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Transitioning a viable farm to the next generation

An exploration of business viability at an early stage in the transition process can help all involved to appreciate the decisions to be made.
Photo: Shapecharge Photography

Farm succession continues to be a hot topic in the grains industry.

Farm succession continues to be a hot topic in the grains industry and one guaranteed to generate diverse opinions on how it is best done. It is often pointed out that the process should be initiated as early as possible. The transfer of decision-making, financial control and asset ownership can take several years.

While acknowledging the emotional and communication challenges that need to be overcome to ensure a smooth process, the financial realities that underpin a viable and successful transition to the next generation need close consideration.

One of the key questions to be answered as part of the succession process is: what is a viable farm scale for the next generation?

It is possible to build a scenario to explore what income and asset levels are required to support family members within a 'typical' grain growing business. These can then guide family discussions and succession plans about profit sharing or asset transition between generations.

Business Viability

Initially, it is important to confirm the financial viability of the business.

Industry business viability indicators can help assess performance and provide a useful communication tool for family members to explore realistic and viable options for generational transition.

Key measures of financial viability include profit and debt servicing and asset availability as security.

Suggested key indicators of business viability are listed in Table 1.

Building A Scenario

A young farming family's goals could include an income of about $115,000 available to cover living, school fees, tax and debt repayment. Based on this targeted personal income requirement, the guidelines provided in Table 1 and Table 2 can apply to determine the total farm income and the associated asset value necessary to sustain the family unit.

We now tackle the question: What is the farm scale needed to generate $115,000 of available family income?

Based on the AgProfit(tm) guidelines detailed in Table 2, we know that labour costs and operating profit typically represent 15 and 8 per cent of total farm income respectively. These two factors combined represent 23 per cent of total farm income (TFI). This is the portion of income available for discretionary expenditure, including living costs.

Therefore for this scenario, the TFI required to meet the family goal of having $115,000 per annum available for living costs, tax and debt repayment is $500,000 ($115,000 = 23 per cent of $500,000).

The guidelines in Table 2 indicate that TFI is typically 15 per cent of total asset value (land, water, machinery and livestock). On this basis, to generate a TFI of $500,000 would require a total asset value of approximately $3.3 million ($3.3 million x 15 per cent = $500,000).

Table 2 also indicates a 1:1 ratio of machinery value to annual TFI is typical. For the scenario of generating $500,000 TFI this would suggest a total machinery plant valued at approximately $500,000 would need to be in place.

The final piece of the equation is the market value of the land asset, which needs to be $2.8 million ($3.3 million [total asset] - $500,000 [machinery value] = $2.8 million).

In summary, the answer to the question 'What farm scale is required to support the next generation and provide opportunity for them to grow?' is: $500,000 of farm income being generated from about $500,000 of machinery assets and about $2.8 million worth of land. This is a significant asset the next generation requires to achieve a viable scale.

Achieving The Required Scale

Table 3 shows the typical break-up of $500,000 TFI.

There are many variations on how the next generation can transition into a viable farming business. The best option first meets the needs and preferences of the parents (older generation) and second, those of the next generation - in that order.

In the case of the scenario proposed above, some options for how to achieve the scale required by both generations working together could include the following.

The next generation leases some of the parents' land up to a value of $2.8 million with a subsidised land rental.

Transfer land valued up to $2.8 million from the parents to the on-farm child/children with a payment of $900,000. This is equal to the proportionate debt loading according to viability guidelines (Table 3). Interest on the $900,000 provides income for the parents and could be quarantined as a future asset for off-farm children.

Lease or purchase new land with some equity contributed by the parents. If leasing, then lease payment for the scenario would be within the $55,000 (Table 3 - finance cost is the total of interest and land lease payments).

Combinations of the above are also possible.

The parents' preference should determine whether land is transferred or ownership is retained by the parents.

This scenario has explored how business health check guidelines and typical viability indicators can contribute to the discussion and give an understanding of the financial factors about any viable generational transfer process or timeline.

If it is the older generation's aspiration to transfer a viable farming business to the next generation of on-farm family members, it is important that all those involved (parents, on-farm and off-farm offspring) understand the magnitude of financial and business factors required to be a viable farming business. An appreciation and exploration of these figures at an early stage in the process can help all involved to understand the decisions to be made about asset transition and other succession arrangements.

Contact your accountant or financial adviser for further advice.

Useful resources:

GRDC Research Code: ORM00015

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