Farm Management

1
Farm Management

• Chapter 14
• Forms of Business Organization

2
Life Cycle

• Each farm business has a life cycle
• with four stages
• entry
• growth
• consolidation
• exit

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Figure 14-1Illustration of the life cycle of a
farm business
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Sole Proprietorship

• The owner owns and manages the business, assumes
  all risks, receives all profit
• No special legal permission required
• Advantages simplicity and freedom
• Disadvantages personal liability, size may be
  limited, lack of continuity
• Taxes on profit paid at tax rate of owner
  (individual or joint for couple)

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Joint Venture

• Operating agreements
• Partnerships
• Corporations
• Limited liability companies
• Cooperatives

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Operating Agreements

• Two or more sole proprietors carry on some
  activities jointly while maintaining individual
  ownership of resources
• Operating expenses usually shared among the
  parties in some fixed proportion
• Income is shared in same proportion as fixed
  assets and expenses are contributed

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Table 14-1Example Budget for a Cow/Calf Joint
Enterprise (One Head)
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Figure 14-2Distribution of income from a joint
venture
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Partnerships

• An association of two or more persons who share
  ownership of a business
• General partners contribute to the management of
  the business and are exposed to unlimited
  liability
• Limited partners do not participate in the
  management and are liable only for what they have
  contributed to the business

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General PartnershipsOrganization and
Characteristics

• Sharing of business profits and losses
• Shared control of property, with possible shared
  ownership of some property
• Shared management of the business

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Written Partnership Agreements

• Management who is responsible for which
  decisions and how they shall be made
• Property list the property each partner will
  contribute and how it will be owned
• Share of profits and losses carefully describe
  how these will be divided
• Records designate who will keep the records

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Written Partnership Agreements (continued)

• Taxation include a detailed account of tax
  basis of property and copies of the partnership
  information tax return
• Termination state the date of termination if
  one is known
• Dissolution method of division of property in
  case of dissolution of partnership

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Termination

• At a particular time, as indicated in written
  agreement
• Upon the incapacitation or death of a partner,
  although the partnership may continue if the
  written agreement contains provisions for passing
  on the estate and continuing the partnership
• Bankruptcy
• Mutual agreement

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Advantages of Partnership

• Easier and cheaper to form than a corporation
• A carefully written agreement can allow the
  partners to maintain much of their freedom
• Flexible form of business that can accommodate
  many different situations

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Disadvantages of Partnership

• Unlimited liability of each general partner
• Any partner individually can act for the
  partnership in legal and financial dealings and
  the other partners will also be held responsible
• Poor business continuity

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Partnership Taxation
A partnership does not directly pay taxes. It
files an information income tax return reporting
income and expenses. Each partners share of
income from the partnership is reported on his
or her own tax return.
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Corporations

• A corporation is a separate legal entity
• It is formed and operated in accordance with laws
  of the state in which it is organized
• Shareholders in a corporation are liable only to
  the extent of their investment

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Forming a Farm Corporation

• File a preliminary application, reserving a name
  for the corporation
• Draft a pre-incorporation agreement outlining
  major rights and duties of the parties
• Prepare and file the articles of incorporation
• Turn property or cash over to corporation in
  exchange for shares of stock
• Shareholders meet to organize and elect directors
• The directors elect officers, adopt bylaws, and
  begin business

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Two Types of Corporations

• C corporation a regular corporation
• S corporation a tax-option corporation

• No more than 75 shareholders
• Shareholders must be U.S. citizens,
• estates, or certain types of trusts
• One class of stock
• All shareholders must agree to form
• an S corporation

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Advantages of Corporations

• Limited liability for shareholders
• This advantage may be negated if a shareholder is
  required to personally sign a note to borrow
  funds
• The corporation, like a partnership, allows for
  several individuals to pool resources
• Business continuity

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Disadvantages of Corporations

• Costly to form and maintain
• Legal advice needed
• Shareholder and director meetings must be held

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Taxes and C Corporations
A C corporation pays taxes on its earnings before
dividends are distributed. The shareholders
then pay taxes on the dividends, at their
individual rates. (Double taxation) If
shareholders are employees, their salary
and benefits (e.g. health insurance) can be
charged as expenses to the corporation,
but these expenses must be reasonable.
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Taxes and S Corporations
An S corporation is taxed like a
partnership. The corporation files an information
tax return, but shareholders report their
share of income on their own tax returns and are
taxed at their own rates.
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Table 14-2 Personal and Corporate Income Tax
Rates (2003)
Check current tax rates for changes
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Table 14-3Comparison of Forms of Farm Business
Organization
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Limited Liability Companies

• A limited liability company (LLC) resembles a
  partnership but offers members the advantages of
  a corporation
• Liability is limited to the assets of the LLC,
  not the individually owned assets of members
• An LLC can have any number of members, all of
  whom can participate in management

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Limited Liability Companies(continued)

• Ownership distributed according to fair market
  value of contributed assets
• Net farm income from an LLC passed to members,
  who pay taxes at their individual rates (no
  double taxation)
• An LLC does not automatically continue in the
  event of a death of a member

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Cooperatives

• Cooperatives are a special type of corporation
• They require articles, bylaws, and detailed
  records
• Members who contribute capital enjoy limited
  liability
• Net income is passed to members and taxed at
  their individual rates
• Return to members cannot exceed 8, with
  remaining profits distributed as patronage
  refunds

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Transferring the Farm Business

• Is the business large enough to productively
  employ another person or family?
• Is the business profitable enough to support
  another operator?
• Can management responsibilities be share?

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Stages of Transfer

• Spin-off separation of operators into
  individual operations
• Takeover older generation retires and rents or
  sells farm to younger generation
• Joint operation both generations wish to
  continue farming together and either use an
  operating agreement or form a partnership or a
  corporation

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Figure 14-3Alternatives for farm business
transfer
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Summary
A farm or ranch business can be organized as a
sole proprietorship, a partnership, a
corporation, a limited liability company, or a
cooperative. Each form of business organization
has advantages and disadvantages.
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1. What are the differences among the four stages
in the life cycle of a farm business? Think
about a farm or ranch with which you are
familiar. In which stage is it?

• Points of emphasis could include personal and
  business goals, size and growth of the business,
  financial management concerns, and attitude
  toward risk.

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2. Why do you think the sole proprietorship is
the most common form of farm business
organization?

• Many farmers prefer to work alone or with close
  family members, record keeping and legal
  requirements are simple, and the management
  decisions can be quite flexible.

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3. What general advantages does a joint venture
have over a sole proprietorship? Disadvantages?

• Advantages include possible economies of scale,
  specialization of labor and management, and more
  financial resources. Disadvantages include
  increased record keeping requirements and a need
  to coordinate decision making.

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4. How does an operating agreement differ from a
partnership?

• Although two or more people may contribute
  resources to an operating agreement, generally
  there is no joint ownership of assets or
  commingling of funds. Gross income rather than
  net income is divided, and each party pays his or
  her own expenses

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5. For the operating agreement shown in Table
14-1, how would you divide gross income if party
A and party B each owned one-half of the
livestock?

• The following entries would be changed
• Value Party A Party B
• Breeding expense 5.00 2.50 2.50
• Interest on variable costs 11.95 3.78 8.17
• Interest on breeding herd 75.00 37.50 37.50
• Total cost 447.4195.78 251.57
• Percent contribution 100 44 56

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6. Explain the importance of putting a
partnership agreement in writing. What should be
included in a partnership agreement

• A written agreement provides a record of how the
  partnership was formed, documentation for tax
  questions, and guidelines for dividing income and
  liquidating the partnership. Points to include
  are management responsibilities, ownership and
  contribution of property, procedure for sharing
  profits and losses, records to keep, tax basis of
  property, and the process for terminating and
  dissolving the agreement.

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7. Explain the difference between a general
partnership and a limited partnership.

• In a general partnership, all partners share in
  management and have unlimited financial liability
  for partnership actions. In a limited
  partnership, partners who are not involved in
  management enjoy limited financial liability.

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Does a two-person partnership have to be 50-50?
Can it be a 30-70 or a 70-30 partnership? How
should the division of income be determined?

• The ownership shares of a partnership should be
  determined by the relative value of assets (minus
  liabilities) contributed by each partner. The
  shares can be in any proportion. Income is
  usually divided in the same proportion as
  ownership, but this does not have to be the case

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9. Explain the differences between C and S
corporations. When would each be advantageous?

• Taxable income from an S corporation is reported
  on the shareholders' personal tax returns. A C
  corporation files its own tax return and is taxed
  at corporation rates. An S corporation is
  limited to 75 or fewer shareholders, other
  corporations cannot be shareholders, only one
  class of stock is issued, and all shareholders
  must agree to operate as an S corporation. An
  advantage of an S corporation is that double
  taxation of income distributed as dividends to
  shareholders is avoided. However, if most of the
  corporation income will be retained in the
  business, a C corporation may provide tax
  advantages.

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10. Why might a partnership or corporation keep
more and better records than a sole
proprietorship?

• Somewhat detailed records are needed to determine
  how income is to be divided among partners or
  shareholders, and how the business should be
  liquidated. Corporations are often required by
  law to file certain financial reports

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12. What special characteristics do limited
liability companies and cooperatives have?

• Limited liability companies combine the ease of
  formation and taxation as a partnership with the
  limited liability of a corporation. Cooperatives
  are similar to corporations, but distribute net
  income through patronage refunds. In addition,
  each member has one vote regardless of ownership
  share.

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13. What form of business organization would you
choose if you were just beginning a small farming
operation on your own? What advantages would
this form have for you? What disadvantages?

• Generally a sole proprietorship would be the most
  satisfactory because of the simple and flexible
  structure and fewer legal requirements.

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14. What form of business organization might be
preferable if you had just graduated from college
and were joining your parents or another
established operator in an existing farm? What
advantages and disadvantages would there be to
you? To your parents?

• The most advantageous organization would depend
  on the value of assets the student had to offer
  to the business, the degree of commitment to a
  farming career, the age of the parents, the
  skills possessed, and the involvement of other
  partners or family members.