Lori Esther shakes her head in disbelief at the thought of her sons farming together.
"Growing up, I didn’t think they would stop fighting," says Lori, with a mother’s knowing grin. "Now they are best friends and business partners."
Friends and partners today, brothers forever. That’s the way Ryan and Chad Esther see themselves moving forward in their journey to take over the family farm operation near Beardstown, Ill. The family just completed the second stage of succession planning by bringing youngest son Chad into the established operation. Chad returned home in 2008 after working as a forester. During the eight years that older brother Ryan has been home, he and their father, Chet, started EFFCO, now a 4,700-acre grain operation, with each owning 50%. The issue long at hand is how they would bring Chad into the operation.
"In everything we do with succession planning, the goal is to ensure financial security and keep the operating entity within active family members," says Kevin Spafford, Farm Journal succession planning expert.
"Getting Chad involved, whether with EFFCO or another entity, is integral to that goal."
THE GRAND PLAN. Typically, there are three ways to bring the next generation into a family farm business:
1. Gifts of stock. You may use your annual gift exclusion to transfer business interests. In this situation, a married business owner can transfer $26,000 worth of stock per year (based on 2010 allowable gifts).
2. Sale of stock. The senior generation sells ownership interest to the next generation.
3. Stock bonus. The senior generation may transfer ownership by paying a bonus in the form of stock instead of cash.
Due to income tax and estate tax ramifications down the road, the Legacy Project team determined that none of the options fit the Esthers’ objectives. Instead, they recommended creating a new partnership, called Esther Farms, with Chad and Ryan starting as equal partners and owners. Under this planning technique, the existing business (EFFCO) stays under Ryan and Chet’s ownership, but any growth going forward will be done through Esther Farms.
"It’s really important for Chad and Ryan to start out as equals and grow the business together so that Chad feels he is earning his way just as Ryan has with his interest in EFFCO," says Josh Sylvester, a Certified Financial Planner and a member of the Legacy Project team.
Allowing the sons their own space and freedom to farm also sends a message to landowners about Chet’s faith in the next generation, says Walter Lynn, the Esthers’ longtime accountant. "I think this is a good decision for the family because it protects Chet’s assets and it gives the boys a fresh start," Lynn adds.
ESTABLISHING LEASE AGREEMENTS. To minimize startup costs, the existing company, EFFCO, will lease equipment to Esther Farms. It will also establish formal lease and rental agreements between the new partnership and the Esthers’ construction company.
Both Ryan and Chad secured operating loans based on input costs per acre and other various factors to begin operating this past spring.
An important part of the Esthers’ succession plan is gradually transferring lease agreements from Chet to his sons. For example, in the past, EFFCO leased about 1,000 acres from Chet’s brother, Joe. This year, Chet and Joe transferred the lease agreement from EFFCO to the new partnership for Chad and Ryan to farm. Allowing Esther Farms to assume land lease renewals from EFFCO effectively reduces the size of Chet and Lori’s estate, which is helpful for estate planning concerns, Sylvester says.
The plan establishes a five-year ownership transition wherein Esther Farms takes over the leases and equipment to coincide with Chet’s retirement option—the date he plans to exit the operation.
Time can be beneficial, however. There is some new equipment that EFFCO recently purchased, and if the brothers’ partnership continues leasing equipment from EFFCO for a while with the intention of purchasing it, the value of the newer equipment will depreciate with time.
"This gives Ryan and Chad time to gain financial strength in their balance sheet before making other substantial equipment purchases," Sylvester adds.
LIABILITY REDUCED. One of the benefits of starting a new company to bring Chad into the operation is that it will not generate income tax or estate tax liability, Spafford says. "There are really only the startup costs of a business, and even those are substantially less since the boys can lease from the existing company," he says.
The family also is not putting the profitable EFFCO at risk. "EFFCO is not lending capital or incurring any debt to bring in Chad, thereby reducing the liability of EFFCO," Sylvester says.
Some of the strategies to bring Chad into the operation had the potential to affect the Esthers’ eligibility to receive Farm Service Agency (FSA) payments. By implementing the proposed strategy, the Esthers accomplish their objective of getting Chad in the business while maintaining FSA payments, Sylvester says.
This past spring, the brothers farmed in partnership for the first time, making their own decisions on inputs, marketing and harvest. "I think it’s the best of both worlds," Chet says. "This solution brings Chad into the operation but allows him to earn his way."
Next Steps for the Esthers
- Review current transition including legal documents, operating agreements, buy/sell agreements, etc.
- Review business plan for Esther Farms (Ryan and Chad’s new entity).
- Promote leadership development for Ryan, Chad and Chet.
- Personal financial planning for each family unit—Chet/Lori, Ryan/Erin, Chad/Tanya.
- Personal estate planning for each family unit.
- Facilitate the transition from EFFCO to Esther Farms including lease agreements, equipment, third party relationships, etc.