Over the next two decades, it is estimated that 70 percent of U.S. agricultural land will change hands, either through sale or transition to the next generation. While most producers express a desire to see their family operations continue beyond their own life spans, the planning required to successfully do so is, for many, a daunting prospect.
For ranchers who have spent their lives building or maintaining a workable operation, the thought of being unable to pass it on as a viable business can be a chilling one. Yet, studies have shown, this is what happens to a majority of farms and ranches as they transition to the next generation.
According to a survey conducted by the Family Business Institute, only 30 percent of small businesses nationwide, including farms and ranches, survive into the second generation. Just 12 percent make it to the third generation.
While there are many reasons for this transitional failure, one of the primary causes within the agricultural sector is a lack of adequate estate planning. According to a 2015 survey by USDA, while 69 percent of surveyed farms and ranches expected to continue into the next generation, only 23 percent had a plan for doing so.
This lack of planning is perhaps not surprising, given the complexity of the issue. Succession planning presents a unique set of challenges, encompassing complicated economic and legal decisions. While relatively few ranchers may think of their operations in terms of assets and capital, that is how they will be treated legally, and it is under those terms that decisions must be made.
Beyond the minutia of the business aspect, succession planning is also a family process, which can present its own difficulties. Anxiety and discomfort over the family aspect alone can be enough to leave ranches kicking the problem down the road, often until it is too late.
However, experts caution that, difficult as that conversation may be, the consequences of not having it are nearly always disastrous.
Having the talk
It’s not a discussion anyone is looking forward to. The younger generation may not want to appear overeager or greedy for an inheritance, the older generation may be wary of sparking a family dispute, and nobody wants to think about mortality, much less discuss its finer points.
With so much potential for discomfort, it can be difficult to know where to start. According to Marsha Goetting, a family economics specialist with Montana State University (MSU), to begin the process, someone needs to speak up.
“There’s ways to start the conversation, and it depends on the family,” she says. “But eventually, someone just sits down and says, ‘You know, we need to do this.’” A good place to start, says Goetting, is by having the individual families of each generation clarify their goals and hopes for the future, before the family meets as a whole.
“You can’t have a big family meeting if the inner families haven’t had the discussion and worked out their goals first,” she says. “Do they want to stay? Is it predetermined that Johnny is going to get it even though Sally is the one living there? Everyone should know what they want going in.”
This also includes detailing who will be in charge of decision-making for various aspects of the business, and at what point these responsibilities will transfer from one generation to the next.
While a key step, it does require every party to know what they want. When this isn’t the case, Goetting does caution against letting this process drag on forever. “It’s about getting down to reality, and it can be a challenge with someone who may not really know where their life is going,” she says. “But if we wait around as a family for that individual, things will never happen.”
If personalities tend to clash, Goetting recommends getting outside help, perhaps even hiring a facilitator, so that someone is not put in the position of being the de facto leader, and no one person can take over the conversation. “If you’re not careful, suddenly you’re the bossy one, or the troublemaker, or whatever,” she says. “But you’ve got to get past that.”
When multiple siblings are involved, Goetting says that she often sees parents falling into the trap of confusing equal with equitable, particularly when one or more siblings have been working on the ranch, while others have not. “At some point, you’re going to hear Mom and Dad say, ‘We love all our children equally,’” she says.
“But ideally, parents should realize that, from the point that a child has been involved in the business, they have been contributing to its growth. It’s appropriate and equitable to arrange a larger share for those children who have been involved in everything that’s going on.
“What you don’t want is for someone to have enough shares to screw up the decision-making when they aren’t there,” she adds.
“If the state ends up dividing the estate, they will simply carve it up equally.”
The worst possible thing to do, emphasizes Goetting, is nothing. “If the state ends up dividing the estate, they will simply carve it up equally,” she points out. “You can always do a better job than the state, because you know your family, and you want the business to survive.”
Making a plan
When planning for transition, most experts paint a line between succession planning and estate planning. Under this delineation, estate planning covers all of the actual transfer of asset issues. All of the legal documents, formation of entities, tax mitigation strategies, etc., fall into this category.
Succession planning, on the other hand, covers the family aspect of the business. How will decisions be made, who will be in charge of various aspects of the ranch, how will disputes be resolved, and the like. All the things, in other words, that should be brought up during the family discussion.
While this really is two separate issues, the two plans must work in concert. Or more correctly, the estate plan must accurately reflect the goals set forth in the succession plan. While the succession plan is a family decision, the estate plan is a complex process that may require both legal and accounting advice to accomplish properly.
There are numerous avenues a ranch can take to achieve their goals, and the right path depends not only on the nature of the business, but also on the wishes and goals of each generation. In the most traditional scenarios, the initial generation sets up some type of corporation, dividing shares among the heirs. While this approach can be equitable, experts like MSU’s Goetting caution that care must be taken to avoid trouble down the line.
For one thing, it must be made clear what happens to those shares when a sibling dies. This is particularly true if all siblings have a decision-making interest in the operation. If those shares are divided among more and more people as they pass from one generation to the next, decision-making can become a cumbersome, if not impossible, prospect.
“Just because a ranch is worth x, that doesn’t necessarily mean each family member gets that amount.”
If there are siblings who are more interested in inheriting a financial windfall, that should be made clear up front, and there may be steps parents can take to address that. If possible, says Goetting, a family should try to avoid putting siblings in the situation of having to buy each other out.
“I see a lot of parents who are still paying off a sibling themselves turn around and make that same mistake with the next generation,” she says. Under this scenario, a family can essentially buy the ranch from itself any number of times over the generations.
“Just because a ranch is worth x, that doesn’t necessarily mean each family member gets that amount,” says Goetting. “I’ve seen systems where each sibling got a percentage that was equal to the rate of return for the farm.”
Another fairly common approach is to divide the estate, leaving non-farm assets such as life insurance or investments to those siblings not wanting to work the ranch. At a minimum, says Goetting, it needs to be ensured that the other siblings have first right of refusal if someone wants to “cash out.”
“You don’t want to have to start selling pieces off and hurting the viability of the business.”
One of the most often brought up concerns when making an estate plan is the estate tax. Currently, the federal estate tax has an exemption of roughly $11.4 million. At this level, stresses Goetting, relatively few ranch estates are likely to be subject to it. In the absence of further legislation, however, that number will revert to $5.5 million in 2025.
Operations that do carry that much value can find themselves faced with a tax bill that may not be serviceable without selling off significant assets. Additionally, three Western states, Oregon, Washington and Nebraska, still have some type of estate or inheritance tax, which can be equally devastating. Oregon, for example, collects 10-16 percent of everything over $1 million in value.
While this tax cannot be avoided, it can be offset, either by transferring as much value to the heirs as possible prior to a parent’s death, or by setting aside money to cover the expected cost. Life insurance is often used as a vehicle to accomplish this, although experts point out care must be taken to ensure that the policy must be structured so that it does not itself add value to the estate.
Despite what may happen, Goetting advises planning for current circumstances, whatever those may be, and changing the plan as changes dictate. “Over a period of decades, there’s going to be change,” she says. “What might have been a good decision then isn’t necessarily the right choice now.”
Conclusion
“In the end, you have to keep the main goals in mind, a continuing business, and a family that’s still talking to one another.”
While there is no one right way to plan for the next generation, there are methods that are more successful than others. According to experts, the most successful plans are those that transition responsibility and ownership gradually, over a period of years, rather than in one big shock when someone dies. They contain a clear set of goals for the business, as well as the expectations of everyone involved.
Successful plans are also ones that contain a high level of forward planning, rather than leaving it up to the children to figure out on their own. “If I had a nickel for every parent who said their kids would get along after they died, only to have it blow up, I’d be pretty wealthy,” says Goetting. “In the end, you have to keep the main goals in mind, a continuing business, and a family that’s still talking to one another.”
