The whole world acknowledges the brilliance of Albert Einstein. He is famous for his discoveries about relativity and the pull of gravity, and for his equation E=mc2, which says that the increased relativistic mass (m) of a body times the speed of light squared (c 2) is equal to the kinetic energy (E) of that body.
Sound complicated? Well then, you should try figuring out how three or more individuals with different personalities and with varying personal and business goals and objectives can, in a family farm business, discover their “relativity between each other” and “stay in orbit.”
Then consider where the main gravitational pull is, and how Dad and Mom feel caught in the middle.
Perhaps the diagram below is a better illustration of this concept. I call it the “Bermuda Triangle,” where there are two or more farming children involved in a family farm. As in its namesake triangle, things happen here that no one can fully explain.
Family farm succession is difficult enough where there is only one farming child wishing to farm, but I have noticed a trend where everyone wants to come back.
This article is not about financial viability but rather how to provide a business framework to allow for business success. It is about creating the opportunity. Throughout my career, my focus has been on business structures to provide clarity of purpose and a roadmap that leads to a clear destination.
Without a proper business structure only chaos ensues. This chaos is caused by not having a structure that assists in the financial and personal outcomes for each generation.
Great introduction, so now what?
To help facilitate this very complex intergenerational transfer, a certain truism is emerging. Many young women and men today do not want to be a member of a single-family farm business with their siblings and parents, even though the traditional recommendation from accountants and lawyers is to have one family farm corporation where Dad and Mom control this corporation and the children become shareholders.
I know income can be distributed through agreements, salary can be paid for labour and management, and parents can receive land rent and perhaps even a return on equity through dividends. Even future equity can be distributed through the issuance of common shares to the next generation.
Yet with all this flexibility, I see a reluctance in this type of business structure. This reluctance occurs frequently even when the farm size only needs one small $500,000 business deduction and there is only one child returning to the farm!
So what do we do?
The key to unlock this puzzle in my view is quite simple. The solution is: one agronomic mind with separate and distinct profit centres.
What does that mean?
This means the farm cannot afford two or three separate lines of equipment. The farm has to be treated as one large agronomic block. Crops shall be sprayed and harvested according to agronomics, not by a “my field first” mentality.
In order to put together such a structure, I like the idea of a joint venture. Joint ventures need to be utilized more in our complex agricultural farms, especially with all of the new corporate and partnership income rules. (These rules are beyond the scope of this article.)
The most common joint ventures I deal with are as follows:
1. Income Joint Venture. In this joint venture (JV) all crops and crop input expenses, including fuel, run through one bank account. The distribution from the JV is done by allocating the margin to each member in a predetermined way for their labour and management.
Each participant in the JV then has independence on how they wish to spend this income allocation on land expansion, personal consumption, etc. Equipment is either owned jointly or independently, but repairs are paid by the JV.
The main advantage of this type of arrangement comes with pooling production and marketing volumes. The cons through pooling are, of course, some restriction of independence and expansion opportunities. For example, if 320 acres come up for rent, the JV rents the land not the individuals.
2. Production Joint Venture. In this type there is no single bank account. Crop revenue is independent. You sell what is grown on your land. No crop pooling exists. Grain is binned separately. All inputs are purchased independently or at the retailer where the retailer simply invoices each person a percentage of their share of the total input purchase. Equipment is either owned jointly or independently and repairs are paid at the individual business level.
The pro of this type of arrangement is more independence, but with that come the cons of independent risk. The main issue in this type of arrangement, however, is determining who gets the 320 acres of new land to rent. Isn’t my combine running over acres that I am not getting compensated for?
3. Hybrid Joint Venture. In this arrangement a combination between the two occurs. First, we create an equipment partnership. All equipment is transferred into this formal partnership and in return the owners receive a partnership interest. This partnership receives a certain amount of income from each member corporation on a per acre basis. One example I saw was 65 per cent of custom rates. All fuel and repairs are paid through the partnership, and all equipment trades and purchases are also done through this entity.
What are the tax implications of an equipment partnership?
The equipment partnership is set up not to make a profit. The funds paid to the partnership are an expense to the partner corporations and income to the partnership. From this income, the repairs, fuel and depreciation are deducted, and thus the partnership has very little or nil net income. The goal is to have a jointly owned equipment entity that breaks even through a per acre charge. The new specified partnership income tax rules will therefore not have an adverse effect on each individual’s corporation’s ability to claim their own small business deduction of $500,000. (Again, these complex new rules are beyond the scope of this article).
Do I need a formal partnership? Can’t I just use a bank account with shared ownership of equipment?
The answer is that I am finding if there are more than two equipment owners, a partnership is more formal and benefits from the written document to cover all the bases.
What is the most difficult part of these business arrangements?
Without “pooling” of acres under an income joint venture, a complete understanding of the independence process has to be clear. The most difficult one occurs when third-party land comes up for rent, or when the parents retire and their land is now up for access to the next generation.
Who gets it?
Analyze this example of a farmer that I met last year. The older son is farming 1,500 acres and works for Dad’s company as well. The younger brother farms 800 acres and has an off-farm job. The parents are farming 1,800 acres and now, because of health issues, have to retire early and are willing to have the sons take over.
So, does the younger son get the first 700 acres and then the parents split the remaining 800 acres 50-50? Or does the older son receive enough acres to replace his wages? Or does the younger son get more acres so he can quit his off-farm job?
Now you know why I call it the “Bermuda Triangle”!
Their parents’ answer was each child will receive 50 per cent of their land to farm and can buy 50 per cent of their equipment. The “boys” will have to decide their own financial viability based on this decision. The business structure I recommended is the hybrid joint venture model as these two individuals could never pool income.
What have we accomplished for this family?
- Each child has an independent profit centre but has to pay into a formal “pooled” equipment partnership. The parents are transferring their equipment into this partnership and will receive a partnership interest equal to its fair market value. The parents at this time do not want to be paid for their equipment, but want the boys to take over their remaining debt payments.The boys will have to agree on the appropriate amount of equipment and what colour to buy, etc. If they cannot at least agree to this, then they probably cannot farm together.
- By using this structure, acres farmed do not have to always to stay the same. If one child wants to expand and purchase land and the other does not, that child has to pay more into the equipment partnership, as they are farming more acres.
- If they cannot agree to agree at all in the future, they can unwind the equipment partnership with no adverse income tax consequences, and then swap equipment and buy each other’s interest out to arrive at complete 100 per cent ownership and farm with their own line of equipment.
I wish sometimes the Three Musketeers’ saying, “All for one and one for all” could apply to multi-family farms.
Reality does force us to think about new structures. If we could agree that one agronomic mind is the key, then independence with interdependency can result in all operations excelling. CG
Merle Good advises on business arrangements
and taxation with GRS Consulting in Cremona, Alta. He is also a faculty member for the Canadian Total Excellence in Agricultural Management (CTEAM) program offered by Agri-Food Management Excellence. www.agrifoodtraining.com
Joint ventures need to be utilized more in our complex agricultural farms, especially with all the new corporate and partnership income rules.”
Merle Good advises on business arrangements and taxation with GRS Consulting in Cremona, Alta. He is also a faculty member for the Canadian Total Excellence in Agricultural Management (CTEAM) program offered by Agri-Food Management Excellence. www.agrifoodtraining.com