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Brother buy-out plan

  • 4.5 min read

The following is a fictional case study created by MNP.

James and his brother Keith farmed together for more than 25 years after taking over and expanding the family grain operation.

Their business was structured as an equal partnership. Both parents had passed away recently and each of the brothers inherited two farm properties. Aside from this land, additional properties had been purchased outside the partnership with the brothers named as joint tenants. All the equipment was owned by the partnership.

In their early 50s, the brothers were hitting their stride and the business was positioned for further expansion. Both James and Keith had young adult children working part time on the farm, but there was no clear indication any of them wanted to take on farming full time.

A fork in the road came after a back injury James suffered while working in the shop. What they thought would be a quick recovery turned into surgery and a lengthy recovery period. It became apparent James wouldn’t be able to work at the pace and physicality he once enjoyed.

At first James suggested he would take on more administrative tasks, but sitting in the office was torture. He began to consider options and decided to study for his real estate license.

When James told Keith his plan, Keith was supportive but suggested they review the situation after six months. After only three, it was obvious it was not going to work. Tensions were rising. There were numerous arguments about his level of commitment to the farm. Finally, James said he wanted out.

They agreed to think it through for a week and then discuss how they might move forward. When they reconvened, both brothers brought a list of ideas.

James:

  • Stepping away was the right thing for him and his family
  • His wife supported his decision and his children did not want to be involved in the farm
  • The process should begin immediately and there should be as much flexibility and good will as possible
  • His exit should not force Keith out of business

Keith:

  • Had come to terms with James’s decision and wanted to keep going with the farm on his own
  • His oldest son expressed interest in gradually becoming more involved
  • He would have difficulty fully buying James out and hoped for a compromise on land ownership

After they laid their cards on the table, both James and Keith felt better about their decisions. The uncertainty hanging over them was addressed and while there was lots to figure out, they had a clear end result in mind. The goal would be to create a five-year transition plan.

An initial meeting with their accountant raised some significant red flags and provided a reality check.  First, the good news:

  • The business was in good shape with manageable debt load
  • Both brothers owned the two properties they inherited outright
  • The equipment, building and inventory were owned by the partnership

Then, the challenges:

  • The partnership agreement was 25 years old and very simplistic, and had no provision to cover what would happen if one person wanted out or died
  • All land aside from the inherited properties was purchased outside the partnership but the brothers were named as joint tenants – a major concern
  • No valuation on the business or assets had ever been done

The brothers were asked to do some napkin math to estimate a value for the business and land – and the results were miles apart.

The joint tenant arrangement meant that if one brother died, the other would get title. A better scenario would be designation as tenants-in-common whereby if a brother dies, his share of the property would go to his heirs or estate. They had started the joint tenancy before either brother was married and had never revised it.

The accountant advised they would need a plan to address capital gains exposure, and laid out some simple steps and hard questions for them:

  1. Valuation: Everyone involved needed to agree on what the equipment and business were worth. The accountant could help with the business valuation. It would be a big number.
  2. Buy out: It didn’t make sense for Keith to simply buy out James’s share in the partnership, as he would be using after-tax personal dollars. He could consider creating a company to eventually purchase the partnership and land using the small-business tax rate. If owned by Keith and his wife, this would help with future tax planning.
  3. Update wills: Both brothers needed to do this immediately and create a working document outlining the transition plan in case something happened to either of them before the transition was complete.
  4. Decide how to handle the land held as joint tenants and whether Keith would buy James’s land or sign a long-term rental agreement.

It was a sobering first meeting and they still didn’t have a plan for handling the land held as joint tenants. Both brothers had always thought they’d work together until they retired. There was goodwill on both sides, but with no roadmap to address James’s exit, they would have to work through the process step by painful step.

From an AgriSuccess article.