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Cultivating Harmony on the Farm

12/09/2016


This article was originally published in the Beef Business Magazine and has been reproduced with permission.

Formalizing Business Structures to Keep and Motivate Key Employees

When it comes to farming, it’s as important to formalize business structures to keep and motivate key employees as it is for any corporation. At MNP we have been working with the agriculture sector for more than 60 years to enable the profitable sustainability of Canada’s farming industry.

​​Key employees isn’t just a corporate term

As we grow older, it’s normal to want to keep involved in what we love, but not work as hard at it – yet still make money. The same goes with farmers: there are those who want to keep farming but not work as hard for the next 20 years as they did 20 years ago, while still bringing in an income.

Agriculture is a fast paced, dynamic industry and, like any business, farms run better and are more profitable with smart, hardworking, motivated young people influencing and driving the business to continually improve and keep up with industry advancements. In order to do that, just as in any business, a farm operation needs to retain and motivate key long-term employees. 

Business succession and goal congruence between owners and employees is not an agriculture-specific challenge. Companies all over the world have invested hundreds of millions of dollars to build and refine structures that encourage management teams to take ownership and to act in the best interest of the shareholders. These structures range from profit sharing, stock options and phantom shares, commissions and share purchase plans among other. The following methods have proved successful in the agriculture sector for aligning farm owner’s and farm manager’s interests.

The Best Person for The Best Fit

You want to find someone with the desire to farm, but who does not have the opportunity.  This person must enjoy working on a farm and be capable of being your key right-hand person. This can be an opportunity to look for a person that brings an additional skill set to the farm.  For example, if your strengths lie in animal health, you may want a more mechanically inclined person.  If your strengths are managing day-to-day operations and logistics, but are weaker on animal health, you may look for that skill set. 

At MNP, we’ve seen farms seeking very similar skills and abilities of the owners to allow this key person to eventually run the farm entirely.  That way, the owners can retire with a passive investment. The farm stays as a family investment even if none of the children take over the operation. 

Such a candidate could be a small farmer in the area without access to the capital needed to operate a farm but who is highly skilled and proficient at running a farm.  It could be a neighbor’s child or an industry person with all the training, knowledge, energy and desire to farm but no opportunity because their family farm is too small, or the parents don’t require another full time operator. This concept can also work to bridge a gap if and when your children are ready to take over the farm.   

For The Common Good

The key to a good business arrangement is goal congruence, in other words, all parties should make decisions and exert their efforts to maximize the performance of the entire operation. Lack of goal congruence is the major cause of friction and frustration in a farming arrangement. But before goal congruence can be achieved, the appropriate structure needs to be established, the division of profits needs to be negotiated and all parties must have a clear understanding of the arrangement.

Here are some common red flags impeding the critical intersect of dreams and goals. They all have one thing in common: they force the participating individuals to choose between being greedy or being unprofitable, neither of which is appealing. 

Operational example of improper farm structure

Operating Two Herds — i.e. The key employee has his own herd.            

Scena​rio 1:   All the hay has been cut and they are forecasting rain in two days.  Does the owner bale his field or the key employee’s field for his 30 cows?

Should owner bale key employee’s first? - Unprofitable

Should owner bale theirs first? - Greedy

Scenario 2:  Farm owner is on holidays for two weeks and someone is coming to buy five replacement heifers.  Should the key employee sell his own or the owners?

Should the key employee sell the owner’s calves? - Unprofitable

Should the key employee sell their own calves? - Greedy

The key point of these examples is that trying to operate two independent businesses under shared roof and shared management team causes an endless number of conflicting decision points. It is critical to be only one business. 

The objective then, is to develop an operating structure which motivates all the operators to do what is best for the whole operation. Everyone should be motivated by the bottom line.

  • In most cases this person does not share in land appreciation so land rent at fair market value is calculated and deducted from operational profits before the profit sharing is calculated. For instance, if the farm has $1,000,000 worth of land and the farm only made $30,000, then the operation didn’t make money that year because they could have made $30,000 by renting out the land and not had any of the work involved in owning cows. 
  • Some operations charge interest for the use of family equity (not equity in land just livestock, machinery/buildings and operating capital).  If there is $1,000,000 in equity in cattle and machinery, then the farm would be charged an agreed interest rate of, for example, three percent. Profits of the farm would be calculated only after the first 30,000 for the use of the equity.
  • The key person is paid a salary (hourly or monthly).
  • Typically profits are shared with this key person based on a percentage.  There is no magic number, but would likely range from 5-15%, based on a number of factors such as age, size of farm, years of the relationship, etc. One useful way to think of the percentage of profit would be to measure it in relation to the number of head of cattle (or acres in a grain farm). If I had a 500 head herd, would I let a key employee run 25 cows on my farm and get the profit off of them? If so, then splitting the profit of the farm 95/5 would be a fair arrangement.

Rules of Thumb

  • Start with the big picture and then work down to the details, in order of importance.
  • More than one herd puts the farm ownership and management team in a constant struggle. Keep it to one.
  • Ensure the farm produces a full accrual financial statement (regardless of whether it is required for tax purposes or not) for two reasons:
  • To allow everyone to see the profitability of the farm, which ensures that it is being managed well, and
  • To track each of the stakeholder’s equity in the farm resulting from their share of profit and their withdrawals and contributions.

Once the business arrangement is finalized, all parties involved work to maximize the farm’s profit so all may benefit.  But it’s not the end of planning. The parties must still figure out how to communicate, determine each individual’s roles and responsibilities, develop an effective decision making process, and address operational and corporate governance. 

While not extensive, this article should plant the seed for further discussion with your accountant or business advisor and perhaps your future business partner.

Remember arrangements and the people in them can change over time, so this key person may only be with you for a couple of years or a decade.   And keep in mind every year you operate your farm with a motivated employee whose goals are aligned with yours, will improve your farm’s profitability and your quality of life. 

Dean Klippenstine, CPA, CA is a Business Advisor, Agriculture with MNP’s Regina office. He can be reached at 306.790.7946 or [email protected]