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An Inactive’s Perspective

March 28, 2009
By: Kevin Spafford, Farm Journal Columnist

Q My husband of 29 years recently died of cancer, and I inherited a 45% interest in his family's farming operation. My brother-in-law owns 40% of the corporation. His inactive siblings (my two sisters-in-law) hold 7.5% each (which they received in annual gifts from their father in an effort to reduce his estate tax).

I have never worked on the farm nor do I participate in the decision making. My oldest daughter is 26 and since my husband's death has been an employee on the farm. She has a real interest in agriculture and hopes to play a role in continuing to grow the operation. My other daughter is in high school, so it's premature to know her career path, but I don't anticipate she'll choose farming.

A couple of years after I got married, my husband, brother-in-law and father-in-law combined the assets from their individual operations to form a corporation. Since then, the enterprise has grown; it has purchased land and machinery and added grain storage and a milling operation. Several years ago, my father-in-law started gifting his interest to his children. He is no longer a shareholder but remains an officer of the corporation.

My brother-in-law manages the business. In his opinion, I am not entitled to income from the farm because I do not actively contribute. I have been encouraged by my accountant and an attorney to talk with my brother-in-law about a return on investment. During the past 27 years, we've received a low wage and few distributions. We've sacrificed immediate income and reinvested most of the profits back into the operation.

Can you help me to better understand my circumstances? Is it possible to objectively quantify our contributions? Is there value in continuing to hold shares? Are there any resources that will help me to negotiate an equitable arrangement? Thank you!

A Your story is compelling and, quite frankly, a quandary. Though every family farm is unique, your questions come from a different perspective. We usually deal with the succession planning puzzle from the family's point of view, and most often the question is, "How do we ensure that in-laws and inactives (people not actively involved in the operation) do not receive ownership in the business?” 

The following assumptions allow me to frame my recommendations for your situation.

 

  • You and the other shareholders (your in-laws) are not talking from a hostile position. (Opposing, yes. Hostile, no.)
  • As a C-Corp, you have the basic legal documentation to support the entity, including a valid operating agreement, regular meeting minutes, etc.
  • You prefer to retain your ownership position to enhance personal financial security and to provide a career opportunity for your active daughter.
  • Your brother-in-law is not compensating other inactive owners (your sisters-in-law) with wages, profits, crop shares or rents.
  • The operation is large enough to support multiple owners.

Look to the future. The past contributions you and your husband made are not as important as the current value of the operation. You hold a substantial interest in what appears to be a nice operation. Using a conservative $10 million net value for the operation, your share is $4.5 million. Your accountant and attorney may have talked about minority interest and marketability discounts, which can reduce your value if offered for sale on the open market. Yet, until or unless you sell your interest, your equity should continue to grow, and you are entitled to a reasonable return on your investment.

When your husband and in-laws formed the corporation, they may not have completed a buy-sell agreement; if they did, it was unfunded—forcing you to become a part owner. When an entity incorporates, it is normal to draft an operating agreement that details organizational structure, decision-making authority, capital contributions and distributions, accounting practices, annual meetings, etc.

Right now, the best resources are your accountant and your attorney. I recommend that you:

1. Review the operating agreement to better understand your rights and responsibilities as an owner.

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