It starts out wonderful. You have a natural fondness for each other, you share common passions, and your life goals seem to align quite well.
But gradually the attraction starts to fade, and you begin thinking about and longing for an exit strategy.
Divorce is defined as a legal dissolution. It’s never an easy subject to broach, not in marriage or in a business relationship.
However, partner buyouts and sellouts are a reality for many dairy farm families.
During the 2021 Pennsylvania Dairy Summit in February, Mike Peachey of Acuity Advisors and CPAs LLP joined Mike Hosterman of AgChoice Farm Credit to talk through the strategies and documents partnerships should have in place long before any invested partners choose to exit the business. Both Hosterman and Peachey have decades of experience consulting for dairy farms and other agricultural businesses, and they have seen the good, bad and ugly in partnership dissolutions over the years.
Mike Peachey
of Acuity Advisors and CPAs LLP
Mike Hosterman
of AgChoice Farm Credit
Prepare for three D’s
“What you need to prepare for is the three D’s,” said Hosterman. “A divorce or voluntarily dissolution of the business is one of them, but the other two that can happen are a death and a disability. The more you can do to plan upfront for any one of these three scenarios, the better off you will be.”
Peachey added that divorce is not always a bad thing. “I can think of one example where two brothers decided to end their agreement and go their separate ways. It turned out to be the best scenario for both brothers because one brother was able to cash out and reinvest in another farming activity, while the remaining brother was able to do quite well in the remaining dairy operation because there was finally a single purpose with everyone rowing in the same direction.
“The two ingredients that made that dissolution successful were adequate profitability for the remaining partner to buy out the exiting partner and a desire to move on by each of the vested partners,” he explained. “That desire to move on was stronger than either brother’s pride in wanting to prove the other wrong. If they would have stayed together, their quality of life and their family’s quality of life would have suffered. But in this scenario, both improved their quality of life.”
Communications and trust are fundamental
Often, when two people decide to go into a partnership, there is a lot of optimism in the fairy tale that everything always works out for the best. But both Peachey and Hosterman cautioned that all that optimism can quickly fade without open communications and a mutual trust for one another.
“There has to be a foundation of trust and communications developed upfront in the relationship to form respect for each other and the gifts and talents each brings to the table,” Peachey said.
He likened the work required upfront to create a successful business relationship to the pre-marriage counseling many couples go through. “Having a process for open communications and mutual trust effectively in place at the beginning requires a lot of foundational work around the ‘soft stuff’ before jumping into the relationship itself,” Peachey said.
“Too often, family dynamics can lead to personal attacks and communicating below the belt,” Hosterman added. “It has to be objective and professional. Personal issues have to remain personal, and business has to be about the business.”
Both Peachey and Hosterman agreed that working with advisers can help farm families and other farm partners think about those tough questions upfront, in preparation for the unforeseeable in case one of the three D’s does happen.
“It’s hard work and often not fun to do, but you have to talk about the bigger-picture stuff,” Peachey said. “Having a good adviser can help you talk through the expectations of the business arrangement – things like what are the expected roles, responsibilities and time commitments of each partner and how to assign a value quotient to what each partner brings to the business.”
Peachey explained that talking about those things upfront can bring to light differences in opinions before they become issues for the business. “An outside adviser can help partners think through job descriptions, how decisions are going to be made and how partners will be held accountable.”
Documentation prevents disagreement
No matter if you are in a partnership, an LLC or any business arrangement, both Hosterman and Peachey say there are certain documents that must be in place from the beginning. Those include corporate bylaws, an operating agreement and a buy-sell agreement.
“Having a well-thought-out buy-sell agreement makes it easier if one of the three D’s does happen because it outlines what you agreed to,” Hosterman said. “It doesn’t make the loss of a partner any easier, but it does aid in the dissolution process.”
He also urged that those documents shouldn’t just be buried in the back of the file cabinet after they are signed. “I am a firm believer that we have to look at these documents regularly. At least every couple of years, ask yourself if they are up-to-date and still what you desire happens if you have one of the three D situations.”
Hosterman shared a tale of two partnerships. In one, the partners had a very solid buy-sell agreement, one that was worked on over years and adjusted regularly. At one point, a cousin in the partnership wanted out. The buy-sell agreement made it very clear how the business was valued and what a partner got if they exited voluntarily. The business did not have to liquidate anything and was able to pay the exiting partner off over time as was outlined in the agreement.
In the other situation, a milk check remained uncashed at the post office for over six months because there was a dissolution with no agreement in place. None of the documentation was there to support what either partner wanted to do, and the dissolution came at a very high cost.
Peachey explained that the written agreements are really there in case you can’t agree on anything else. “It becomes your default,” he said. “Without it, there could come a stalemate, and a stalemate may be the worst possible scenario because then the business is paralyzed and can’t move forward.”
Expectation gaps lead to conflict
Peachey encouraged drilling down into the financials on what is viable if a partner does exit the business. “This may take some time upfront to understand what the appropriate length of time is to make it viable for that business to buy out a partner,” he said.
Hosterman also added the importance at documenting where value discounts may come into play. “I work with a lot of farm families where partners gain ownership through gifts from the previous generation,” he said. “Those gifts can be significant – 100,000 dollars or even a half million dollars. What happens if that partner decides after only a year or two that they want to do something else? If there is no value discount documented, it could create a significant drain on cash flow to the operation.”
Hosterman said that differences in value between whether a partner leaves voluntarily and whether there is a death should be documented. “Death is a dissolution that nobody wants, and you need to think about how to fund it, whether it is through life insurance or cash flow, to protect both the surviving family and the business for those remaining partners,” he said.
Finally, Peachey emphasized the importance of looking at values on a regular basis. “Make it a part of your annual business meeting to look at those agreements and make adjustments based on how the business has grown and values have changed,” he said. “Make sure each partner signs off on the agreed value each year.”
He cautioned that when their values are not reviewed from year to year, a huge gap in value expectations can grow over a period of five or 10 years. “What happens then if someone wants to exit? The exiting partner may have one idea on what the value should be, and the remaining partner may have a different idea,” he explained. “You end up with an expectation gap. That expectation gap becomes filled with disappointment, which may lead to disillusionment and, ultimately, a pretty significant conflict.”
