So, you are thinking about being a farmer or rancher and starting your own farm or ranch business. There are many things to think about in starting your own farm, such as what form of business entity you should have and how you are going to pay for the business.
Types of Business Entities
Three types of business entities make up the majority of farm and ranch businesses. These include:
- Sole proprietorships
Traditionally, farming has been carried on under the sole proprietorship form of organization. In fact, most farms and ranches today are sole proprietorships or partnerships. However, there has been a lot of interest in recent years in the corporate form of organization for farms and ranches. This interest has focused on the small, closely-held corporation.
You should choose the most suitable organizational form based on your objectives. If you want the farm business to continue as a going economic entity beyond your generation, you should consider the corporation as a possible method of organization. Also, if there will be many owners and decision makers involved in the farming business, the formation of a corporation is warranted.
For many farm and ranch businesses, however, continuation of the business after the death of the owner or major stockholder is not contemplated. If the assets involved will be sold, or transferred by gift or inheritance, and recombined at retirement or death with assets of other firms, the governing objectives will be heavily influenced by estate planning considerations. These objectives include maintaining reasonable security of income and capital for retirement and fairly distributing family wealth among the heirs. The corporate form may also be beneficial in these situations due to tax considerations. You should check with an attorney to see which organizational form is best for you.
Farmers operating their businesses as sole proprietorships contribute all of the equity capital used in the business. Debt capital is obtained from outside lenders, usually in arm's length transactions. Sole proprietors may not be creditors with respect to their business. So, if their business is unsuccessful, their creditors will get paid first.
Partners, in comparison, may make advances or loans to their partnership in excess of equity capital contributions. Advances are paid after the claims of outside creditors but, upon liquidation, are paid before return of equity capital contributions. Thus, for at least part of their total capital contribution to the partnership, partners can attain a ''hybrid'' status between that of a creditor and an owner of an equity interest.
Upon incorporation of a farm or ranch operation, the owners of the business may become corporate creditors as well as shareholders. The incorporators must determine how much capital (in the form of cash and other assets) to transfer to the corporation and the amount of debt capital to be borrowed from outside credit sources. The incorporators may further determine whether their contributed assets should be exchanged for equity securities or for equity securities and debt securities. The number of debt securities issued will have an effect on voting shares since voting shares are equity shares. The debt-equity structure of the corporation also has income tax considerations.
Talk to Your Lawyer
The organizational form which you choose for your farm or ranch business has many consequences. It determines whether or not you will have anything left if your business is unsuccessful. It also determines the tax treatment for income and expenditures. So, it's really important to talk to your lawyer if you are thinking about setting up a business.
Questions for Your Attorney
- If I am going to start a farming business, what kind of organizational structures are possible?
- What should I consider in choosing an organizational structure for my farm?
- What kind of financing is available for a sole proprietorship?