Statistics indicate that most family farming businesses do not survive three generations. They often flounder because a comprehensive set of rules for the family farming operation is lacking or insufficient.
Before the rules can be considered, the following question should be asked of every family farming enterprise: “Is ours a family farming business that should continue to exist over many generations, or should the assets be divided among the members of the next generation when the older generation passes away?”
If the parties decide the farming concern should keep going, a thorough family constitution is essential. It is the glue that holds the family farming enterprise together.
The family constitution sets out rules for the family farming business, focusing primarily on the operation’s viability. Aspects that should be covered in the family constitution (among many others) include:
- How is conflict resolved?
- How are farming assets distributed?
- What parties have rights to what assets?
- How are decisions made?
- Who is the successor?
- How does the succession process work?
- What is the involvement of inactive members (relatives who do not work for the farming business)?
The ideal family constitution is constructed with 10 important pillars that are necessary to ensure the survival of the farming business. These elements cannot exist in isolation but should “talk to one another” in the constitution.
1. Management succession
Management succession doesn’t only refer to the decision about which child will take over from the parent. It is a comprehensive process of analysis and planning that aims to formulate the rules and policy on succession and articulate them in the family constitution. The rules should provide guidelines that will also apply to successive generations involved in the family farming business.
The management philosophy of every family farming business is unique. This, too, should be carefully articulated and outlined, along with the vision of the family farming enterprise.
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How are day-to-day decisions made, and who makes them? Questions like these should be asked and sound policy should be prepared to answer them. A participatory decision-making process is often better than an autocratic system.
Naturally, planning is also required to decide on the successor(s) in the family farming business. The “baton” must be handed over to the successor(s) at the right time. The training, qualifications and experience of the successor(s) should be stated in clear guidelines to ensure there are objective standards for choosing the right successor(s) who will add value to the farming enterprise.
Sound commercial business principles should be applied to this decision-making process. The next leader should have particular skills and attributes, as well as the character traits required to manage and expand the family business effectively.
If no family member is suitable, the best successor outside the family should be sought.
Appointing and remunerating family members are often problematic. If a father decides which child should be appointed and how they should be rewarded, it can cause conflict and division in the family. Independent advisers should be involved to provide objective guidance about the appointment and remuneration of family members.
The family constitution should also document the succession of the directors of the company/companies, as well as the trustees of the trust(s).
2. Ownership succession and the transfer of assets
Family farming often involves different asset classes, such as farmland, moveable assets, livestock, game, shares in companies and interests in trusts. The family constitution should describe how these assets are transferred to the next generation. Naturally, it depends on which entities own the assets and the ownership model the family has selected. There are several ownership models to choose from. The main ones are the equal distribution, unequal distribution and no-rights models.
Asset Ownership – The Basic Models:
Equal Distribution Model:
- All assets are divided equally between the children
- Each child usually also gets an equal share of the productive assets
- Family assets are divided — either within one trust structure or each with their own trust structure
- Family business and scale are handled contractually
Unequal Distribution Model:
- The active child(ren) take over the farming completely
- Provision is made outside the farm for other children
- Fairness is not the same as equal distribution
- Family asset remains intact
No-Rights Model:
- Assets are typically owned by a family trust
- Trustees manage the assets in terms of the trust deed
- No vested rights to dividends or distributions
- No asset allocation upon inheritance
- Family asset remains intact
Not every family farming enterprise’s ownership model is an exact fit with one of these. They are merely a guideline for the farming business to build its ownership policy and to ask the right questions:
- Is the family entitled to vested rights to certain farming assets?
- How are the farming assets distributed?
- Or should nobody have any rights to the farming assets?
These difficult questions need to be answered to plan the succession and transfer of the assets. The appropriate ownership model is often a combination of the three models.
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3. Estate planning and wills
Estate planning refers to the process of deciding what happens to the assets when the farmer passes away. The farmer should draw up a liquidation and distribution account as though he were about to die. This account indicates what assets are transferred to whom according to the will, as well as the liabilities and costs that must be settled.
This should be done while the farmer is still alive to allow the farming business to determine the liquidity needs of the estate and the family farming operation.
Several expenses and liabilities will need to be covered when the farmer dies, such as estate duty, capital gains tax, outstanding bonds, loans, executor fees and other administrative costs. The estate plan means sensible recommendations can be made for the wills of the individuals, and it ensures their wills are in line with statutory documents of the other entities (trusts and companies) in the succession plans. It also ensures that cash-flow planning can be done so there will be no need for the sale of farming assets to settle liabilities or pay tax and other expenses.
4. Business structures
The business structures in South African law are sole proprietorships, partnerships, companies (and to a lesser degree closed corporations) and trusts.
Some small farming businesses still operate in a sole proprietorship (in the farmer’s own name). In this case, the value of the farmland and the farming business forms part of the estate, with the implications of capital gains tax and estate duty when the farmer dies.
Sometimes a farming business is run in a partnership. The tax liability is then in the capacity of each partner, which is often not ideal. Partnerships are not limited to natural persons but can also be between any combination of natural persons, companies and trusts.
Most family farming businesses use companies and trusts as structures. A company is a separate legal entity and the directors or shareholders are not liable for its responsibilities. The company also exists perpetually, even if a director or shareholder dies, which is not the case with a partnership or a sole proprietorship.
If the shares in the company are owned by the farmer, they also form part of the farmer’s estate at his death, with implications for estate duty and capital gains tax. For the family farming business to prevail, therefore, it is imperative that shares in the company are owned by the trust(s). When the trust is the shareholder in the company, the value of the company does not form part of the farmer’s estate and no capital gains tax or estate duty is payable.
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Like a company, a trust does not cease to exist when someone dies. However, managing a going concern in a trust is not always advisable and may present hurdles in terms of administration and tax. A trust is ideal as the owner of the shares in a going concern or the shares in a company that owns the farmland, or even as the owner of the farmland.
The statutory documents of the various business structures should be revised and updated frequently to ensure the structures protect the family farming enterprise sufficiently.
These statutory documents should also clarify the dividend policy of the companies and the distribution policy of the trusts so that everybody’s expectations can be managed and to ensure legal certainty to prevent disputes.
5. Reviewing financial facilities and sponsorships
Most agricultural businesses use external financing, and each loan has terms and conditions. These should be analysed to ensure everyone understands them, as well as to check that they are structured optimally for every farming operation.
The family constitution can also provide peace of mind for financiers because it illustrates that the family farming business has staying power over generations, meaning there is no need to withdraw or review facilities when the father dies.
6. Life cover
Life cover is often decisive in family farming enterprises when it comes to ensuring there will be no need to sell farming assets to supplement cash flow when the farmer passes away. A wholesome balance is required between the life cover amount and the savings in wealth outside the family farming business. Life cover does not form part of retirement planning and often becomes unaffordable when the farmer reaches an advanced age.
In our experience, most members of family farming businesses are over-insured as far as life cover is concerned and underfunded when it comes to wealth planning.
7. Retirement planning
We all need to provide for our retirement. The sooner you plan for it and the more structured your approach, the better your chance of success. Every member of the family should have their own financial plan that ensures they reach their goals.
Without sufficient retirement capital outside the farming business, it is difficult for the older generation to walk away from their farming income. The capital shortfall causes the older generation to remain dependent on income from the farm, making retirement impossible. Financial retirement plans should also be consistent with the goals of the family constitution.
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8. International investment diversification
A family farm or family farming business will always be exposed to South Africa’s political and economic risks. International diversification – a risk-management technique that aims to reduce volatility by spreading the risk across more than one geographical region – means you are not keeping all your eggs in one basket. The core principle is to invest a portion of your assets in a tax-friendly jurisdiction away from South Africa.
It’s true that the farmer will always earn more by investing capital in the farming business. But this is about diversifying risk and having the ability to write a “dollar cheque” if necessary. Once the strategy is ready and surplus capital is held abroad, the farming enterprise can concentrate on the business with the knowledge that it has a dollar safety net.
9. Comprehensive tax planning
Family farming enterprises often have several companies and trusts within their business structures. Tax planning involves analysis of financial statements and meetings with the auditor and tax adviser to ensure the farming business’s tax savings are maximised within the framework of relevant legislation.
10. The downscaling plan
An effective downscaling plan takes into consideration personal financial elements (Am I financially set up to enjoy my golden years?) as well as business elements (What are my responsibilities?). The better a farmer plans for the handover process, the better the chances of success.
