Families owning large farms are often faced with the dilemma of how these assets should be transitioned to the next generation, who often have a differing appetite for a rural lifestyle.
"Drafting is the selection of a person, animal, or groups of either; and relocating them for a certain purpose"
Farmers are regularly drafting their livestock, with lambs selected for the works and older ewes identified for a life on lower flatter pastures.
Rural families also go through an internal ‘self-drafting’ process where children develop a life path that may see them remain on the farm (“farm child”) or opt for a new career and a city lifestyle (“non-farm child”).
Open Decision Making Process
The openness of the process that the family uses to discuss the future farm succession and distribution of family wealth will not only assist family members to make informed decisions, but will also in many cases determine the quality of the future relationship between family members.
When there is differential involvement of children through the decision making process, which often occurs when the children taking over the farm are involved in the decision process with the exclusion of their non-farm siblings, an unhealthy degree of sibling conflict can develop.
Equalising Risk and Quantum of Inheritance
Rural assets traditionally deliver a lower and often more variable yield on capital invested. In many cases, the majority of capital growth that has been experienced by farmers has not been a direct result of on-farm improvement, rather related to a change in agri use or zoning of the underlying asset. There is no certainty of continued capital growth in the rural sector.
When considering a succession plan and the distribution of inheritance to children, senior family members must assess the assets that are being distributed and the risks associated with these assets.
Children taking over the farm with higher risk and uncertainty will likely receive a greater quantum than children, who for example, receive real estate that has been leveraged against the farm.
The “Family Farm Co” vs Division of Family Assets
Farm owners may decide to keep the farm “in the family”, implement an appropriate management structure which will likely include some but not all children and implement a governance structure that allows for all children to have a say in the long term direction of the farm. Children would receive dividends from the farm subject to agreed liquidity parameters.
While this option may suit the children staying on the farm as they effectively can replace bank debt with capital from other family members without the need to pay interest. This option is however less likely to be supported by family members who are not working on the farm as they will often prefer to have direct control over the investment and management of their inheritance.
Timing of Inheritance
As farmers make a decision to bring the next generation onto the farm in a day to day management capacity, they will also often see this as the appropriate time to define and implement the process for distribution of wealth to non-farm children.
While the release of equity to children may be staged, providing certainty to all children as to how the family wealth distribution will occur will be essential.
If the family members who opt to stay on the farm are provided with earlier financial assistance, then it will be seen as only fair that other children are accorded the same certainty over opportunity.
New Zealand farmers are an aging demographic, with most farmers having much of their wealth invested in their farms. They need to access some of this capital for retirement. In most cases, the transfer of a farm to the next generation will in be planned and executed well before the death of the senior family members.
“It may not always be possible to treat your children equally, however they must be treated fairly.”
Historically in most cases, the control of farm assets remained with the eldest son, requiring subsequent family members to either take a role of employment on the farm or embark upon a non-farm career path. Many of these historical transfers were seen as inequitable by children as they perceived an unfair distribution of the family’s wealth.
While it is will be difficult to be seen to deliver full equality when children choose different paths, as a parent or senior family member, it is important to have all children actively involved in the decision making processes so that each family member knows how the process pwill affect them and making them more likely to support the process outcomes.
Once the decision has been made on how assets will be distributed, it is then necessary to determine how the distribution will be funded and how capital will be sourced to fund the senior family members retirement.
In some cases, there may be equity reserves available which can fund retirement and which can be used to fund payments to non-farm children, allowing the residual farm asset to be transferred to the family member with a combination of bank and debt from the senior family member.
Alternatively, a decision may be made to downsize the farm through a partial sale, providing cash liquidity for farm owners retirement and some cash for distribution to children.
Another alternative is to use the farm to provide equity to support the purchase of other higher yielding assets,
eg commercial property which will deliver cashflow and asset growth to non-farm children.
Use of Leverage to Facilitate Inheritance
The amount of debt which a farm can support will be limited by cash flow, rather than by the value of the assets.
It is often possible to use this residual equity to acquire cash flow generating assets that can be distributed to non-farm children in the future.
As a specific example, a farm owner who wishes to provide some capital to a non-farm child, may use equity in the farm to purchase a commercial office building, which may have a return well in excess of bank interest rates. Through a leveraged acquisition, and with surplus annual cashfow going to debt reduction, equity in the assets will grow. In addition, rental growth in the building may see an increase in the asset value, which will likely occur at a faster rate than the underlying growth in the farm asset.
This process can also assist farmers to balance the perceived inequality of wealth distribution between farm children and non-farm children, as the capital value required to deliver equal income from a building may be significantly lower than the asset value required to generate the same income from a farm.
Factors to Consider
There are a number of factors to consider, including:
- Consult with family members from the outset, to ensure all family members buy into the process and own the outcomes.
- Plan retirement and incorporate your proposed financial requirements into your farm succession plan.
- Children (non-farm) must understand how the future wealth distribution process will benefit them at the time when the farm is transitioned to the farm children.
- A transparent and open process around farm succession and inheritance transfer will assist in stronger relationships between siblings in the future.
- Understand risk of relative assets classes (farms vs buildings) and the use of leverage, to assist with delivering fairness to farm and non-farm children.
- Perceived equality of inheritance between children is preferable, while fairness between children is essential.
- '‘Fail to plan’ and you will ‘plan to fail’.
Download a PDF of this Article
Families and Business Series, by Ocean Partners