Succession Planning in Times of Crisis:
A First-Hand Account of the Steps You Should Take
Jim Scott, Partner
Country Guide
December, 2008
A crisis or emergency situation can seemingly jump out of nowhere and threaten any business’s operations, especially business owners like farmers or ranchers. Having a crisis plan in place to deal with an emergency can help maintain a business’s operations and ensure its longevity.
Take for example, the case of the Doe family. The Doe family owned a large cattle ranch comprised of 600 cows, selling yearlings at approximately 18 months of age for finishing. The operation was a family run affair with Mom and Dad at the helm and three of their four adult children - all well into their 40’s - involved in the business on a full-time basis. One of the children was previously involved full-time but eventually opted to walk away from the business. The dynamic of the operation was such that the parents were in charge and the children were employees; they had little say in the decision making process. The parents managed the weaning and backgrounding process out of the family home with help from two of the family members, while the remaining family member was responsible for managing the cow herd at a secondary location.
Out of the blue a crisis hit – Dad learned he was terminally ill and was given six months to live. As the family’s accounting advisor, we suggested a family meeting and stressed the importance of immediately implementing a succession plan. After much discussion, we realized that Dad had two major concerns:
- That Mom be taken care of financially; and
- That the farm remain intact and NOT be sold.
Initially, Dad wanted to use a company he had incorporated years ago, but left inactive. He felt this would compel the family to work together and keep the business intact.
After a series of meetings which involved me, the family’s lawyer and a family counsellor to discuss family dynamics and the role each member would retain in the future, a plan gradually evolved.
Discussing the varying legal implications of the different ways to keep the business moving forward led us to an important conclusion: if the entire family was to be involved in the operation, they would be unlikely to operate together in the long run. We had to provide a way for them to transfer the operations intact, and provide a method of splitting the operation without incurring an income tax liability. We decided against using a corporation for this exact reason; it would be too difficult and expensive to separate.
We agreed that the best course of action would be to roll the entire operation into a partnership. Dad would retain 40 per cent and all of the siblings were to receive various percentages based on Dad’s perceptions of their contribution over the years and active participation. The intention was that on his passing, Dad’s partnership interest would transfer to Mom.
Choosing a partnership over a corporation allowed the family members to use up the balance of Dad’s capital gains deduction. It ensured that depreciable assets and inventories could be transferred at their tax cost - which in this case was considerable – and most importantly, the partnership would have the ability to unwind without incurring a tax liability.
The partners, in this case the siblings, would only pay tax if and when they disposed of their share of the assets. Also, they would all be able to use their respective capital gains deductions, and the land base was such that a division would enable each of the partners to continue their share of the operation unless they chose to take a different direction.
The active partners met on a regular basis when the transition from owner-managed business to partnership occurred. One partner managed the cow/calf operation and the other two looked after the backgrounding part of the business, while Mom took part in the meetings.
Although the operation carried on intact for several years, the siblings ultimately decided to dissolve the partnership and each partner received their share of the assets. Basically, each partner received a share of each asset; for example if a partner had a 15 per cent interest in the partnership they received 15 per cent of each asset; 15 per cent of each ¼ section, each piece of machinery etc. When the assets were outside of the partnership, each partner traded their respective portions of each asset so that the 15 per cent partner owned 15 per cent of the land, 15 per cent of the machinery and 15 per cent of the inventories.
Two of the siblings decided to carry on separate operations; one based out of the primary location, and the other out of the secondary location. The other siblings and their mother leased their land to the two active siblings. Mom leased her cattle and equipment ½ to each. The other two eventually sold their cattle and machinery incurring a liability for tax.
While the partnership was successful for a time, better planning could have resulted in a partnership agreement that would have been able to endure in the long run. A mutually satisfactory plan that had the blessings of all the partners involved could have ensured future success for the farm operation Mom and Dad worked so hard to build.
