Orderly Exit From the Family Business
Farm Business Management Update, February 1999
By David M. Kohl of the Department of Agricultural and Applied Economics, Virginia Tech
In the next 15 years, 70 percent of North America's farm assets will change hands. This transition will accelerate in the next decade as age demographics of the current farming generation reaches retirement age. Pivotal players in this transition will be elderly females over 65 years of age, and the non-farm family children who retain ownership in the assets. According to the December 1998 issue of Success Magazine, up to 42 percent of family businesses will be in transition in the next 5 years. Many family businesses are in agriculture.
A major issue is how to provide an orderly exit for the older or Omega generation. The question is how can this exit be accomplished while maintaining their goals and values in the autumn years of their lives?
I'm Never Going to Die
In a study conducted by J.R. Marker in the Agricultural and Applied Economics Department, producers were asked when they were going to retire. Nearly 75 percent responded by saying, "Never! I want to die on the farm." Most do not get this option. Producers and small-scale business people must think about the eventual exit, beyond the normal thoughts of minimizing estate taxes through a will. Cost of living, income flows in retirement, long-term health care, living wills, power of attorney, medical insurance, and the eventual death must be considered.
Living Cost in Retirement Years
The first step when considering retirement is to develop a family living budget. Identify an itemized expense list and increase expenses 3 to 5 percent per year due for inflation. In developing a budget, consider that a person can expect to live 18 to 25 years after the age of 65. Sixty percent of lifetime health care costs generally occur in the last six months of life. In general, family living costs will be $30,000 to $50,000 annually in retirement years because of increased medical costs, travel, and leisure time activities.
Income Flow in Retirement Years
Many older agricultural producers find over 70 percent of their equity base in land. Though land can be a good investment over the long run, it is not liquid. That is, it may be difficult to turn into cash in a short period of time without accepting a lower price than would be received if more time were allowed.
An older person needs to ascertain a breakdown of income flow in retirement from various assets and retirement funds. First, check Social Security to determine how much income will be generated. Check, too, whether any conditions exist that may influence the surviving spouse benefits in the event of death. When reviewing Social Security, examine Medicare benefits and how they might influence finances in the event of major illnesses.
Second, determine how much income will come from pensions and retirement programs. Will the surviving spouse continue to receive benefits after the death of the original beneficiary? Generally speaking, it has been found that when up to 50 percent of retirement earnings comes from Social Security and retirement accounts, a family business has a much greater degree of success in the transfer of the business to the younger generation.
Third, check for any possible inheritance and other windfall income. Keep in mind that inheritance taxes can reduce the actual amount received.
Next, determine how much income can be derived from the sale or lease receipts generated through business assets. For leases, consider the possibility that income could be disrupted in the event the renter faces economic hard times or changes strategic direction of the business. All contracts and agreements should be in writing, even with family members. If the sale of the asset occurs, remember that up to 30 to 40 percent of the asset base planned on for retirement could go for deferred taxes.
Finally, up to 30 percent of Americans find that they have to work in their retirement years to provide sufficient income. If this is your situation, you must consider employment opportunities, stability of employment, earnings, fringe benefits, and the number of years your health will permit employment in retirement. How about the effect it would have on any Social Security payments, Medicare, etc.?
If you have more than $500,000 equity in your business, an extended health care policy is a good idea. Nearly 40 percent of Americans will need extended health care sometime in their retirement years. The current nursing home stay is 3.3 years at an average cost of nearly $40,000 annually. However, this stay is usually either less than eight months or more than eight years. A family business assets can quickly disappear if they are not protected from this downside risk.
Call in Professional Support
A family businessperson needs to develop a transition team. This team will include the following: accountant, lawyer, lender, and financial planner. Often a facilitator is suggested to provide guidance and ask the tough, objective questions. An outside facilitator requires trust in that individual and an open mind. A few dollars in retainer fees can save thousands down the road. Each individual should be on a retainer rather than paid an hourly rate. Periodic meetings provide an opportunity to develop and update a written transition plan. Updates need to be made as conditions change.
These issues are only a few of the important ones that need to be considered to make an orderly exit for the retirement years. In agricultural and small businesses with their wealth and business complexities, a well-defined transition plan for management is the most important step for the older generation.
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