If you have been following along, I hope you had the chance to start with the my introductory article on consolidation in the row crop industry entitled “Why Would We Focus on Keeping Families on the Farm?". The article sets the stage for the five major factors in consolidation. If you're keeping track, so far we've covered the first three. 1) farmer age, 2) rapid integration of technology, which includes two parts; autonomous equipment and big data 3) capital access part one and part two. Today, we are moving on the fourth factor which covers staff and organization structure. Next blog will cover the the fifth factor, discussing the inability to envision the future of crop ag.
Farm entity structure and staff structure
In a consolidating crop ag production environment, structure will have two primary components. The first component is the entity (organization) structure. The second part is the people structure (staffing).
From an acceptable entity structure concept, sole proprietors will no longer be an effective or efficient organization option. The reason is that they are too limiting. For example, it is difficult to bring family or others into a sole proprietorship or add outside capital. Therefore, businesses that want to grow and thrive will be forced to choose one or more entity structures.
There are a myriad of entity structures that can be used. If you use a partnership, it can be a general partnership or a limited partnership. If you use a corporation, it can be a C-corp or an S-corp. Or you can choose an LLC, and it can be taxed as a partnership or a corporation. There are additional options, but these are the most common. Many of you will have multiples of these entities. There are times when one entity structure is better than another for certain situations. You need to consult with a competent professional for the selection, and that competent professional is not always your local or family attorney, tax preparer, CPA, etc.
In a consolidating industry, as we have discussed in an earlier article, you are a consolidator or a consolidatee.
The reason I mention that here is because, first, your choice of consolidator or consolidatee may impact your choice of organization structure. Second, if your decision is to become a consolidator, organization entity flexibility becomes extremely important. The reason for the importance has to do with separating capital (fixed) assets from operation assets (rented land). Let’s address those two issues.
Let’s begin with operating assets and entities. In a consolidating industry, growth will almost certainly be dominated in the future by mergers and acquisitions. In any merger or acquisition, there are two assets components. Operations and the fixed assets associated with the business being acquired.
Operating entities should include just the farming activities. The operating assets are rented land (leases), investments in operating cash, growing crops, raw materials (fertilizer, chemical, seed, etc.), and finished good (grain) inventory. Assets in operating entities should rarely include fixed assets such as land, infrastructure and/or equipment. There are limited instances where including equipment may make some sense; however, usually equipment would be in a capital asset entity.
Capital asset entities: In a consolidating industry, it is usually better to separate out the fixed capital assets. The asset entity (ies) usually include one or more entities for the various capital assets. For example, your trucks, because of the liability associated with over-the-road vehicles, are often put into a separate entity because of liability exposure.
Another capital entity for some operations is infrastructure assets, such as grain bins, buildings and other facilities. The farmland can remain in a sole proprietorship or can be assigned to LLCs or partnerships. Simply put, the fixed assets are rented to the operating entity (ies). This has a distinct management benefit of separating operations management from capital asset management.
Almost certainly, you will have multiple capital asset entities - for example, equipment, infrastructure, real estate entities and maybe more than one of each. These capital entities are where the value and the assets are managed. As to operations, you may have only one operating entity; however, be prepared to have multiple operating entities, which, if large enough, will probably have a unique operations manager for each entity.
Merging operations vs. merging differing capital assets
It also helps in a consolidating industry because you can merge operations or you can merge differing capital assets. For example, if you are merging with another farm operation, you can put the rented land in the operating entity and if the merging individual has equipment, it may create a tax problem. With a multi-entity strategy, they can keep the equipment and rent it to the operating entity, or sell all or part as they prefer, or they have a third option of putting the equipment in an equipment entity with all or a portion of what you own. This strategy has a very decided advantage to you: you may not have to acquire equipment with the new land. You save equipment capital and often, because of the way the arrangement can be structured, you can benefit from using some of others’ working capital.
So, an example is perhaps you have three or four thousand acres located close to someone who is retiring, in financial distress or can’t grow fast enough. You can combine some of your acres and some of their acres into a new operating entity. That way you leave the rest of your operations intact. Of course, there is the alternative of merging their operating assets (rented land) with all your rented land assets in your operating entity. Your attitude toward bringing another equity partner into your business will determine which alternative you choose. The land referred to is rented, not owned land.
Option 1: A portion of your operation’s land + Mergee’s land forms a new entity and this results in two farming entities (your own operation, no merged land, and the new entity with both the merged land along with some portion of your acres.
Option 2: Your operation’s land + Mergee’s land and this results in your one farming operation entity (essentially the rented farmland and/or rented infrastructure assets).
The result is, in a potential merger, you can put the merge rented land in a new operating entity or put it in your existing operating entity. As to the fixed assets, your options let the mergee keep those and receive a rental income which has tax benefits, or part can be sold or merged into your equipment entity.
Management support of the business
This brings us to the last point. In one of your entities, you would have the management support portion of the business. The management support components would be accounting and finance, grain sales, technology and data management, marketing and PR management, general and administrative (G&A), and governance. This portion of your business would do the accounting, grain sales, technology/data management, adding acres and farms, for all of the other entities. Be sure to see the next article in this series which discusses People/Staffing as a Macro Factor in Row Crop Consolidation.
If you are interested in learning more about consolidation and how FamilyFarms Group can help your family preserve your farming legacy, call us at 618-372-372-7400.