The Importance of a Strong Buy-Sell Agreement

Farm succession planning isn’t just about transferring assets to the next generation. It’s also about protecting the farm when life takes an unexpected turn.

If your farm operates through an LLC, partnership, or corporation, one of the most important documents you can have in place is a buy-sell agreement. Without one, transferring ownership during life can create significant risk for the operation and the family.

Why Farms Often Use an Operating LLC

In many farm succession plans, the ownership structure is separated into two main parts:

• Land ownership, often held in a trust or land partnership
• Operating assets, placed inside an LLC

Operating assets may include:

• Machinery and equipment
• Livestock
• Grain inventories
• Prepaid expenses
• Other day-to-day operational assets

This structure allows farm families to begin transferring ownership of the operating assets gradually, while still maintaining control of the farmland, which is often the most valuable long-term asset.

Think of the farmland as the farm’s “gold bar.” It’s typically the last asset families are willing to transfer until they are confident the transition plan is working.

However, when you begin transferring ownership of operating assets to the next generation, you need safeguards in place. That’s where a buy-sell agreement becomes critical.

What a Farm Buy-Sell Agreement Does

A buy-sell agreement creates a clear plan for what happens if something unexpected occurs involving an owner of the farm business.

These agreements typically address situations such as:

• Death
• Disability
• Divorce
• Voluntary withdrawal
• Bankruptcy or creditor issues

For example, if a farming heir owns 10% or 20% of the operating LLC and suddenly decides farming isn’t for them or faces a divorce or financial issue, the buy-sell agreement ensures the farm has a structured plan to regain ownership of those shares.

Without a buy-sell agreement, that ownership interest could end up in the hands of someone who has no connection to the farm or the family.

Determining the Value of the Farm Business

One of the key components of a buy-sell agreement is determining how the business will be valued if a buyout is triggered.

Common valuation methods include:

Appraisals

An appraisal determines the fair market value of the farm’s assets at the time of the triggering event.

Balance Sheet Valuation

Another option is using the farm’s annual balance sheet to determine the value of the business.

Each year, the LLC adopts the updated balance sheet into its records, creating a defined value for that period.

Agreed or Stipulated Value

A value that the owners mutually decide on in advance and record in their buy-sell agreement as the price that will be used.

However, this method must be used carefully. If an agreed value is never updated, it can quickly become outdated.

For example, if the farm was valued at $200,000 years ago but is now worth $2 million, an outdated agreed value could create serious problems.

For that reason, it’s important to include an expiration date for agreed values so that the agreement automatically switches to another valuation method if it isn’t updated regularly.

Why Buy-Sell Agreements Often Include Discounts

When a minority ownership interest is sold back to the farm, the agreement often includes valuation discounts.

For example, if someone owns 10% of the operating LLC, they typically would not receive 10% of the total fair market value. Why? Because they don’t own the entire asset. No one is paying full retail value for 10% of a tractor or one-third of a combine. Minority ownership interests are less marketable and often require discounts.

Some agreements even use a sliding scale discount where the discount decreases over time as the next generation becomes more established in the operation. This approach helps protect the farm while still rewarding long-term commitment.

Structuring the Buyout Payment

Another critical part of a buy-sell agreement is deciding how the purchase price will be paid.

In most cases, farms cannot simply write a large check to buy someone out overnight. Doing so could severely strain the operation’s finances.

Instead, many buyouts are structured as:

• Installment payments over time
• Low-interest promissory notes
• Balloon payments if appropriate

This structure allows the farm to regain ownership while maintaining financial stability.

Using Life Insurance to Fund Buyouts

When death is the triggering event, buy-sell agreements may use life insurance to fund the buyout. The business could carry a $500,000-$1,000,000 policy so if an owner dies, the life insurance proceeds can be used to purchase the ownership interest immediately without placing financial strain on the farm.

The Three Key Parts of a Buy-Sell Agreement

Every strong farm buy-sell agreement should clearly address three key issues.

First, it must identify the events that will trigger the agreement. These triggering events often include situations such as death, disability, divorce, bankruptcy, or a voluntary decision by an owner to leave the operation. By defining these scenarios in advance, the farm can avoid uncertainty if an unexpected situation arises.

Second, the agreement must establish how the farm business will be valued if a buyout becomes necessary. The valuation method may involve obtaining an appraisal of the assets, relying on the farm’s annual balance sheet, or using an agreed or stipulated value that the owners update periodically. Having a clear valuation method ensures that everyone understands how the purchase price will be determined.

Finally, the agreement needs to explain how the buyout will actually be paid. In many cases, the purchase price is structured as payments over time so the farm’s cash flow is not disrupted. Some agreements may also incorporate life insurance to fund a buyout in the event of death.

When these elements are clearly defined, farm families can begin transferring ownership with greater confidence, knowing there is a plan in place to protect the farm if something unexpected happens.

Why Buy-Sell Agreements Are Essential for Farm Succession

A buy-sell agreement allows families to start transitioning ownership during life, rather than waiting until death.

In some cases, farmers begin transferring small ownership interests to the next generation when they are in their mid-20s or early 30s, allowing them to gradually build equity in the farm over time.

At the same time, parents maintain protection because every transfer remains subject to the buy-sell agreement.

This balance provides the security needed to move the transition forward while ensuring the farm remains protected if something unexpected happens.

Protect the Farm Before You Start Transferring Ownership

If you are planning to transfer farm assets to the next generation, it’s critical to have a strong buy-sell agreement in place first.

Without one, unexpected life events could jeopardize the future of the operation.

But with the right structure, farm families can begin the transition process confidently knowing that the farm will remain protected no matter what happens.

Take the Next Step

To learn more about estate planning, keep an eye on our Events page located at: https://www.wagnerlegalmn.com/events/

If you’re ready to start being proactive about your estate plan and want guidance tailored to your family, assets, and goals, contact Wagner Oehler, Ltd. to get started.

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