Using Multiple Entities for Transition of Farming Operation
A challenge that many farm families face is how to bring the next generation of farmers into the farming operation. In addition to the challenges of management, delegation of responsibility and communication, the intensive capital nature of farming presents a unique challenge to many farm families. That is, how to bring a 25 year-old into a multi-million dollar farming operation? The next generation farmer may not have the resources to buy into the farming operation. Also, the current generation may not want to make a large gift to get the next generation into the farming operation. Using multiple entities can help reduce the challenges of this situation.
Let’s start with a typical farming operation that has all assets under common ownership, either as individuals or an entity. The value of this entity is the combined value of all the farm assets. For the next generation farmer to gain ownership in this operation, the total value of the farm assets is used to calculate their buy in or gift. This scenario is illustrated in the following diagram:
In this scenario, Mom and Dad own all the farming assets in their names. The total farming operation is valued at $3.5 million. For Daughter to even enter the farming operation as a small percentage owner, say 10%, she should either need $350,000 to buy into the operation or Mom and Dad would need to gift her $350,000. Also, Mom and Dad may be reluctant to give Daughter part ownership of the machinery and land in event Daughter ends up not staying on the farm.
To overcome this difficult situation, the farming operation is divided into three separate entities. The operating assets are held in an Operating LLC, the machinery in a Machinery LLC and the land in a Land LLC. By dividing assets among multiple entities, the total value of the farming operation has been divided among the entities. See the following diagram:
Each entity has a value which is considerably less than the total value of all farm assets. Now, Mom and Dad can bring Daughter into the Operating LLC as a 10% owner for only $50,000. Daughter may have $50,000 available for a buy-in or, more likely, Mom and Dad are more comfortable making a $50,000 gift. Also, it may be possible to get the Operating LLC to a near $0 value by distributing out the cash and grain to Mom and Dad before Daughter enters the operation.
The entity diagram after Daughter becomes an owner in the Operating LLC is as follows:
Daughter has become and owner in the Operating LLC and can help with management and decision making for the farming operation. However, Mom and Dad retain full ownership and control over the machinery and land. Perhaps after a few years, when Mom and Dad are more confident Daughter intends to stay on the farm, Daughter begins to buy into the Machinery LLC or is gifted ownership. Or, perhaps Daughter eventually buys her own machinery for the farming operation. The same can be done with the land LLC.
When bringing in the next generation into the farming operation, a multi-entity should be considered. It is a good method for the next generation farmer to enter the farming operation without the burden of accounting for the value of all farm assets. It also allows the current generation to maintain ownership and control of the more important farm assets.