agreement is by stating (in a written legal document) that the older generation will give a small percentage of ownership of the farm for every year the younger generation works (one to five per cent is common), in addition to wages for working on the farm. Through this arrangement, the next generation could become a full owner over a set amount of years, or inherit the remaining interest when the older generation dies. They could also potentially buy the remaining interest or decide not to continue to farm and cash out the value of their accumulated shares, or use that accumulated equity to leverage further expansion.

The other side of the coin is addressing the common assumption that you need to own land to farm, whether you are at the end, middle or the beginning of your career.

“Why do you need to own ground to farm?” says MacLeod. “Ownership is entirely pride based.”

Sometimes in wills, someone will inherit an asset because of the work done over the years on the farm. As well, one child may be gifted a farm asset on the basis of paying the other children out over time, and that can accomplish something similar. For example, the will can give the beneficiary four or five years to earn enough to buy the others out.

With corporations, alternatively, sweat equity can be transferred for shares in an ongoing basis when the older generation is still alive and involved in the operation. Basically the older generation does an estate freeze on their farming corporation where they freeze the value of their common shares and exchange them for special shares worth a fixed amount. The parents redeem those shares over time for their retirement income, and the corporation issues new common shares to the successors, who would then accrue all the future growth.

When the parents die, a timing clause in a shareholders’ agreement is triggered. This avoids putting the farming children in a tight financial spot due to the non-farming children calling for payment or redemption of their inherited shares right away. Also, they can’t redeem them all at once so the farming children have the opportunity to pay out their non-farming children over time.

Concludes Norris, “We are going to have to get truly creative and look at all of these options going forward.”

Contesting a will

Swarms of siblings, cousins, uncles, aunts, estranged, second and common-in-law spouses fighting over farm assets… it’s easy to imagine the nightmare.

In the middle is a family farm being torn apart, neglected, sued and publicly sullied. The relationships — the very best part of a family working together — are beaten to a pulpy mess by greed, stupidity, poor communication and not writing things down.

As poignant as such cases seem, contesting a will isn’t as easy or as successful as you might think. It’s quite a process. At its core it means applying to the appropriate court to have a will struck down as invalid. The case has to be proven with sufficient relevant evidence.

Typically, wills are contested successfully if it can be proven one of three things was wrong. There was undue influence; the will was written with lack of mental capacity; or the will document itself has problems such as improper witnessing, lack of signature, or other formalities not observed.

“Dependent relief” is something different and refers to an application by a spouse or child to get a larger share of an estate under a valid will. The will itself would still stand, but the court is asked to give a larger portion of the estate to someone in the family.

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