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Brodies LLP: Managing risk on the farm

Conventionally, farming businesses are run as general partnerships
Conventionally, farming businesses are run as general partnerships

A family-run, rural business – like any other commercial venture – will face challenges from time to time. The key is to identify the risks and, in so far as possible, mitigate them while balancing this with commercial realities and the family’s primary goals.

By anticipating the issues that may arise and taking informed decisions the family can control how these challenges might be addressed in order to provide certainty and avoid disputes.

Succession is one of the biggest risks that many farm businesses will face and managing it effectively is crucial to success. It makes sense to anticipate changes in circumstances and consider what the preferred outcome would be in the event of death, divorce, incapacity or, indeed, retirement.

Developing a strategy that has the support of the key stakeholders is important. The initial discussion may be led by the exiting owners of the business, but seeking the views of both those who may be involved in its future, and also those who may not be, will contribute to a successful and robust outcome.

Once a succession strategy has been decided these issues can be addressed in one of two ways – in the formal constitutional documents of the business and contracts between the family members involved (which are legally binding), or by less formal means such as family charters (sometimes called family constitutions or protocols), which are simply statements of intent or agreements entered into by the family members in relation to a family business. These would not normally be legally binding.

When it comes to managing risk another important consideration is which business vehicle to choose. Much will depend upon the risk profile of the business, the attitude to risk, tax implications and how important limited liability is for the business owners.

Conventionally, farming businesses are run as general partnerships. This flexible business structure with tax transparency has long been favoured. When the agreement between the partners is correctly documented and updated to reflect changes in circumstances, it can form a sound foundation for running a business. The principal disadvantage is the lack of limited liability for the partners. In contrast, other structures can provide security against business risk for the business owners, and the ability to more readily distinguish between ownership and day-to-day control.

A limited company provides the benefit of limited liability for its shareholders and a structure that is familiar to banks and other lenders. The distinction between management and ownership can afford opportunities to leave management in the hands of those actively involved in the business, while providing other family members with a financial interest. The company is, however, a separate ‘legal person’ from the owners and directors, and will be assessed to corporation tax on its income and capital gains on property disposals. The relative rates of tax and the taxation of payments made by the company to its shareholders will help inform views on whether this is the right vehicle for the business.

A limited liability partnership (LLP) – a hybrid between a traditional partnership and a limited company – can be an attractive alternative. It is taxed as a partnership and also has its organisational flexibility but the LLP’s members also enjoy limited liability. The members are free to agree how to share profits; who is responsible for management and how decisions are made; and when and how new members are appointed and retire. Just like a partnership agreement, any members’ agreement is a private document that is confidential to the members.

When thinking about the business structure, it is important to remember that a business’ risk profile can change over time, for example, where the family diversifies into new ventures. It may also be the case that there are benefits in using different structures for different parts of the overall business, such as a limited company for a diversified activity and a general partnership for the farm business.

Selecting the correct legal entity and documenting the agreement is the foundation of the family business and a springboard for the future. Planning and review are essential. The decisions made now to manage the internal relationships are important to preserve both family relations and the business for the next generation.

Case Study

Donald and Margaret Famer’s family have been farming at Inverkirkaig for several generations. Their son, John, has recently become a partner in the farming partnership. John is a huge fan of ‘Dragons Den’ and has been pitching an idea to his parents. John and his good friend Jimmy have an opportunity to take on a craft beer franchise business at Inverkirkaig.

John’s parents naturally have some concerns. They do not wish to put the core business at risk and they are conscious that any investment in a new business may benefit John without benefitting his siblings. Jimmy is not a family member, nor is he involved in the farm partnership and yet they want to make sure John and Jimmy are properly rewarded for their efforts. Taking these factors into account the family take the decision to form a new limited company, in which John and Jimmy are the two shareholders and directors, in order to ring fence this venture and keep it separate from the farming business.

Jimmy is not a family member and is not involved in the farm. In order to protect both his and John’s interests, they enter into a bespoke shareholders’ agreement setting out clearly what has been agreed between them. This will cover issues such as the contribution that each will make to this venture, their respective shareholdings, control of decisions on key matters, how deadlock in decision making will be resolved and what happens in the event of a dispute or if one of them leaves the business voluntarily or as a result of death or incapacity.

If partnership resources, such as farm premises, are to be used, consideration should be given to how the farming partnership is to be compensated. In this case a formal lease of the land to be used will be entered into with the new company.

John would also be well advised to take advice in relation to this new business opportunity. A business plan and cash flow projections should be scrutinised to establish whether a business case can be made for the proposal. The legal franchise agreement should be carefully checked to make sure John knows what he is committing to.

Gill Summers is a partner in the corporate & commercial team at Brodies LLP. For more information, contact Gill on 01224 39 2268 or at