The Messy Middle of Farm Succession Planning

Introduction How would you describe your attitude or emotions to the words “farm succession planning”? Excited, hopeful, motivated? Or maybe the words that come to mind are apprehensive, stressed, or conflicted. Perhaps at different times all these words can be used to describe your attitude about farm succession. Transferring the assets and management of the farm business is what I call “Big Change”. It can be exciting to think about the business continuing to the next generation and even good things are stressful when there is Big Change connected to it. Big Change Big Change like farm succession is not going to happen overnight and it will involve making space for new goals, visions, and ideas. I’ve worked with farm and family members when they have first recognized the need to talk about succession. They are motivated and excited to start– and maybe they are even a little bit relieved that they are starting the conversation – because it may have felt like succession planning was “the elephant in the room”. Then the farm members get to that place where they face some tension points – it might be the financial capacity of the business, or the balance of inheritance needs to be discussed. Or it might be that the successor generation wants to bring their management ideas and opinions to the table.  This is where farm members start feeling a bit unsettled. They can’t keep moving forward on a linear path to an immediate decision. But now the elephant is not only in the room, but it is asking for a seat at the table! The Messy Middle or Groan Zone Feeling unsettled and perhaps not having a clear direction of what to do next brings us to the Messy Middle. The Messy Middle is a term I first learned about from a Brené Brown podcast, Brené on Day 2, as the term for the middle of any experience where things get rocky, or we hit a wall. She compares it to a three-day conference.  Day One is all excitement about new ideas, concepts, and new possibilities. Day Two is the “oh, crap, how is this going to work in reality” day.  But we need Day Two to get to Day Three.   When thinking about this in regards to group decision-making, Sam Kaner and his colleagues call it the “Groan Zone” in their book, Facilitator’s Guide to Participatory Decision-Making. This is the time after differing ideas and opinions are voiced and there isn’t a clear path on how to take the best pieces of each idea and synthesize it into a decision or a plan. On the left side of the image is where the issue, problem, perhaps succession discussion, or opportunity comes to light. The blue dots are familiar ideas or opinions. And maybe you have others who are now a part of the discussion, and they are bringing new ideas and opinions to the table as well. In this drawing these new ideas are the pink asterisks. These differing ideas lead the group into what Kaner calls the “Groan Zone” and Brown calls “The Messy Middle”. The Messy Middle sounds like something nobody wants to go through, right? This is the point where farms might stall-out and perhaps drop the discussion. It’s where you may want to stay in your comfort zone and continue making decisions and managing the farm in the familiar patterns of the past. I want to challenge you to stick with the process and sit with the uncomfortableness. A Facilitator Can Help You may need a facilitator or someone outside the business and family to help you move through the Messy Middle – which is where deeper conversations and mutual understanding of the needs of the farm and family members can be discovered. Mutual understanding can lead you out of the Messy Middle into the right side of the drawing, where the best of all the ideas and opinions are examined to decide which one or combination of them will best address the issue or stressor you’re trying to address – and when that’s done, the fun part of planning and acting on decisions can happen. But if you try to avoid the Messy Middle, you risk leaving great ideas on the table unexamined and you risk leaving key people out of the decision-making process. Farms that skip over this part of the decision-making process may be able to move forward for a while. However, ignoring it won’t make the issue go away. In succession planning, skipping over it may mean that you’ve made promises or entered a business arrangement that you now wished you hadn’t. Skipping the Messy Middle may drop you into a bigger and more expensive mess you have to unwind. The Main Points are when you get to the Messy Middle: Don’t panic! And now you have a name for that unsettled feeling so you can acknowledge it and dig in a little deeper. Resist the urge to go back to the left side and pick an idea because that feels comfortable. Resist the urge to skip over the Messy Middle – and think you’re fast-forwarding the process – you need the Messy Middle! While the Messy Middle and the Groan Zone have slightly different contexts, they both emphasize the importance of embracing discomfort and uncertainty as a necessary part of any process of change or decision-making. Both Brown and Kaner argue that by acknowledging and working through these challenging phases, we can ultimately become more resilient and better equipped to handle the challenges that come our way. Are you interested in some of the resources referenced in this article? Contact PA Farm Link today to request your copy of “Cultivating Your Farm’s Future” workbook and companion guide. This workbook contains invaluable tools to help with your farm’s succession planning. Reach out to PA Farm Link today!

Sweat Equity and Farming

Introduction A part of the Cultivating Your Farm’s Future program In farming, sweat equity is a term that is loosely used to define how established farmers use payment of a commodity or capital assets to replace some of the cash wages for employees. Sweat equity is also the term sometimes used to compensate a successor for years of labor and management that helped build the owner generation’s wealth. It can be used to justify gifting personal, titled property, or giving a discounted price when the property is eventually sold to the successor. When considering labor compensation in forms other than money, the goal of both the employer and employee should be analyzed to ensure it is an appropriate compensation package. Sweat Equity used for Commodity wages Forms of commodity payments include: Immediately consumable meat, milk, eggs or other food items in place of a cash wage A commodity of grain, milk or animals that will be sold and eventually converted to cash Breeding stock that can either remain in the employer’s herd or used to start the employee’s own herd Transfer of ownership or a percent interest of ownership in a capital farm asset If the employee’s goal is to learn more about the farm business and gain management skills, commodity payments can provide a way to allow him/her to make management decisions on a smaller scale. Sweat equity payments in the form of commodities can help the employee gain experience in the management and marketing of the commodity. One example would be the payment of grain allowing the employee to make decisions of when and where to market that grain. Market livestock can provide additional skill development as the employee makes management decisions to raise the livestock to market weight. From the employer’s perspective, skills development can translate into a better employee who can be given more responsibilities. In addition to skill development, the employer may not have the cash flow to completely compensate the employee, but can provide the commodity as part of the wage package. Finally, there can be income tax savings if a portion of the wage is in the form of a commodity. However, if this is the main or only goal, the parties should consider if the tax savings is large enough to warrant the work required to document and adhere to the income tax rules. If the employee’s goal is to eventually manage their own herd, payments in breeding stock may be a viable option. Again, this provides the opportunity for him/her to develop management skills while the farm manages cash outlays for labor. With this option it is important to consider where the animals will be housed. In the case of a dairy, if animals stays in the original herd, but are owned by the employee how will feed and other ownership costs be paid and how will milk income be distributed? The employer must consider the long-term implications of the employee’s animals remaining in the herd and taking facility space from the owner’s herd. The employer should determine if they can manage the loss of the income? Or does the owner need to calculate overhead costs and charge this expense to the employee? Sweat Equity used for Succession When the goal is to slowly transfer business assets to the next generation, sweat equity can provide the transfer of assets or percent interest in assets to the successor. For example, breeding stock can be transferred to the successor over time allowing them to own a significant portion of the herd. This mode of equity transfer can be facilitated by forming a business entity that owns farm assets as shares or interest. These shares or interest can then be transferred to the successor. This option, when clearly outlined in a farm succession plan, can provide the successor generation a guarantee that the assets will be transferred. This guarantee removes the speculation that surrounds a verbal promise of “Someday, this will all be yours”. Sweat equity can also relieve the pressure of cash flow on the operation if the successor can manage their living expenses with a smaller paycheck. One thing to consider with this option is how much of the assets can and should be transferred in this way. Is the owner generation dependent on these assets for retirement? If the answer to this question is yes, how much of the assets can be provided in trade for labor? How much needs to be retained by the owner or be sold to the next generation for cash to fund retirement needs? Valuing Sweat Equity Sweat equity is as valuable as cash equity and should have a one-to-one conversion rate. Therefore, it is important to correctly value the items being given as sweat equity. Some commodities have a worldwide market and their value can be more easily determined by this market value. Other commodities produced on farm such as cattle are not as easy to value. While market can be used to determine an animals worth, this may be undervalued if the animal can command a premium above what they could be harvested for. For example, cattle with high value phenotypes or genetics can sell for much higher than market value. It is important to have production records on these animals including milk, fat and protein to determine the value of these animals. In addition, rolling herd average and classification scores can be useful marketing tools. In addition, cattle can be appraised to determine their value. This is most commonly done for insurance purposes but also can help determine a baseline value of your herd. To assess the animal’s worth, the appraiser will evaluate the quality of the animal. This can include a comparison of your animals to animals of similar quality that have recently sold. An appraiser may use a calculation to determine fair market value. This calculation will be specific to the type of cattle, cow or replacement. Milk cow appraisal includes future milk production, future calf production and the current

Identifying Strategies to Maximize Potential and Minimize Risk

Business strategies are practical actions that communicate how a business plans to reach its goals. Thinking strategically about the farm business as a whole helps determine emerging themes, issues, patterns, and opportunities. This allows for proactive management and helps maintain more control over what happens to the farm. Goals are of little value if there is no tactical plan for achievement and no implementation with ongoing monitoring and adjustment opportunities. Develop three business goals Each farm should develop at least three business goals. These are the basis of the farm planning process and should be kept in mind when decisions are being made. Once developed, use them to determine how you get to where you want (and need) to go. This begins by assessing the current farm situation and focusing on worthwhile issues to address. Complete a SWOT Analysis SWOT analysis, a process to determine strengths, weaknesses, opportunities and threats, is one way to establish where you are now and what you have to work with. It helps establish benchmarks for the farm’s current situation so that there is something to measure against moving forward to see if the farm is moving in the right direction. This process also helps you identify strategies to get there. To conduct a SWOT analysis, the farm leadership team identifies internal strengths and weaknesses and external factors that affect opportunities and threats to the business. The objective of this process is to capitalize on strengths and eliminate or minimize the impact of weakness. It is a profit-seeking and risk mitigation tool. Identifying internal strengths and weaknesses The first step to a SWOT is to identify internal strengths and weaknesses of the farm. The strengths are those that give an advantage or opportunity and weaknesses those that stand in the way or limit what the farm can do. Use this as an opportunity to reach out to people within and outside the farm to have a casual conversation about what the farm does well and what it could improve on. Gather feedback on others’ perceptions, and compile industry benchmarks to measure the farm against. It is helpful to rank these in terms of their level of importance to your operation’s competitive advantage. It is also worth looking at how the business has performed in the past (during good times and bad). Look at the financial analysis measures from the last five years, how business decisions are made, and how the farm has been managed. This is the time for an honest self-appraisal. Recognizing external opportunities and threats The second step in a SWOT is to look at external opportunities and threats to the farm. This includes the general condition of the economy (and how it affects the business), input and commodity prices (and trends), federal and state rules and regulations, industry trends and changes, and competition. Creating strategies or action steps The final step and most important part are pulling it all together. Creating a list does not do any good unless it is put to work. Use the SWOT to create strategies or action steps to address opportunities and threats by taking advantage of strengths and minimizing or eliminating the impact of weaknesses. A helpful way to do this is to look for the intersections of strengths, weaknesses, opportunities, and threats in order to maximize potential and mitigate risk. Identify opportunity-strength strategies, opportunity-weakness strategies, threat-strength strategies, and threat-weakness strategies. Strategies that show up more than once might be areas to focus on and prioritize higher.A comprehensive SWOT analysis helps a farm acknowledge and be responsive to opportunities and threats in the current business environment. The business strategies derived from the SWOT should be realistic actions that help the farm reach its goals. Spending time developing goals and strategies, helps a farm adapt nimbly in a changing environment and make proactive business decisions. Getting Started with the SWOT Matrix and Strategy Analysis: Use the worksheet in the Cultivating Your Farm’s Future workbook to analyze the internal and external factors affecting the farm business by identifying strengths, weaknesses, opportunities, and threats and using them to identify strategies to help reach your goal/vision for the future. Additional Resources: “Cultivating Your Farm’s Future” workbook and companion guide. This workbook contains invaluable tools to help with your farm’s succession planning. “Cultivating Continuity“ the companion guide to Cultivating Your Farm’s Future features additional resources. Authors

Farm Asset Division: A 21st-Century Conundrum

The best way to divide farm assets is a challenge that farm families face with each generation of owners. As a parent, we strive to treat and love our children equally, and we want them to know that we love them all the same.  When our children perceive their inheritance as a direct indicator of how much we loved them, it makes dividing farm assets a daunting task. The fear of upsetting one’s children often causes parents to divide farm and family assets equally among all heirs. However, it can be beneficial to look at farm and family assets separately when dividing the estate. Long-term viability for the farm, financial security for the founding generation, and continued family ownership of the farm are documented goals of many farmers1. Research from the Farm Business Institute indicated that family-owned and operated businesses have roughly a 30% success rate in transferring the assets and control from the founding generation to the second generation2. Failure to transfer the business is often caused by a lack or avoidance of planning from the owner generation. This results in the implementation of the state’s succession plan which divides the assets equally among the heirs. Oklahoma State University has created a statistical model that compares various transition strategies and their probabilities of success. The results demonstrate that the most common farm succession strategy of dividing the assets equally among all heirs has the lowest success rate. Farms employing this strategy normally do not continue to the next generation3. Distributive Justice Principles When the owner generation makes decisions concerning farm succession, they are subconsciously considering three principles4: (see What is the biggest threat article for further information) Equality principle: assets are divided equally among heirs regardless of their contributions Proportional equity principle: distribution of assets is in proportion to the heir’s contribution in maintaining or growing the asset Needs-based principle: the heirs’ needs are given primary consideration   Research has shown us that the equality principle does not help us reach our goal of transferring the assets and control to the second generation. Therefore, let us delve deeper into the proportional equity principle and needs-based principle3. Proportional Equity Principle of Distribution Proportional equity distribution relies on an accurate accounting of the heirs’ contributions. Contributions can be defined as money, labor, management, providing care and maintenance on the home and facilities, mechanical repairs, or being a caregiver that allows the aging parents to stay in their home, etc. There are several questions to consider when dividing farm assets based on proportional equity. When do the contributions start? Does it begin when the heir becomes an adult and makes a conscious choice to continue providing labor? Or is childhood labor also considered? Are the on-farm heirs compensated at a fair market price for their labor? Or are they receiving below-market wages with a promise of “making things right” with inheritance? Is this arrangement documented? Are the on-farm heirs adding value to the farm with their labor and management? Is the owner generation growing the business because they know they have consistent labor and additional management? Would this growth happen without the on-farm heirs, and should they be given credit in some way for this increase in wealth? Are the on-farm heirs helping preserve the farm’s wealth by maintaining the asset base?  If they weren’t there, would the owner generation keep the business operating at the same level? Are the on-farm heirs helping their parents age in place? Are they providing services to the owner generation that would otherwise be an out-of-pocket expense and deplete the asset base?   To help us visualize equality vs proportional equity distribution, let’s look at an example from John Baker, Iowa State University and Dave Goeller from the University of Nebraska. In this example, we will use an example farm that has one person in the owner generation and three heirs. Two of the heirs are off-farm and do not contribute to the farm.  The on-farm heir joined the farm in 2000, and we are crediting 50% of the farm’s growth in net worth to the labor and management contributions of this heir. For this example: The farm’s net worth in 2000 is $600,000 The farm’s net worth in 2020 is $3,600,000 What will the distribution of the farm net worth look like using the equality principle? Using the equality principle, each heir would receive ⅓ of the farm’s 2020 net worth.  $3,600,000 divided three ways leaves $1,200,000 for each heir regardless of their contributions to the farm. What will the distribution of the farm net worth look like using the proportional equity principle? Using the proportional equity principle, we would divide the original 2000 net worth equally among the three heirs. The net worth at this time is solely due to the contributions of the owner generation. This gives us a distribution of $200,000 per heir. We would then consider the change in net worth from 2000-2020 and determine how much of the change was due to the on-farm heir. The change in net worth is $3,000,000 with the on-farm heir being responsible for 50% of that growth, or $1,500,000. The owner generation’s portion of the net worth is divided equally amongst the three heirs. This $500,000 is added to the $200,000 from the 2020 net worth resulting in each off-farm heir receiving $700,000. The on-farm heir received $700,000 plus the $1,500,000 for a total of $2,200,000. While this division is not equal, it is equitable and provides the on-farm heir with compensation for their contributions and increases the likelihood of keeping the farm business viable and in the family. Each farm will value the contributions of the on farm heir differently. The questions posed above can help you determine what this will look like for your farm. We recognize that this was a simplified example but hope it helps give you a place to start thinking about what proportional equity may look like on your farm. Remember, you may need to treat each

Control of Farm Management Decisions

Earlier we discussed the importance of transferring management to the successor generation. However, we did not delve into the details of making this transfer successful. To help with this process the University of Wisconsin – Madison Division of Extension Farm Succession educators developed the Control of Farm Management Decisions Worksheet. This worksheet allows the farm owner and successor to rank how important the following are to them: To be involved in the daily operation of the farm business? To be involved in the production decisions for the farm business? To be involved in the marketing decisions for the farm business? To maintain some financial control of the farm business? Once each generation has identified how important the above items are to them today, they are asked to think about how important they may be in 3 years and in 5 years. Once the ranking has been established it is time to talk about what is most important to the owner and most important to the successor. The owner and successor can then utilize the rankings they provided to work on the “Planning Transfer Control” page of the worksheet. If marketing the farm’s soybeans is not very important to the owner generation but it is to the successor then this should be listed as a management decision that will be transferred immediately to the successor. Working on each management decision by order of importance gives the two generations the ability to develop a transfer plan that allows each to hold on to what they feel is the most important, and to make compromises about others. When working through developing a plan to transfer management decisions it is important to realize that management decisions should be transferred incrementally. In the worksheet the owner and successor can select what will be transferred in a year, in two years, and in three years. Having a framework of when management decisions will be transferred will give both the owner and the successor generations peace of mind. Through the incremental transfer of management, the owner generation can gain confidence in the successor generations ability to make decisions that will result in the continuation of the farm the business and their legacy. The successor generation gains confidence in their farm management decision making while utilizing the safety net of the owner generation. At the end of the transition period, the successor should feel confident in their ability to make management decisions in all aspects of the farm business. Additional Resources: “Cultivating Your Farm’s Future” workbook and companion guide. This workbook contains invaluable tools to help with your farm’s succession planning. “Cultivating Continuity“ the companion guide to Cultivating Your Farm’s Future features additional resources. Authors

The Invasives Creep Up on Us

Every time I glanced at my flower bed; I saw them. Yet others didn’t. An invasive flowering plant had gotten away from me. Very early in the season I pulled some out, but I was in a hurry and didn’t get them all. Short on time I let it go. I knew I should address the issue by setting time aside to free my flower garden of them, but I didn’t. This morning as I was finally removing the invasive flower, I realized I had a very pretty lily that was almost snuffed out by the invasive. Thankfully it still has a few small blooms and was uncovered in time for the plant to regain its strength. As I was pulling weeds and the overgrown invasive the wise words of a renowned farm succession expert rang in my head. Attorney John Baker of Iowa State Beginning Farmer Center, often remarked, “You have what you put up with.” A simply yet profound statement of truth. Farm Invasives Not all of the invasives are in farm fields, hedgerows, or forests. They can be found in the financials, equipment, structures, employees, working relationships, family members and family dynamics, to name a few. They are items that we “put up with,” avoid addressing or ignore. However, as with all invasives the issues grow bigger and out of control if left go. Examples include: 1. Financials It often starts unintentionally when savings or personal funds are tapped to pay the bills. Thinking next year, we’ll catch up and get back on track. Debt increases and the conversations around farm financials are tense. It could be financials have never been a strong point but we’re too proud to ask for help. 2. Equipment Farm equipment can present safety hazards. Unaddressed safety hazards are accidents waiting to happen. Accidents harm people, livestock, equipment and result in potential for legal action. Time and dollars spent fixing farm equipment prevent down time when you most need the equipment, time spent in court or heaven forbid lifetime regret of loss of life. If the hazard cannot be fixed, it may be time to develop a plan to replace the equipment. 3. Structures Farms often have a wide array of structures from historic to newer and the challenges are as varied as the buildings. It’s easy to let building issues go because they are lower on the project list. Be careful the issues don’t become safety hazards or prevent the building from functioning as it should to safely hold livestock, feed stuffs, or equipment. 4. People Issues The messiest invasive of all are people issues. There may be communication challenges including personality struggles or conflict resolution issues. It may be a learned defensiveness or wall that’s been put up as the result of an abusive professional or personal relationship. There may be a toxic relationship among family members or employees that has gone unaddressed. Remember you have what you put up with and it’s time to deal with the issues and set boundaries. Bad behavior is unacceptable behavior. Removing the Invasives The first step is acknowledging the issue(s) we have to admit there is a problem in order to deal with it. Working together with others on the farm to address financials, equipment and structure problems will spread the burden and creative thinking among many people and often results in the best potential solutions. The best option for the farm may be the hardest to accept. The best option may require transitioning farm enterprises to a more financially feasible enterprise for the farm. A piece of grandpa’s farm equipment may need to be replaced because it’s too dangerous and someone is going to get hurt. A farm building from the 1930’s may have outlived the remodels and need replaced. Working together the farm team can determine the best options for the farm. The Root of the Problem If people issues are the root of the problem, they need dealt with first. If inappropriate actions have been accepted in the past it will take time and patience to change. Addressing issues one on one may be the best place to start. We may uncover someone dealing with personal issues/crises and the frustration from those are spilling over on the farm or vice versa. The person may not realize their words or actions are negatively impacting others and the farm. Things may also be addressed in the group setting of a farm meeting. The best way to ensure all know behavior expectations is to provide meeting guidelines and follow them. Reminders may be required throughout the meeting until everyone gets used to the new protocol. A prop may be used to ensure everyone is heard during the meeting. For example, if one person tends to dominate the meeting, pass around a small stress ball or other object and the person in possession of the item has the floor and the rest of us listen. Once they are done speaking the object is passed on to the next person. This also gives a voice to those who normally don’t speak up. Everyone listens to learn while others are speaking. The meeting facilitator or leader should remind people there are not any wrong answers and we should use our listening skills to learn other points of view. It will require practice to adjust but the method works. The Beauty of an Invasive Free Farm The best results occur when invasives are removed root and all. It’s also the most challenging method. Don’t get overwhelmed by the immensity of the issues. Set aside time to focus on one invasive at a time. As everyone’s voices are heard and positive results seen we will be motivated to continue the process to address other farm challenges. One step at a time we can get rid of invasives and renew farm vigor.