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Ryan Conklin

Farm Transitions through Business Buyouts

Back in August, Robert and I presented at Ohio Farm Bureau’s Financial Essentials Workshops throughout the state. Each workshop focused on risk management, farm transition planning, or retirement. For this article we are going to concentrate on a common tool for these areas: farm buyouts.

We often use buyouts to transition a farm to the next generation. Sometimes a buyout occurs when a family member exits the farming operation while he/she is still living. The farming heir buys into the operation right away and the exiting family member receives income for retirement. In some instances, though, buyouts occur at death as part of a person’s estate plan, so an estate or off-farm heir has some cash.

However, if not setup properly, a buyout can do more harm than good. Here are some key considerations to ensure your buyout proceeds as smoothly as possible.

Ensure proper structure is in place

Which of the following is easier to purchase and own: 25% of a farming LLC or 25% of a combine? If you chose the LLC, you would be correct (in my opinion). Buying shares of equipment or other assets is messy from a financial, tax, and paperwork standpoint. Purchasing shares of an LLC, however, can be completed with some simple paperwork.

Planned buyouts can be simple. Unplanned buyouts can be very tricky. Unplanned buyouts can arise when family members pass away, file for divorce, have creditor problems, or want to withdraw from the business. Some business documents require the company to immediately pay 100% cash for these shares. For a farm family, this can be extremely difficult to do. Properlystructured operating agreements and buy/ sell agreements can mitigate the negative effects of these events.

Remove certain assets from business

Ideally, a farming heir should buy the assets necessary to continue the farming operation, such as equipment, inputs, supplies, tools, and some cash. Pretend two brothers farmed together for years as a partnership and accumulated $2 million in cash in their farm bank account. If a farming heir attempts to buy into this partnership as a 1/3 owner, then he/she will need purchase 1/3 of that cash.

For the brothers, it might be best to remove some of those funds from the partnership. Reason being, this will lower the purchase price for the farming heir, making it easier to buy into the business. Also, this should be after-tax money the brothers have worked for their entire lives. It makes sense for them to put this cash in their personal names for use in retirement or in their estate plans.

Develop purchase terms that cash flow

If a business buyout is not set up to cash flow, then there is a good chance it will fail. While some family members can complete a buyout in cash all at once, this will not work for others. Parents exiting the business can help with the buyout by financing the sale. For example, a farming heir can receive his/ her parents’ shares in full and, in return, he/ she executes a promissory note indicating the shares will be paid in installments. In sellerfinanced transactions like this, the parents can actually take the shares as collateral. This separate agreement states that if the farming heir ever stops paying on the promissory note, the shares return to the parent. This gives the farming heir incentive to pay. If the farming heir is purchasing a business entity, make sure your business attorney prepares new ownership certificates, share ledgers, and other updated documents to reflect the buyout.

Keep taxes in mind

Bringing your accountant into the process is another important step. As you might expect, taxes are going to factor into any buyout of a business. Most likely, the seller of shares is looking at some form of capital gains tax. While the legal components, such as operating agreements and purchase documents are important, receiving the “all clear” from your accountant is essential. Remember, however, if you inherit a business, or buy out the farm after a parent passes away, the tax consequences may be minimized because assets received a step up in tax basis when the parent passed away.

Factor into your estate plan

Sometimes a business buyout can occur at death. For example, if parents want to make sure their off-farm heir receives a sufficient amount from their estate, they can include language in their estate plan to allow a farming heir to buyout the off-farm heir after the parents pass away. Oftentimes we will include favorable purchase terms to help the farming heir cash flow the transaction.

Alternatively, if a farmer funded a buyout with a promissory note, the farmer’s estate plan could also forgive the debt after his/her death. Or, the plan could allow the payments to continue, except the payments now would go to the off-farm heir. Every now and then a farming heir may purchase life insurance on a parent to fund a buyout when the parent passes away. Life insurance can give the next generation some quick cash to pay a sibling for his/her share of the farming business.

Most importantly, if you are going to complete a buyout while a parent is still living, it is essential your estate plan be revised to reflect the buyout. The last thing you want is for a farming heir to pay for assets twice due to an out-of-date estate plan If your estate plan or business documents feature a buyout of land or a farming operation, take some time to review those plans to make sure they still satisfy your goals. If necessary, review the buyout plan with your attorney and accountant.