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FORMS BUSINESS ORGANIZATION 3 basic options for the legal structure for the business Sole proprietorship 86% Partnership 10% Corporation 4% Trusts, estates, other corporations 0.6%
Percentages are from the 1992 census of agriculture
The demise of the family farm has not materialized. The percentage of farms under sole proprietorship has only decreased by 2.5% between 1978-92. The decrease came from an increase in partnerships more than an increase in corporations. Most corporations are Afamily corporations.@ Farms of course can freely move among the various forms of organization, and it often makes sense. The appropriate form of organization has important implications for: 1) ability to raise capital 2) legal liability of individuals involved in the farm 3) transfer of the farm
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Form of organization and the ALife Cycle of the Business@
1. Most frequent motive for change in organization of business is when business is transferred from parent to offspring A. A farm which previously supported one family must now support two families
Life/business cycle diagram
2. Must balance need for retirement income of parents with income need of the younger family. Which is the more important consideration? Value judgement but, protecting the security of the older generation, rather than making it easier for the children to get established must be the number one priority. 3. The size and past success of the farm is a key determinant of the difficulty of this transition A. A large farm can accommodate two families, but may mean a reduced income for the parents, or Aless than opportunity cost@ income for the child B. Transition more difficult for small farms because the farm must be expanded to utilize the additional labor a.Expansion means risking equity or borrowing capital, which parents may not want to do at this age C. Multiple offspring make transition even more difficult 4. Older generation should maintain control of sufficient assets to live comfortably 5. The key is to balance respect for the years of work that went into building the farm with desire of younger generation to build and manage farm in the way that they think best. If your daddy was a cattleman but you know that you make more money in timber and vegetables, you might have to have a little of both. Considerable potential for conflict.
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Options for transfer to offspring
The two extremes are: 1. Merge the life cycles of generations - partnership, corporations, joint working agreements or spin-offs (sharing equipment or swapping labor for capital in a livestock operation). Life cycle stages (ages, # dependents) of both families affect how the merger will be structured - Allows gradual transfer of assets at a pace that children can afford without large concessions by parents - Allows older generation to ease into retirement, allows parents to feel useful and needed - Allows younger generation to grow into the financial and management responsibilities, learning from parents - Allows a "testing phase" where children can see if they really want to farm and parents to decide if they want to retire 2. Immediate transfer (parents leave the farm) - sale or renting with transfer through estate. -Parents immediately have access to all farm equity Allows parents to enjoy retirement by accessing all of their life=s savings Provides stable investment income - Reduces conflicts from family partnership - Forces younger generation to assume more financial and management responsibility early on in the new life of the business - Unless handled through some concessionary contract for deed, transfer is difficult given the economic size of today's farms - If children don=t have the financing transfer may require sale of part of farm assets to provide cash for parents to live on.
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Forms of Business Organization
SOLE PROPRIETORSHIP (SP)
1. MOST COMMON FORM OF ORGANIZATION: "FAMILY FARM" 2. DEFAULT FORM OF ORGANIZATION IF NO ACTION TAKEN NO LEGAL REQUIREMENTS for FORMALIZING THE ORGANIZATION 3. MAY BE IMPORTANT MOTIVES TO CHANGE TO ANOTHER FORM OF OWNERSHIP A. EXPANSION OF FARM ASSET HOLDING AND INCOME - GREATER NEED FOR BORROWED CAPITAL - INCREASED TAX LIABILITIES
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CHARACTERISTICS OF SOLE PROPRIETORSHIP A. NO SEPARATION OF BUSINESS AND PERSONAL FINANCES OWNER ASSUMES ALL RISKS, RECEIVES ALL PROFIT B. MAJOR ADVANTAGES a. LEGAL SIMPLICITY b. STREAMLINED DECISIONMAKING NO PARTNER OR BOARD OF DIRECTORS TO CONSULT ON MANAGEMENT DECISIONS C. MAJOR DISADVANTAGE IS LEGAL EXPOSURE OF 2 TYPES 1. ALL PERSONAL ASSETS ARE EXPOSED DURING BANKRUPTCY 2. ALL PERSONAL ASSETS ARE EXPOSED DURING TO CIVIL DAMAGE LAWSUITS NOTE THAT THESE CONSIDERATIONS INCREASE IN IMPORTANCE AS THE BUSINESS MATURES AND GROWS BIGGER FARM HAS MORE TO LOSE, AND OLDER FARMER HAS LESS TIME TO REBUILD D ABILITY TO RAISE CAPITAL LIMITED TO OWNER'S RESOURCES E INTERGENERATIONAL TRANSFER OF FARM - ESTATE TAX CONSIDERATIONS - EQUITABLE TREATMENT OF MULTIPLE HEIRS CAN BE COMPLICATED MUST DISTRIBUTE PHYSICAL ASSETS, RATHER THAN EQUITY SHARES, I.E. BUSINESS CANNOT BE TRANSFERRED, ONLY THE ASSETS OF THE BUSINESS F. LIMITED OPTIONS FOR TAX MANEUVERING
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JOINT OPERATING AGREEMENTS AMONG SOLE PROPRIETORS MANY VARIATIONS (E.G. SWINE INDUSTRY) QUITE COMMON AMONG FAMILY AND NEIGHBORS CAN BE FORMAL OR INFORMAL - SWAP LABOR FOR USE OF EQUIPMENT, etc. VERY EASY TO DISSOLVE TO KEEP AGREEMENTS FUNCTIONING POINT TO REMEMBER IS THAT EACH PARTICIPANT REQUIRES COMPENSATION FOR: 1. LABOR 2. MANAGEMENT 3. CAPITAL 4. RISK EACH FARMER WILL CONTRIBUTE A DIFFERENT MIX OF EACH SO DECIDING ON "FAIR" COMPENSATION CAN BE DIFFICULT AND WILL NEED TO BE DISCUSSED PERIODICALLY
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PARTNERSHIP
TYPE OF JOINT VENTURE COMMON ESPECIALLY AMONG FAMILY TRICKY TO KEEP GOING LEGAL PARTNERSHIP CAN BE JUDGED TO EXIST BY THE DUCK TEST IF A BUSINESS IS RUN AS A PARTNERSHIP NEED IT NOT HAVE A FORMAL AGREEMENT TO BE TREATED AS A PARTNERSHIP BY LEGAL SYSTEM WHETHER THIS WAS INTENDED BY PRINCIPALS OR NOT. THIS IS IMPORTANT IF THE FARM COMES INTO FINANCIAL OR LEGAL TROUBLE - DEEP POCKETS SEVERAL INDICATORS OF WHETHER A BUSINESS IS A PARTNERSHIP JOINT OWNERSHIP OF ASSETS OPERATION UNDER A FIRM NAME JOINT BANK ACCOUNTS SINGLE SET OF BUSINESS RECORDS MANAGEMENT PARTICIPATION BY ALL PARTIES SHARING OF PROFITS AND LOSSES ASSETS USED IN BUSINESS MAY BE OWNED BY PARTNERSHIP OR INDIVIDUALLY BY PARTNERS AND LEASED TO PARTNERSHIP SAME TAX TREATMENT AS SOLE PROPRIETORSHIP PROFITS REPORTED AS INDIVIDUAL INCOME TWO TYPES OF PARTNERS 1.GENERAL PARTNERSHIP
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-GPs PARTICIPATE FULLY IN MANAGEMENT RESPONSIBILITIES AND SHARE ALL BUSINESS RISKS G.P.'s SHARE: -MANAGEMENT AND PROFITS AND LOSSES -NEED NOT BE ON A 50/50 BASIS CONVENTIONAL FORM OF ORGANIZATION HAS ONLY G.P.s EQUAL PARTNERS 2. LIMITED PARTNERSHIP -HAS BOTH GENERAL AND LIMITED PARTNERS (LPs) MUST HAVE AT LEAST ONE GENERAL PARTNER MAY HAVE ANY NUMBER OF LIMITED PARTNERS -LIMITED PARTNERS SUPPLY CAPITAL TO THE BUSINESS AND SHARE PROFITS AND LOSSES LPs CANNOT PARTICIPATE FORMALLY OR INFORMALLY IN MANAGEMENT OF FARM BUSINESS -FINANCIAL EXPOSURE OF LPs LIMITED TO ACTUAL INVESTMENT -FINANCIAL EXPOSURE OF GPs UNLIMITED, INCLUDING PERSONAL ASSETS A SHARE IN A LIMITED PARTNERSHIP IS PERSONAL PROPERTY TRANSFERS CAN BE AFFECTED THROUGH SALE OR WILL PARTNERSHIP AGREEMENTS MUST COVER 1. MANAGEMENT 2. ASSET OWNERSHIP AND CONTRIBUTION 3. COMPENSATION - COMPENSATION MUST BE PAID FOR: A. LABOR B. MANAGEMENT C. CAPITAL D. RISK EACH FARMER WILL MAKE A DIFFERENT CONTRIBUTION SO
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DECIDING ON "FAIR" COMPENSATION CAN BE DIFFICULT 4.RECORDS 5. TAXATION 6. TERMINATION - AGREEMENT MAY SET A TERMINATION/RENEWAL DATE, BUT NOT REQUIRED 7. DISSOLUTION A. G. PARTNERSHIP GENERALLY DISSOLVES AT DEATH OF ONE PARTNER, BUT CONTINUATION CAN BE PROVIDED FOR IN PARTNERSHIP AGREEMENT B. ASSETS BELONGING TO THE PARTNERSHIP MUST BE DIVIDED AT DISSOLUTION C. DISSOLUTION MAY OCCUR EVEN IF ONE PARTNER WISHES TO CONTINUE THE BUSINESS a. E.G. HEIRS MAY DESIRE CASH D. WRITTEN PARTNERSHIP AGREEMENT VERY IMPORTANT AT TIME OF DISSOLUTION
PARTNERSHIP ADVANTAGES 1. CAPITAL FROM ALL PARTNERS 2. MANAGEMENT AND LABOR COMPLEMENTARITY OF PARTNERS - I.E. FATHER- SON, TIM-EARLE 3. EASY TO DISSOLVE RELATIVE TO CORPORATION 4. FLEXIBLE ESPECIALLY WHEN LIMITED PARTNERS ARE USED NOT LIMITED TO A 50/50 SPLIT OF ALL RESPONSIBILITIES AND ASSETS 60/40, 90/10, CAPITAL/LABOR, ETC., 5. TRANSFERRING ASSETS TO LIMITED PARTNERS CAN BE USED TO REDUCE EXPOSURE OF THE BUSINESS
PARTNERSHIP DISADVANTAGES 1. UNLIMITED PERSONAL LIABILITY OF GENERAL PARTNERS A. SUIT CAN BE BROUGHT AGAINST G.P'S 2. EACH PARTNER CAN ACT ON BEHALF OF THE BUSINESS, EVEN IN VIOLATION OF THE PARTNERSHIP AGREEMENT A. ONE PARTNER DOES SOMETHING FOOLISH BOTH PAY NAME ONE PERSON WHO YOU WOULD TRUST WITH YOUR NEW 4X4, CHECKBOOK AND RETIREMENT ACCOUNT - THIS IS ALMOST WHAT YOU ARE DOING WITH A PARTNER BECAUSE A LARGE PORTION OF YOUR NET WORTH IS TIED TO THE FARM 3. JOINT DECISIONMAKING A. WILL NOT WORK WITHOUT TRUST AND UNDERSTANDING BETWEEN PARTNERS 4. NEED (PRACTICALLY, IF NOT LEGALLY) TO HAVE A FORMAL BUSINESS INCORPORATION A. LIMITED PARTNERSHIP MUST HAVE LEGAL PARTNERSHIP AGREEMENT 5. EASY TO DISSOLVE A. SO, MAY BE FORCED TO DRASTICALLY ALTER FARM BUSINESS IF ONE PARTNER CEASES TO PARTICIPATE, EVEN IF BUSINESS IS DOING WELL 6. PARTNERSHIPS OUTSIDE OF THE FAMILY MAY MAKE INTERGENERATIONAL TRANSFERS MORE DIFFICULT RATHER THAN EASIER A. i.e. PARTNER MAY NOT BE AS ENT...