The best strategies to use when transferring the farm to the next generation
Farm succession and transition is always a difficult topic that no one wants to think about, but it's too important to forget – especially now in the midst of a pandemic, when having a plan for your business is more important than ever.
Shannon Ferrell, an associate professor at Oklahoma State University specializing in farm transitions and ag law, offered insights for farm families considering the transition during a UW Madison Division of Extension webinar Monday, Jan. 5.
Ferrell said it's extremely important that the owners and operators of each farm – "Mom and Dad" – get started early when it comes to retirement age and end-of-life preparedness. And even when a family member passes away suddenly, there are still ways to handle the transition, Ferrell said.
He shared that earlier this year, a woman's husband passed away from COVID-19 in the hospital, and in six hours he was able to put together a will and estate package, take it to the emergency room and then finalize the plan over a video chat with nurses acting as witnesses and a notary.
"It just kind of shows you that in these times, it may be strategic planning or at least it may be enough of a motivation to get people to do the critical things to get their estate covered," Ferrell said. "I just want to make sure that everybody is as equipped as they can be to rise to those opportunities."
A team of researchers, along with Ferrell, completed a simulation study that looked at different ways to distribute the pieces of the farm to successors, including many different kinds of farms with varying levels of income. Some strategies worked, while others mostly failed.
Ferrell said the most common strategy used in real life by transitioning farm families was actually one of the least successful during the simulation. He said 64% of farm owners divide their farm assets equally among their children, regardless of if they all plan on continuing the farm themselves. He said this is usually not a good strategy, especially if your operation only has recurring operating debt that is paid off regularly.
"They're forcing the farm to buy the farm back from itself, and it was probably pretty close to debt free," Ferrell said. "Matter of fact ... we looked at the moms and dads who would be about to transition the farm to the next generation (and) the only debt they had really was operating debt which they were probably paying off on a fairly regular basis. People are choosing a strategy with the lowest chance of keeping the farm intact."
While it's crucial to make sure the farm does not lose significant value during a transition, Ferrell said many families find it even more important to maintain good relationships with their family members, especially between parent and child. While some parents may want to divide their farm equally among their children because they don't want to display favoritism, they should also take into consideration each child's willingness to invest in the farm and continue working on it, since some children may not want to continue doing farm work.
By dividing assets equally, parents are putting their farming children into a tough position by having to buy the rest of the farm from their siblings who are not interested in maintaining the farm, which can lead to serious cash flow problems, since the purchasing sibling simply may not be able to afford it.
"I obviously care about the assets of the farm, and if I've got a lot of assets to transfer, that's great for the generation that's receiving them – if they're receiving them without having to buy them back again," Ferrell said. "But if I'm giving someone a really large form asset value that's got pretty low cash flow, I'm not sure they're going to be able to buy it off of their fellow heirs."
Instead, Ferrell said parents should consider giving children interested in the farm all of the farm and/or operating assets, while giving their uninterested children non-farm assets of equal or less value, but giving them both equal ownership of the land. This way, there would still be an equal amount given, but with much less of a burden on the successors.
Another strategy, which Ferrell calls the "lifetime farm transfer," involves children interested in continuing the farm making payments over a certain period of time to their parents that would essentially be buying shares of the farm, as the parents decrease their percentage of ownership. Ferrell said 20 years was the period given in the simulator, although this can be tweaked to fit any plan.
These strategies also varied in success depending on the ability to pay off debt every few years, according to the simulation. Many farms failed when they divided assets equally among children when they were also paying off all debt every three years; only farms that are able to generate high amounts of cash, like corn farms, were able to successfully make the transition. This strategy also failed if no operating debt was incurred.
"You can't do it without incurring debt somewhere along the way, and of course that obviously had an impact across the other strategies as well," Ferrell said. "When we look at the US farm asset base, about 86% of it on average is land. So we've got to deal with land in some way, but if we can find some way to avoid buying the land back from ourselves, but still use it to provide some sort of return for the heirs that we want to provide for, we've got a much better chance of making it."
Ferrell said the strategy that consistently worked the best across farm types and incomes in the simulator was only giving farm assets to children interested in farming, but dividing land ownership equally among them. He said that it was the most successful because it prevented farmers from "buying the land back from ourselves" over time. This strategy also worked well when not incurring operating debt.
Farmers should also consider their ability to turn assets into direct cash flow, Ferrell said, which could make a big difference in the ability to make a clean transfer. He said in one example, a farm that divided its assets equally among successors suddenly lost half its value during a transition of ownership because one sibling was forced to purchase half the farm from the other sibling, losing $4.75 million in value.
It's also OK to be transparent about contributions (or lack thereof) to the family farm, Ferrell said, because it's important to recognize that some successors may not need as big a share as their sibling if they don't contribute as much to the farm's success. It's also good to give your children a choice whether or not to invest.
"One of the most important things that we can do is give people a choice. If (the) city kid never came back (to the farm), is that because they just flat out had no interest in the farm, or did they just not see a pathway, that there was an opportunity for them?" Ferrell said. "Maybe they said to themselves, well if my brother and sister's already in the farm, there's not enough there for me."
Ferrell said that as more farmers are finding more off-farm jobs and creating extra income that way, they are also gaining more benefits like retirement accounts, which helps generate financial assets to pass on to children who aren't interested in farming.
And even without thinking of succession, the diversification of assets is a good thing, because you don't want to have all your eggs in one basket – Ferrell said having investment accounts allows you to have something to fall back on as the farm gets harder to maintain in old age.
"That is important not just for having income stability for Mom and Dad as they retire and draw back from the operation, but it's having a diversification of risk," Ferrell said. "If all of your eggs are in the farm basket, you've concentrated a lot of risk, and it would be nice if you could diversify that out to have an income stream that's not dependent on farm commodity prices."
A decision tool from Oklahoma State University on farm succession plans will be available in late 2021, and the full study is pending publication.