Value of "sweat equity" must be clear, communicated in transition plan
Kelli Boylen for Progressive Dairy
Boylen is a freelancer based in northeast Iowa.
Someday this will all be yours.”
In today’s economy, most dairy families know that vague promises about transferring the farm to the next generation are simply inadequate.
Unfortunately, there are still many questions related to non-monetary contributions to a business and the value they carry in a transition plan.
In many cases, “sweat equity” is a term used for turning the labor of the younger generation into cash net worth. In many peoples’ minds, it’s a way to reward on-farm heirs – compared to offspring who left the operation – in estate planning. The term also arises in situations where the business has grown substantially in value due to the managerial ability and efforts of the on-farm heir.
Is using sweat equity really a good idea? It depends.
If value is assigned to sweat equity, it should be used as a part of transition planning, and not a “the kids will find out when they read our will” estate plan, warn specialists who assist farm families with generational transitions.
“Sweat equity arises in part when an on-farm heir is paid less than their true opportunity cost to work for the business,” explained Michael Langemeier, Purdue University agricultural economist.
He calls that situation less than ideal. “Without first addressing sweat equity, the farm heir could face a situation in which they worked for below-market wages for decades and then received the same inheritance as the non-farm heirs,” Langemeier said.
“It can also end up with the situation that I have seen in dairy operations where the older generation says, ‘We don’t have any cash to pay you for your contributions this year, but don’t worry – someday this will all be yours’,” said Kelvin Leibold, farm and ag business management specialist with Iowa State Extension. “Sometimes, ‘all of this’ ends up being a worn-out manure spreader.”
Start planning early
It is not enough to tell the next generation that they will be taken care of when the parents are gone; the time to start transition planning is now.
“The better situation is where you pay the on-farm person what they are worth every year,” said Leibold. “If you can’t cash flow the payment then you need to set up a ledger account where you keep track of the amount of ‘sweat equity’ the on-farm sibling should be compensated for at least annually.
“Ideally, each party would get paid each year for the value they contribute, whether that is in assets they have contributed, or contributed labor or management,” he said.
Langemeier said it is sometimes appropriate to include sweat equity in planning when the on-farm heir is paid a wage that is substantially below what they could have obtained in another job. It is less appropriate when the on-farm heir receives farm income that is similar or higher than what they could have obtained in another job. If the farm is not profitable, the value of the on-farm heir’s wage and sweat equity will be relatively small.
While it may be very difficult to be specific regarding the value of sweat equity, the principles should be included in a transition agreement, Langemeier said. The older generation could indicate that assets owned before the younger generation joined the operation will be split equally among the heirs. Assets obtained after the agreement would be split between the older and younger generations who are farming. The non-farm siblings would inherit part of the parents’ assets upon the death of the older generation.
Factors to consider
There are many factors that need to be taken into account when calculating the value of sweat equity, Langmeier said. “The important thing is to address it when coming up with a succession plan.”
Langemeier lists the top three factors to take into account when including sweat equity in a farm transition plan:
farm wage of the farm heirs
growth of the farm since the farm heirs joined the business
value of the land when the farm heirs joined the business
Good record-keeping is essential, as is good communication with all family members. And every operation needs to have its own plan.
“It is about transferring labor, machinery, management and assets,” Leibold said. “I have used a lot of strategies in the past. Each one is custom designed. Beginning farmer tax credits are one tool; or you might start off as an employee for a few years and then take a reduced salary and start to farm 80 or 160 acres. The younger generation needs to build up management skills and get some credit established.
“At some point they get off the salary and farm on their own,” he continued. Sometimes the younger party is part of a “super firm” and sometimes they are a “separate firm” but shop for inputs together and share machinery and labor together. The plan needs to start with joint goals and have a timeline setting out when certain goals are scheduled to be implemented.
An Illinois dairy family shares how they used sweat equity
There are many different ways to transition farms to the next generation – with or without sweat equity. Don and Marcella Lueking put a lot of thought and planning into how to fairly pass the farm on to one of their three children.
“When we received some inheritance it was later in our lives when we didn’t really need it,” Don said. “Our kids could really use it now, so we are giving them what we can now.”
Don, who started farming with his dad full time in 1972, took over the farm in 1975. They incorporated the farm, located near Centralia, Illinois, about an hour east of St. Louis, Missouri, in 1981.
Their son, Doug, graduated from college in 1996 with a degree in dairy nutrition and returned home to farm with his parents. One of his sisters is not active on the farm. Another sister is somewhat involved with the dairy operation and her husband helps with fieldwork occasionally for an hourly wage.
Don says he has talked with a neighbor who has struggled with a transition plan as well. Fair does not always mean equal.
Don and Marcella have put in their will that their farming son, Doug, will receive about 55% of their farm land; the daughter who is somewhat involved with the farm will receive about 25%; and the daughter not involved will receive about 20%.
When Doug started farming with his parents, he received a monthly salary, and each year he earned 1% ownership of the corporation, which includes the assets (such as machinery) and debt of the farm. By 2016, he owned 20% of the corporation and borrowed funds to purchase an additional 50%; his parents still own 30%. Don rents the land to the corporation and that, along with Social Security, fund his retirement. When Don and Marcella are both gone, Doug will own the corporation.
When Doug took over the operation completely two years ago, Don still owned the cows. Each year Don gives his son an agreed-upon number of the cows, and each of his daughters receive a cash payment equivalent to the value of the cows.
Their farm has faced tough times in recent years, like much of the dairy industry, but Doug’s 10-year-old son Drew has what his grandpa describes as an “unbelievable enthusiasm” for dairying. “It would be really nice if Drew could end up as the fourth generation on this farm,” said Don.