Volume 8 • Issue 10 • November 2018
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. This month’s issue is the last installment of a four-part series about the farm succession process. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
This month’s newsletter will discuss the fourth and final phase of the farm succession process, implementation. In Phase 1, you assessed where the farm is now. In Phase 2, you made goals and determined where you want the farm to be in the future. In Phase 3, you created a written farm succession plan, the road map that will get you from where you are to where you want to be. Now it is time to implement your farm succession plan.
The Four Steps of Implementation. Implementation involves four steps that can be identified as follows:
- the testing phase;
- the commitment phase;
- the established phase; and
- the withdrawal phase.
The Testing Phase
The testing phase is the period where the incoming owner and the departing owner work together to determine the compatibility of the relationship. In many farm transitions, this phase has already begun, albeit without intentionality. The transfer process will involve the transfer of labor, income, management, and ultimately ownership.
While most incoming owners have proven to be great at labor, management remains an unknown. Some great employees can never make the transition to management and ownership. The testing phase allows for the gradual transition of responsibility while the current ownership group remains firmly in control.
During the testing phase, compensation is generally going to be wage based. If an organizational chart is not in place, one should be created with detailed job descriptions. The potential successor should be provided with a clear understanding of what his or her responsibilities will be and what the expectations are. If sweat equity is part of compensation, it should be discussed frankly so that all parties understand. In providing specific responsibilities, care should be taken to include exposure to management decisions and responsibilities.
Historically, the farm may have operated in a family structure. During the testing phase, effort should be made to separate business issues from family issues. Finally, during the testing phase, in addition to learning the management abilities of the incoming farmer, the parties should assess the financial capacity of the farm. Normally, the farm income will need to be increased as it moves from supporting one family to two or more.
The road map created during Phase 3 should provide the time the parties expect to spend in the testing phase.
The Commitment Phase
The commitment phase begins when the testing phase concludes and when both the incoming owner and the departing owner have committed to continuing the farm operation. It is often appropriate at this point to review estate planning and, if not in place already, put a will or trust in place that will allow for the continuation of the succession plan through completion in the event of an untimely death.
During the commitment phase, milestones and markers in the farm succession plan are honed and given more depth and understanding. Increased management responsibility should be placed upon the incoming owner. It is often appropriate to begin moving away from a wage based model to a compensation model that involves sharing of income. This will help the incoming owner begin to rely less on his or her parents and gain an understanding of the inconsistency of owner compensation. Time should continue to be spent assessing and evolving the financial model of the business. The parties should be visiting with professionals and learning of options to transfer assets and changes to the business structure that may be necessary.
Again the road map created in Phase 3 should provide for the expected time spent in the commitment phase.
The Established Phase
Moving into the established phase, the successor will be providing more of the work and will have taken on substantial management responsibilities. The transfer of assets should begin during this phase. Usually the transfer of assets will begin with equipment and livestock. It may involve the incoming generation replacing equipment as it wears out or starting their own herd. Land can often be the most difficult asset to transfer and can extend beyond the transition.
Each generation’s needs must be balanced and planning should be undertaken for retirement of the departing owner. Not just financial planning, but planning for what comes next. This can be a time when the process gets rocky. There may be a reluctance on the part of the departing owner to follow through on prior commitments. This reluctance may come from many places including a fear of being obsolete or a fear that there is insufficient income for the incoming owner to succeed. Obstacles will appear in many places.
The Withdrawal Phase
Withdrawal is the final stage. By this point, management of the operation should be fully in the hands of the successor. A plan should be in place to ensure the total transfer of assets. This may occur over time, but it should be locked in so as to eliminate the possibility that the rug can be pulled out from under the incoming owner. Estate plans should be updated as necessary to reflect any changes that have occurred and all other legal documents should be in place. As part of this process, a plan should be in place to deal with the possible long term care needs of the departing owner. This could include insurance or a commitment that the farm will cover any nursing home costs. This could also include a commitment from the son or daughter to care for their aging parents.
The departing owner now moves from management and ownership to complete disengagement or a more limited role as an employee of the farm operation.
With the conclusion of the withdrawal phase the farm succession from this generation to the next is complete, but the succession planning is not over. Now it is time for the incoming owners to turn their attention to who will take over from them and the process repeats itself. You cannot guarantee success in succession planning, but you can take the steps that will make success much more likely. You can also avoid the missteps that will ensure failure. Missteps can include: not communicating, not training, not transitioning management, not analyzing the numbers, and not having an estate plan. Communicate, communicate, communicate. Nothing is more important. Involve a qualified farm succession coordinator to help you move through each of the four phases. Don’t take counsel from your fears. Succession planning doesn’t have to ruin the family. Success is possible, even likely, if you follow the right process.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.