Setting ground rules for fair treatment of business partners is the best preventative medicine for conflict in farms and other closely-held businesses, instructors at this week's TEPAP conference in Austin, Texas stressed. Not only will this deflect misunderstandings later, it could avoid legal judgments from increasingly unsympathetic courts.
Don't wait until death, divorce, disability or a partner's departure to discuss how to value the family business. It's always better to set the policy before the need, says farmer-financial consultant Dick Wittman of Culdesac, Idaho.
Wittman encourages families to tally all their assets (reduced for any taxes the firm would need to pay upon liquidation) and agree on a stock valuation at the firm's annual meeting. That way all shareholders know how each would be compensated and no one gets preferential treatment. Other buy-sell terms can spell out a 10- or 20-year repayment plan so the farm isn't crushed by debts when partners exit. Likewise, the farm's bylaws can set terms applicable to anyone marrying into the business, rather than springing the issue on an unsuspecting bride and groom in a prenuptial agreement. If in-laws are ineligible for ownership, stress that this isn't personal, it's family business policy, Wittman says.
Wittman's family buy-sell arrangements always take deferred taxes into account. In some cases, federal and state taxes on unrealized gains would knock 40% or more off the market price of stock. C corporations are ineligible for capital gains treatment, for example. "If shareholders think the business is worth 40% more than it really is after-tax, it's a huge mess in transition planning," Wittman says.
However, judges can come down hard on families that don't offer off-farm partners a fair return on their investments. A June 2013 ruling by the Iowa Supreme Court "was the clearest and most direct assault on the power of majority owners" Iowa State University agricultural law professor had observed in his 50-plus-year legal career. It harshly criticized mistreatment of minority shareholders in a farm family C corporation.
In the Baur v Baur Family Farms case, the minority shareholder was an off-farm heir who had inherited his father's share of an Iowa farm organized as a C corporation. For more than 25 years, he had failed to receive some return on the asset. The C corporation had paid no dividends since formation in 1966, preferring to reinvest all proceeds into buying more land for the benefit of on-farm operators. Their amended 1984 bylaws allowed for a buyout of an exiting shareholder at book value, if no other price could be agreed upon, and set the price at $686/share. Back then, the state's farmland was worth just a fraction of today's average $9,000/acre value. The Supreme Court ruled that the minority shareholder was entitled to a fair return on his investment and ordered a lower court to devise a fair liquidation price.
Harl faults the original family partners for failing to plan for a stockholder's departure. Book value should only be used as a fallback position, because it grossly understates asset value, said Harl. Like Wittman, Harl said families need to vote on stock valuations annually, usually within 45 days after the end of their tax year. You don't need the expense of a professional appraisal, he added, but can use public data such as state land surveys and a machinery dealer estimate of equipment values to negotiate terms.
"It's amazing how fair parties can be if they don't know who will die or sell their stock this year," Harl said. "People are very careful."
Punishing minority shareholders by failing to pay dividends or by discounting the value of their stock too severely could trigger more backlashes. "This is a [legal] decision that will ultimately be replayed in many states," Harl says.
Follow me on Twitter@MarciaZTaylor
© Copyright 2014 DTN/The Progressive Farmer. All rights reserved.