Farm generational transfer – processes and structures
Author: Stephen Park ( Pacer Legal). | Date: 14 Mar 2018
Take home messages
- Parents who have invited or allowed their children to participate in the family business have a moral obligation to ensure a succession plan is in place.
- Early and honest disclosure of parties’ expectations, reveal if these expectations match reality.
- Understanding business structures is a critical part of succession planning.
- Succession planning isn’t only about the transfer of control it includes consideration of exit strategies.
After growing up on the family sheep farm in Narrogin and having pursued separate careers, Pacer Legal was founded by Stephen and David Park in 2009.
The decision to go into business together, was done with the full knowledge that we would face organisational challenges that are unique to family businesses. We considered that the decision-making processes we undertook required each partner to consider the emotional and financial expectations of our respective spouses and that our parents, while not business owners, would have a heavy emotional investment in our business succeeding.
Notwithstanding this knowledge and having the opportunity to start from scratch, we have made mistakes and our business processes have evolved over time as we continue to strive to do things better.
In part, we have been assisted in this process by being afforded the opportunity of being involved in succession planning for many of our clients and to see where things have been done well and not so well.
The qualities inherent to successful succession plans can in part be summarised as accepting there is a moral obligation to ensure best practice is adopted, that all parties must honestly communicate their respective expectations and that informed decision-making tends to maintain healthy family relationships.
Elements of succession planning
The elements of succession planning include:
- Legal and accounting.
- Individual requirements.
Understanding the most common agribusiness structures
Informed decision-making can only be made when there is an understanding of existing and proposed business structures.
The most common agribusiness structures that we work with include:
- family trusts; and,
- structures that utilise trusts as partners in a partnership.
These business structures interact and are often governed by aspects of legislation such as the Trustee’s Act and Partnership Act. Consequently, a working knowledge of the legislative framework should be considered important.
Know your business structures
The starting point for considering succession planning is to break down the business structure itself and clearly identify:
- What entities comprise the faming business?
- How is land held and does this structure affect access to exemptions regarding the intergenerational transfer of farmland?
- How is control held within these structures and how is control transferred should a key person lose legal capacity or be deceased?
- How does debt interact with the proposed succession plan?
Debt and succession
Experience shows us that succession planning can unnecessarily expose incoming children and their families to farm debt.
What is interesting is that this assumption of liability takes place without receiving a commensurate level of control or share in profits and in doing so displays a level of non-commercial behaviour that would not occur when deciding to join a business that comprised of unrelated parties.
This non-commercial behaviour is often overlooked in the excitement of having children enter the family business and sound business practices such as asset protection may not have been considered.
However, good business practice dictates that all parties must make informed decisions and while an informed decision-making process will not ensure a non-commercial decision is not reached, it does at least afford the decision-maker the opportunity to consider all their options and to understand in advance, the potential consequences of their choices.
In fact, it is not a stretch to say you are morally negligent if you fail to comprehensively ensure in advance, that family members contemplating joining the family business fully understand how your business structure works from a control, liability and future succession point of view.
The most common structure adopted by our clients, is that of a partnership.
The advantages of a partnership include:
- Opportunity for shared management and joint ownership of assets.
- Profits shared in proportion to equity, unless otherwise agreed.
- Allows for income splitting.
- Simple and cheap to operate.
The major disadvantages of a partnership include:
- Partnership law provides that all partners are jointly and severably liable for all the debts of the partnership.
- In summary, this means that a 5% partnership equity holding does not equate to a 5% liability for partnership debts. Rather it equates to a 100% liability for that debt.
The partnership business structure is characterised by informal partnership agreements (i.e. no written agreement) or formal agreement agreements (i.e. there is a deed of partnership which provides a framework of governing rules).
Where a partnership is informal, its conduct and operation are governed exclusively by the Partnership Act and a failure to understand the consequences of not formalising the partnership arrangement can be critical from both a business survival standpoint and for succession planning.
Partners are often unaware that certain provisions in the Partnership Act can be in effect, contracted out of by making alternative provisions in a partnership deed and consideration of the following Act provisions (i.e. make alternative arrangements) is worthwhile:
- The Act provides that a partnership is legally dissolved as at the date of the death of a partner and this can result on a freeze of partnership bank accounts by financiers.
- Under the Act, a partner cannot be expelled by the other partners and this provision can be a problem where a partner loses legal capacity, does not perform to expectations or is bankrupt.
South Australia (SA) is in a unique position, whereby trusts that have a substantial connection with the state of SA can last beyond the maximum legislated lifespan of 80 years that is adopted in other states.
However, this simply reinforces that as trusts have the potential to hold assets for many generations, consideration must be given to how trusts are structured, how control is transferred and how the control of trusts will be managed where siblings or grandchildren assume joint control.
Understanding family trusts begins by acknowledging that assets held in a trust of which you are a beneficiary or an office holder, are not your personal property and cannot be distributed in your will.
These assets are held by the trustee on behalf of the trust’s beneficiaries and it is the trustee who is responsible for the day to day operation of a trust and who will make decisions as to which beneficiaries will receive distributions of income.
Usually the trustee holds its position at the absolute discretion of an appointor who holds the power to effectively ‘hire and fire’ the trustee.
Regarding the qualification of ‘usually’, each drafter of trusts will include characteristics which are particular to their trust deed and as such, care must be taken to carefully read and consider any trust deed.
For succession planning purposes:
- It is important to ensure that the succession of the office of the appointor will go to the appropriate persons; and,
- depending on trust deed provisions; succession can be done via your will or by formal deeds of appointment (with deeds being the preferred method as wills are subject to challenge under family provision legislation).
Trust considerations for all parties involved in the family farm:
- Does your trust deeds adequately cater for dispute resolution between joint appointors (as putting your children into joint control of trust without the necessary mechanisms for resolve disputes is a failing on your part)?
- Is there an adequate exit strategy in place that will allow a joint controller (i.e. appointor) of a trust to hand over control and exit for fair value?
- What asset protection strategies do trust structures offer and how can these be maximised?
Farm business structures and the Family Law
A common issue that arises in undertaking farm succession, is concerns over how a future divorce or separation will affect the family business.
Often, we are asked to advise on the best strategy to quarantine family farming assets and unfortunately, in our consideration the best strategy is to retain control and engage children in the business as employees.
This advice is based on the propensity of the Family Court to look at who holds the control positions in structures comprising the family farming business and the pattern of income distributions from those structures.
However, this advice is not a practical long-term option and consideration when passing control over can be given to:
- Utilising loan agreements which are on commercial terms and impose a liability to repay monies; and
- Utilising Binding Financial Agreements which children’s spouses or defactos can enter (although these face serious practical impediments and tend to have greater effect in the short term).
Farm succession summary
While every succession plan will have its unique characteristics, overwhelmingly the successful succession plan is one based firstly on honest communication of expectations and secondly, on informed decision-making.
While all parties that are part of a succession plan are similarly obligated to partake in honest communication, the responsibility to ensure all parties make informed decisions, falls primarily to those who are inviting or allowing children to enter the family business.
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