Three ways to assess that you're ready for farm transition
Develop a clear vision for future transition by first fully assessing where you’ve come from and where you’re at today
Break down your assessment into the following three categories:
- Legal documents and agreements: Anything that represents a legal or binding situation should be fully reviewed and understood. This includes your will (a key element of any transition plan), insurance policies, pre-nuptial agreements, land rental agreements, mortgages etc.
- Financial statements and business performance records: Anything that helps clarify the farm’s financial position helps you make good decisions for your transition plan. This includes looking closely at financial statements – net worth statement, income statement and balance sheet. If the business is not incorporated, business, personal items, transactions and activities should be separated. Cash flow and debt servicing capability are also important.
- Relationships and communication styles: Think about & identify who is directly involved in the farm business and who else is connected to the farm (such as an heir). Who is communicating with each other right now? How often? What communication could be improved? Acknowledge and plan for the challenges inherent in some relationships.
1. Legal documents and agreements
Start with a will
The starting place for any transition plan is for everyone involved to have an up-to-date will, more specifically, one that matches your business plan i.e, can the farm business support the financial obligations outlined in the will. Not having a will means when you die, your estate is in the hands of provincial and intestate laws.
For instance, in Saskatchewan, if there’s no will in place, the spouse gets the first $100,000 and then the rest of the estate is divided equally among the spouse and the children. Each province has its own separate legislation – it is a best practise to consult with a lawyer in the province where you farm.
Without a will, things get very complicated - especially if there’s no spouse, the deceased was in the middle of a divorce or if there’s a common-law spouse. Relying on provincial laws to carve up a farm operation and personal estate is an unnecessary risk for your farm and family. The junior generation should also have an updated will. Tragedies happen, and the consequences of not having a will are just as severe for young people.
Legal agreements put some certainty around risky situations.
Hire a lawyer with agricultural experience to help you draft your will. They’ll better understand the complexity and nuances of farm transitions. And nominate a clear executor. If you don’t, you may be setting your family up for squabbling and be at risk of estate litigation among your heirs. A sound will ensures the estate transfers according to your wishes and caps fees and taxes that can be significant if there is no will.
It's also important that your lawyer talks to your accountant. Drafting a will without taking into account the financial aspects of your business is often overlooked.
Good business practice is partly about identifying and reducing risk. Farmers deal with price and production risks every day, but it takes foresight to address risks that the farm business faces relating to death, disability and other unforeseen events. Wills are just one way to reduce uncertainty for the business.
Addressing the five D’s
Do you have the appropriate legal documents and risk management tools in place to address the five D’s of risk management?
A will covers death, but what about an injury or disability? What about divorce or a breakdown in relationships? What if you or someone else involved just wants out at some point?
Assessment should consider what protection is in place to deal with the unexpected. A third of Canadians, on average, will suffer an injury or disability for 90 days or more at least once before they reach age 65. Is your farm adequately insured if you or a key player in the operation is injured or becomes disabled?
Once you have a handle on your current legal documents and agreements, bring everyone up to speed on where things are at. You may find it helpful to have a lawyer or accountant explain complex scenarios or structures to the team. It is unlikely that your family will be better off being surprised after your funeral when you’re no longer alive. If a ten-year land lease is about to expire, the team should know about it. Be clear on the intent when explaining or preparing legal documents and keep all interested parties informed along the way.
As the transition plan begins to take shape, everyone will know how the existing documents and agreements will need to change. Proper legal and accounting advice isn’t guaranteed to save families from transition strife. But not having or not understanding written agreements creates an avoidable risky scenario. The family should have easy access to the documents, and more than one person should know the passwords required to retrieve legal and financial documents if stored digitally.
Learn more about using legal agreements.
2. Financial statements and business performance records
Don’t assume a healthy or depleted bank balance tells you everything you need to know about a farm’s financial health. The bank account certainly matters, but it only provides partial insight into the current financial situation. You and your transition partners need to deep dive into the numbers.
What farm financial statements can do:
- Compare the farm’s financial performance to industry benchmarks
- Determine if the business is profitable
- Provide important data about the future viability of the farm
- Show if the farm business generates enough income to support another household and provide retirement income for the senior generation
Start with the common financial statements you’ve become familiar with. If you haven’t been producing or monitoring them, start now. Your accountant can help. If the farm is incorporated, review both the business and personal financial statements.
|How it works||Why it's useful|
|Income Statement||Shows revenue and expenses over a given time||Assesses profitability|
|Balance Sheet||Provides a snapshot of the company’s assets, liabilities and shareholder’s equity for a specific point in time||You might have cash in the bank but that doesn’t tell you anything about the farm’s liabilities or assets|
|Cash Flow Statement||Information from the income statement and balance sheet are used to show the change in the amount of cash you have over time||Helps you budget cash flow into the future|
Ask these important questions
For parties leaving the farm and those taking on more ownership of the business, now is the time to ask the hard financial questions:
- Just how healthy is the business?
- Is the debt level serviceable based on the cash flow and revenue projections?
- Is there enough profit to allow for a quick transition?
- Is it more realistic to consider a multi-year plan?
If answers come easy, the plan can start to take shape with confidence. If there are red flags or financial concerns, those issues need to be addressed. Either way, being brave and asking tough financial questions is key to good transition planning.
Unsure what to ask? Consider these questions for the current owner, successor and of the operation.
Using financial ratios
Information from financial statements allows you to calculate financial ratios. Ratios provide more clarity to your financial situation, pinpoint opportunities for growth and address any challenges.
One example is the current ratio – a simple indicator of liquidity and ability to pay bills, interest and principal. It’s calculated by taking the value of current assets and dividing it by current liabilities.
Current Ratio = Current Assets / Current Liabilities
- Current assets: Assets that can be converted to cash within a year
- Current liabilities: Liabilities or expenses that must be made within a year
Knowing financial ratios is helpful for transition planning. If you want to expand or take on more debt, they can direct you on how aggressive or cautious to be.
Get calculating! Here are more financial ratios and how to use them.
Regardless of transition planning, it’s always important to assess the total value of the farm and the business enterprises. Knowing your asset values and business revenue stream strongly indicates your borrowing capability going forward. It also helps you decide how to allocate assets or funds to family members, whether they’re involved in the farm or not.
Three common business valuation methods:
- Earning valuation: Determines fair value by assessing a business’ likelihood of future earnings.
- Market valuation: Compares sales values of businesses of similar size, industry, and location. When evaluating a farm, land quality is included in this assessment.
- Asset-based valuation: Used when a business is being liquidated. It subtracts the value of a business’ liabilities from its assets to determine how much cash would be produced if the business were sold and all liabilities paid off.
Income needs for exiting and remaining participants
The financial health and valuation of the farm business offers an honest and reasonable prediction of future earnings. For those leaving the farm immediately or gradually, there must be some assessment of the payout or income required from the farm. After all, the senior generation has often built up the farm and has value they have earned, but not yet been paid for.
Calculating the cost of retirement allows the younger generation to identify ongoing obligations for the farm. Banks or financial planners also have expertise and software that can help estimate your long-term needs. Not enough farmers leverage their relationships with their bankers.
Also, work out how much extra you’ll need for your special goals. For those remaining or taking over the farm business, assessing available income is required to determine if there’s enough to cover the costs of living for the families involved.
The older generation needs a budget for their retirement dreams. Your expectations for retirement might be high. That’s okay, just be honest about your ability to afford to pay for your dreams.
If you don’t have enough saved already and you need more money than the farm can provide, you should work with your accountant and financial planners to review your projections and identify if other options should be considered.
3. Relationships and communication styles
The final assessment is less concrete. There are no documents or numbers to crunch, but being honest about relationships within the business and between family members involved in the farm or not, can’t be overlooked.
Even the best legal and financial plan will fail if the transition strategy doesn’t account for the personalities, loyalties and, in many cases, assumptions that have been made in the absence of ongoing transition communication.
Third party specialists can help. If there has been friction among farming family members, or if there has been a falling out between farming and non-farming siblings, this will impact how the transition plan unfolds. Everyone reacts to change differently, and for some, change is very unsettling. The problem may not be related to specifics of the transition plan, but more about the idea of transition itself.
In the simplest cases, an estate or non-farm business is liquidated, and the money is divided equally among family members. But that usually doesn’t work for a farm family, even when everyone is amicable. If the farm is going to stay in the family and other members of the family want to leave, it’s going to get tricky. If everyone is up to speed on the plan going forward and all parties recognize that a fair distribution of assets may not mean equal distribution, the first major hurdle has been cleared.
A third party specialist can help create a safe environment and process that allows everyone to express their thoughts without derailing the transition. It requires taking an active interest in each other and sincere effort to understand each other’s concerns, hopes and expectations to figure out how to move forward in the present.
People’s different communication styles and distinct personalities will impact how these discussions go. Not everyone realizes that people don't think the same way. There are many fun, free personality tests each family member could do online and report back their findings. The Bird Personality Test is a non-confrontational and interesting way to establish the different personalities and preferred methods of approaching decisions. You may be surprised at what you learn!
Some family and relationship issues require outside expertise such as mental health issues substance abuse or addiction, elder abuse, divorce, financial issues or insolvency. These go beyond the realm of a transition specialist (even private-sector planners) and need to be addressed before a true transition plan can be initiated.
Don’t worry if this feels daunting. This is just an assessment of where you’re at so far. The next step on the path to transition is to take a more in-depth look at relationships and how to get from the current situation to a successful transition.