As you consider the best way to transfer the ownership and management of your ranch to a successor, knowing what your future goals are can help determine if the legal structure of your business should also be modified.
As part of this process, ranch families should examine the current organizational or managerial structure of the business. This is a reflection of how decisions are made and who is responsible for what, according to Michael Langemeier and Rodney Jones, agricultural economists with Kansas State University and Oklahoma State University, respectively.
“Most ranch businesses are more complex in terms of investment, cash flow and gross sales than people think. I would recommend that ranch families think of their businesses just as they would if they were businesses in town,” says Barry Dunn, executive director of the King Ranch Institute for Ranch Management. “If a family ranch business has multiple families involved, having a board of directors, appointing people in the business to distinct roles, creating job descriptions and standard operating procedures, and regularly communicating financial information is very helpful. All of these steps help the process of transitioning wealth and management by building communication and structure.”
Major changes in a farm or ranch business such as distributing assets as part of an estate plan may dictate changing the legal organization of your business. Understanding the different options can help guide decisions on what structure best meets your needs.
“Are you looking for a structure to reduce estate tax burdens, one that will help you transfer assets to a successor or something that shields you from liability?” says Dave Goeller, assistant director of the North Central Risk Management Education Center. “If you know what you want to accomplish, then a good advisor can tell you what type of structure will get you there.”
This is the most common form of business organization for agricultural operations. The business is limited to the life of the owner, and the individual is responsible for all debts and obligations. According to Jones and Langemeier, there are multiple advantages to this structure, including ease of startup, flexibility and minimal legal reporting requirements beyond income tax filing. “The disadvantage is that the sole proprietorship terminates with the death of the owner, and this ‘life cycle’ disadvantage makes a sole proprietorship one of the least effective structures for maintaining the overall farming operation at peak efficiency when transferring the business across generations.”
An unincorporated partnership operates in much the same way as a sole proprietorship with regard to legal and tax liabilities. Two or more people contribute assets and share management of the business. A partnership agreement should designate how income and responsibilities should be allocated.
Some agricultural businesses may choose to create a limited partnership, which can reduce the liability to the individuals involved. This form of partnership is more formal in structure, and creation requirements are dependent on the state where the partnership is formed.
If you are analyzing scenarios for estate planning, Goeller recommends that you consider the viability of a future business structure for your heirs. “You need to ask yourself if your operation is big enough for all of the potential successors to be involved or to even own an interest.” Often the answer is no, and Goeller says that for the long-term viability of a farming or ranch operation it is often better to reduce the number of successors rather than continually expanding the number of parties in each estate transfer. “If the success of the operation is important, then any of your heirs who are not currently involved in the operation should not automatically inherit an interest in the farm.” You should consider finding other ways to include them in your estate.
Goeller also says that anyone considering entering a partnership “should know how to get out before they ever get in.” In other words, it is important to have good exit mechanisms such as buy-sell agreements to account for changes in relationships, business dynamics or personal situations.
Many farm and ranch families consider incorporating in either subchapter S or subchapter C corporations. There are certain advantages to a corporation, including the ability to sell or transfer interests, which can facilitate estate planning, according to Jones and Langemeier. However, corporations are expensive to start and have more stringent administrative requirements.
Limited Liability Company
This business structure combines positive attributes of a corporation and a general partnership but can be complex and expensive to set up.
There is no “one size fits all” approach when it comes to determining which legal business structure suits both your management style and your farm or ranch. To make the most effective choice, it is important to have a clear idea of both your goals and those of any potential successors.