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Fair Versus Equal

Even with professional help, half the families that farm adviser Don Forbes meets can t get past what is emerging as an ever bigger obstacle in farm succession planning. How do you treat farming versus non-farming children?

Ironically, while the issue has always been fraught, it used to be easier to deal with it when the outlook for farming seemed bleak. Asset values were lower, and it was painfully obvious that if the farming children were to have any chance of success, they d need a hand up.

Now, there s real money on the table, which means the stakes are higher all around, including for Mom and Dad s retirement plans. Plus when you start seeing more zeroes on your net worth statement, the niggling doubts that used to get swept aside suddenly move to centre stage: Can you really risk using that much family money to back Johnny when you aren t even sure if he s got what it takes to succeed in the new world of farming? And, what if you give him all that money and he decides in five years that he doesn t really want to farm after all?

Farmers have long come to accept that there s a difference between fair and equal when it comes to succession and estate planning. Say that my total assets farming and non-farming are $3 million and I have three children, explains Strathroy, Ont. lawyer George Sinker. For someone with a simplistic view of the world, they would leave a third to each child. That is equal, but it s not fair to the farming child, and it s probably not fair to the non-farming children because if you happen to own a farming corporation, how are you going to make that division?

For the majority of farm families I talk to, that s their stumbling block how to come up with that fairness formula for the non-farming siblings. A lot of times, it s pretty emotional, says Forbes of Don Forbes &Associates in Carberry, Man.

Yet when families can t reach their own compromises, they essentially leave it up to the courts to decide. And the track record shows that when the courts get involved, they decree absolute equality.

Fairness boosts survival

If the parents primary succession goal is to see the farm survive and thrive after they re gone, then breaking up the farm into equal pieces to give to their children is not the answer.

If you ve got a farm that currently has, say, $2 million in assets which would be a modest-size operation in today s terms and you had a family of four children and you ve said let s split this four ways, well you may just as well call the auctioneer today and get it done with because it s over, says Jeffrae Rothwell, agriculture account specialist with Affinity Credit Union in Shellbrook, Sask.

Whether it s a small or large farm, taking away a portion of its equity can result in a less viable operation.

To coin a phrase, if you ever have to buy a quarter section of land twice in a farm operation, you ve got to really consider how that s going to change your future path, says Rothwell, who has spent 20-some years in farm finance. The most crippling thing a lot of times is having to repurchase land that s already part of the farm operation.

Should the parents of that same $2-million farm decide to split it equally amongst, say, four children, suddenly a non-farming child would at some point in his or her life inherit a $500,000 asset, which to them might be like winning the lottery. Knowing full well that half a million dollars can change their lives pretty quickly, the non-farming children ask themselves why they would leave that value in the farm for a small return on their investment. If given the choice, they re likely to sell at some point.

Even if there s a mechanism in place that disallows such a sale and calls for annual lease payments which could be on the land or on assets like livestock, quota, or equipment that could hurt a farm s chances too, as anything that impacts the bottom line will in turn affect future viability and expansion plans.

(Expansion) seems to be a necessary part of the program these days, says Rothwell. There s very, very few farms that can stay static in size and productivity and expect to survive long term. Growth is almost an expectation.

In deciding who should get what, Forbes says the fair and workable solution would include considering whether the farming child or children have been receiving market-value wages for the time they ve spent on farm. Forbes has known offspring who ve spent 30 years on the farm but the operation remains in the parents name, so for those 30 years, he has worked for groceries.

Should that son die first, his wife and children could be left with nothing because the parents never added their son s name to the title. And if instead the parents in this hypothetical situation die first but without a plan in place their assets would be split equally between their farming son and their non-farming daughter. Would that be fair? Forbes asks.

Consequently, parents in similar circumstances need to consider sweat equity, basically calculated as the value of the farming child s contribution to the farming operation, especially if they haven t been paid a fair market value $40,000 to $50,000 a year, say, for a professional farm manager in Manitoba as well as what the other child or children have received during the parents lifetime, such as university tuition, school room and board, or maybe even a vehicle or a house in town.

You ve got to wade in and look at the bigger picture and ask what is roughly fair, Forbes says. A lot of times they can t necessarily articulate it or clarify it and so they do nothing, Forbes says.

To make the job even more difficult, this is when issues can get emotional. But Forbes and other advisers have straightforward advice. You ve got to accept the fact that emotions are part of the mix, they say, and you ve got to deal with them.

Any qualified accountant or financial planner can read your income tax returns, ask a few questions, and have a mathematically sound plan in a couple or three hours, Forbes says. But does it fit the needs?

Buying land twice

Sinker believes parents want to make sure the farm goes to the person or persons who are best equipped to be successful at farming.

You re never going to be equal dollar-wise with all of your children, says Sinker, who s also a national director of the Canadian Association of Farm Advisors. Most of my clients try to be fair if not equal.

Sinker says the meaning of fair has changed thanks to skyrocketing land prices plus dairy, chicken and egg quota values. Before then, fair but not equal on a typical farm might mean, for example, a three-to-one split, so the farming child might get $300,000 worth of farm assets and the non-farming child a cheque for $100,000, with the theory being the latter could take that cash and invest it, whereas the $300,000 in assets are required to make a living on the farm.

But such simple approaches are getting harder and harder to endorse because of the dramatic appreciation in farm assets. One option, Sinker says, is with an estate freeze.

Parents can do 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 would redeem those shares over time for their retirement income, and the corporation would issue new common shares to the successors, who would then accrue all the future growth.

At the time of the parents death, a timing clause in a shareholder s agreement would be triggered to avoid putting the farming children in a tight financial spot due to the non-farming children calling for payment or redemption of their inherited shares.

They can t redeem them all at once and the farming children have the opportunity to pay out their non-farming children over time, says Sinker. (This) gives a little more equality to the situation, and we find that the non-farming children are then left with the feeling that their parents did their best and tried their best to treat them fairly& And the farming child is left being able to continue to operate the farm.

Rising quota values, though, can throw a whole new monkey wrench into even the best-laid plans. Sinker solved the problem in one transaction last year with a plan that made provision for the non-farming children based on the current value of the quota, and another provision in the shareholder s agreement to refreeze the assets if after the succession plan the quota dropped by more than a certain per cent.

When we made the arrangements and did the documentation, the quota was at a high value and so the farming son would have had to pay off a certain amount to his non-farming siblings, Sinker says. But if the quota after he acquires it should drop like a stone, we don t want him to be left paying the value that was established when the quota was at a high rate.

Of course, what happened was that the quota substantially increased during the year and a half since the plan was drawn up. So the parents returned and made further provisions.

Just because you make a succession plan doesn t mean that it s cast in stone, stresses Sinker. It s an evolving document. Everyone needs to keep an eye on things to make sure it continues to be relevant.

The trouble with insurance

Definitely a very strong minority 30 to 40 per cent of Forbes clients want their farming son to inherit the farm. In those cases, he asks if they re prepared or able to take out a life insurance policy or make other off-farm investments which could help ensure the parents can pass on part of the estate to their non-farming children without actually taking resources out of the farm operation.

(Life insurance) is a really good option, as long as it s started soon enough, says Rothwell. That s something that can t really be started when you re 60. The cost of doing it in your later years can be very prohibitive& That s where good planning throughout their farming career comes into play.

Ted Kennedy, a certified financial planner with Edward J. Kennedy Financial Ltd. in London, Ont. points out farmers in general not just older ones have a tough time coming to terms with implementing a fairer succession plan using insurance.

They only see the cost and it doesn t seem to make sense. It s certainly not as advantageous as if you had done it when you were (in your 30s and 40s), says Kennedy, who notes business owners in other industries won t hesitate on life insurance. Farmers have a harder time justifying that money, typically because it could go back into the farm.

All the same, it s an arrangement that can work.

Sinker recalls a situation where two boys were going to inherit a dairy-farming corporation which owned the quota, land and buildings. But there were still three non-farming daughters to consider, so the parents early on bought a joint-and-last-survivor life insurance policy for a substantial sum. It was the sons, however, who paid the premiums on that policy until their parents passed away. On the second parent s death, the three girls were the beneficiaries of that policy, and the boys weren t required to pay them off with any share of the farm.

In another case, the non-farming daughter was made a beneficiary on a life insurance policy, but in addition to that, the parents had some additional land that was separated from the main farm operation that they sold to the daughter. They then took back a mortgage on that land, (and included in their will that the mortgage was forgivable upon death), so the parents had some control over it during their lifetime. The daughter was able to build a house on that land, and entered into a long-term leasing arrangement with her brothers in the farming corporation, thereby giving them access to the land as part of their farming operation, even though she owned it.

The old days are gone

When Sinker started practising with his corporate lawyer wife Sydney Pearson 37 years ago, he would get farm clients who wouldn t even leave their assets outright to their wife, fearing she d get remarried and end up piddling away the estate. Instead, she d receive only a life interest on the farm assets.

That s not the case now that s an outmoded way of thinking, Sinker says, adding clients are more sophisticated nowadays because they re running, in many cases, multimillion-dollar operations.

Also common was giving the first-born son the entire farm. But what about, say, the daughters? Well, maybe they got married. Or got an education. So they were taken care of, at least in the context of the times.

That used to be the school of thought, Sinker says. These days, we have lots of farm clients who are females who are running the farm operation and they re much better equipped mentally and otherwise to do so rather than their brothers. So I think that things have changed remarkably.

When Forbes started 25 years ago, the parents alone decreed where their assets went, without consultation with the children. He says he still sees some of that conservative approach, but he s also seeing farmers who are paying greater attention to the full complexity of the issues they re faced with.

It s becoming a lot more acceptable to have a family conference, Forbes says. Without question, the most successful succession plan is when they do have one or more family conferences to get everybody to buy in and agree.

Traditionally, there was also a reluctance to hire advisers, largely because advice is such an intangible. We ve seen that change dramatically in the last five to 10 years where we have more advice being paid for, whether it be from agronomic advice to legal, accounting advice, says Rothwell. We re seeing a lot larger uptake of the professional advice that s out there, especially in growing, viable farm operations. CG

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Let s Talk

Odds are, your kids have figured out a lot more than you think

Few succession plans will succeed without good communication, and parents hopes for their farm to continue and grow will be dashed if those plans fail.

Once the farm has been determined to be viable and the parents are ready to make plans to move it on to the next generation, the next key step is communication.

Family conferences are integral because that s where the hidden problems will emerge, says financial planner Don Forbes based at Carberry, Man. These conferences need to be addressed ahead of time. Otherwise there s a risk that unresolved animosities will derail your succession plan.

The next step is deciding who sits at the table: is it the parents and all their children or grandchildren? Are the spouses of children there? Or only the family that s involved in the farm?

I m a strong believer in family councils so that the parents and the children communicate frequently and discuss what is going to happen, says George Sinker, a lawyer in Strathroy, Ont. I don t believe in the old-school thinking of the parents making the will without any discussion because it was none of the other children s business what the parents did. Most of my clients have full and frank discussions with all of their children.

Next is determining what everyone wants. What do the parents want? asks Jeffrae Rothwell, agriculture account specialist in Shellbrook, Sask. They worked their whole lifetime to build this farm operation. Is their primary concern to see the farm survive and thrive? Or are they more concerned about getting the best value of those assets transferred to their children? Those are all questions that need to be asked early on.

The parties concerned also need to be able to communicate well with their professional partners, as accountants, tax advisers, legal professionals, financial advisers or bankers, and insurance professionals will likely each have a role to play.

Someone versed in family counselling may also be helpful in establishing the direction of any proposed plan and how to get there.

In some cases we do have a facilitator because the parents think they know what the children want but they never really ask them. So we ll get a facilitator in to communicate with each of the children and, lo and behold, the answers we get back sometimes are quite surprising to the parents, says Sinker.

Somehow, parents think family meetings will just add more negatives to what is already a difficult process. The experience of these advisers, however, is that family meetings are just as likely to take useless fretting out of the process.

Facilitated meetings might reveal, for instance, that a son or daughter really doesn t want to farm after all, or that the two brothers already know which of them is better at managing and which of them might be better on the tractor.

Good advice and planning will circumvent many stumbling blocks, but not addressing them will only produce conflict. That s when we really see some dustups, says Rothwell. A lot of times a third party is necessary.

If a succession plan is created and the children consider it unfair, they might not say any more about it during the parents lifetime. But chances are good that upon the death of the surviving parent, one of two things will happen, says Sinker.

Someone who s been treated completely unfairly is not going to have a family relationship with their siblings going forward, Sinker warns. Or even worse, there s going to be litigation over it and someone s going to challenge this.

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Time on their side

Expert advice helped the Galbraith family, but so did taking their time

Ontario farmer Bill Galbraith has taken steps to avoid the potholes of succession planning. The father of two sons and one daughter is in his 70s, and his corporation Braithland Farms Ltd. is primarily a dairy operation of 500 acres near London.

Both boys work together in the corporation and have an equal share in it and will take over ownership when the time comes. The daughter is a non-farming child, and will eventually receive the proceeds of the parents insurance plan.

Galbraith included his entire family his children and their spouses in meetings. But he also made sure not to rush into anything.

We took our time at it and I think that s important, Galbraith says. We found that these decisions that had to be made were about as critical as any we ever had to make in our lives.

When the parents decide they want to embark on this succession plan, they have to be fully ready to do so, says Ontario lawyer George Sinker. They can t and shouldn t be pushed.

Although Galbraith found the process an expensive one, with an insurance salesman, financial planner, lawyer and their accountant, plus a tax specialist accountant included in meetings, he realized the alternative wasn t much of an option.

We tried to do it the way all of the experts have told us it should be done, and that means you bring in these people and work with them, Galbraith says. At the end of the day, I feel it s worked out.

Galbraith also believes succession has changed a great deal over the years. Back at one time, you sat down with whoever your family lawyer was and you got it done. Now you can t do that anymore.

Certainly the cash outlay can be fairly large at the onset, agrees farm adviser Jeffrae Rothwell. It gets better, I would say, but if the farm is viable and the intent is to see the next generation take over and have the farm remain viable, then it s money well worth spending.

Besides, says Manitoba adviser Don Forbes, the odds are that someone is going to spend the money. If you don t spend it to produce a solid succession plan that essentially has family support, Forbes warns, the next generation will spend the money to clean up the mess.

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