Following is a condensed version of George Mueller's presentation at the 2009 Pennsylvania Dairy Summit. Mueller is a partner in Willow Bend Farm at Clifton Springs, N.Y., and a long-time American Agriculturist's Profit Planners panelist.
Necessary building blocks for a solid foundation
1. Profitability is the first block. If your farm doesn't have record of good financial progress, you haven't yet created a business worth saving.
2. Desire to build a lasting business is the next foundation block. The preamble to Willow Bend's partnership agreement states that this farm will continue to richly reward future partners, if it's carefully managed. That's an important and big "if". It also states that survival of the business should be the main objective of this Company. If family members cannot be found with the interest, dedication, and skills necessary to be the operating members, then outside members should be brought in with the necessary interest, dedication and skills.
3. Envision the lasting potential and significance. Future generations should consider this, written by Noel Perrin:
Some make their own bodies a lifetime work of art -- too small a surface to be worthy of that much attention; and over the last 30 to 40 years, it's a work of art whose esthetics steadily diminish.
Some make their homes lifetime works of art, but with little scope. And when it's all finished and remodeled, there isn't much left to do but dusting and cleaning windows.
A farm, on the other hand, can keep on changing and growing more beautiful for a thousand years. A farm is, in fact, an immortal work of art.
4. Skillful partners who love of farming are certainly an essential building block. If you love it, and can make money at farming, there's no better way to live and raise and teach children a good work ethic. If your child doesn't enjoy farming, other lines of work should be their goal.
Regardless of whether it's your own child or the neighbor's who seems to be lining up for future managing, make sure they get a taste of college and work somewhere else to gain added experience. I prefer they work three years away from the home farm, if possible.
5. Partners must enjoy working with people: As present day owner/partners, we can perform most of the required tasks – some well, some rather poorly. But as farms grow, managing people becomes the key ingredient of an owner.
Willow Bend has prospered because of it. Our son, John Mueller, spent three year working for Agway, learning a lot of what worked, and what didn't. As John Mueller took the farm from 600 cows to 2,100 cows, his ability to handle people has been absolutely essential. Partners that like working with people are an essential building block for a long lasting partnership.
Partnership framing rules
1. A time clock keeps it all fair. Even as partners, we punch a time clock along with the employees. Our weekly draw (guaranteed payment) is based on the hours we work. Then, if a partner wants to take some time off, he doesn't feel guilty.
In the busy season, we get paid extra for our extra effort. But, the main reward for the major owners isn't from the hours worked, but from their profitable returns based on their proportional investment in the business.
2. Ownership is proportional to our investment. Many farm partnerships are set up to give the next-generation son or daughter a 50 % share to start (or a third each if two are included). This keeps all partners equal in ownership. They then sign a note to pay for their initial share of the partnership. Any profits and appreciation going forward are then shared equally. There's nothing wrong with such a plan.
At Willow Bend, young partners must earn their way into the partnership by saving and purchasing a greater equity share of the business. The boy who came back to the home farm got no special deals for being loyal. But increasing his equity in the business depended on his frugality and good business management.
John, seeing the business was returning over 15 % on investment for many years, borrowed heavily from Farm Credit to increase his business equity. Then he worked even harder.
A capitalist is one who can save money and invest it where it will give him the best returns. Mary Lue and I put our whole farm in to get the partnership started in 1991. John Mueller put in his cow herd in.
All the other children were gifted equally over the years, by putting money into the partnership for them. They watched their money grow. Those that pulled some money out had less to watch grow.
The Nedrows put the value of their equity (assets less debts) into the business when our two farms were merged. Our herdsman borrowed money from Farm Credit to start his initial investment in the partnership.
3. Partners vote their capital account's net worth. Capital account is like shares of corporate stock in a corporation, only it's call "capital account" in our partnership. If your equity in the partnership is $500,000., that's the value of your capital account and of your weighted vote on important issues.
4. Voting is required only for key decisions. Most day-to-day decisions are made by the managers without concern for who has the voting power. If there's a key decision and a difference of opinion, John Mueller, the general manager, will usually wait for a consensus.
Key issues, such as setting hourly rates that partners can draw from the business, requires 75% approval by the capital account. Large expenditures for real estate or buildings also require 75% in favor.
5. Partners can only cash in 5% of equity a year. One of the most important rules of a partnership is how you get your money out. Many businesses fall apart when one partner pulls out, taking of the equity. Since the main object of our agreement is survival of the business, we require payout over 20 years. The first step in any such payout is to establish your equity's value.
6. An honest balance sheet is crucial. Each year-end, we run a careful inventory of owned and owed. This balance sheet is the most important report card on how the business is doing. It's especially true for a business with growing herd numbers and feed inventory.
Of our five children, only son John faithfully kept track of his own financial progress. John now manages Willow Bend and owns a third. So pay attention to your father when he preaches frugality and financial planning.
7. Partners certify asset value at each year-end. When we come up with a balance sheet with acceptable numbers, all partners sign a "Certificate of Value". That establishes the value of partner equity going forward.
8. Pulling money out is a slow process. If a partner wants out, his or her value of the equity has been established. He or she receives a 20-year amortized note for the equity value turned in, at a Farm Credit rate from Farm Credit at the time the note is issued. The slow payout gives the business a chance to turn itself around and survive. Survival, as I keep saying, is the primary goal of this partnership agreement.
9. Gifting a capital account. From time to time, Mary Lue and I will gift all our children equally. Hopefully, they'll use most of it to add to their own capital accounts. Those that did have profited greatly. As limited partners, we keep them informed and ask for input on key issues. The joint ownership has helped bond the Mueller family together.
10. Is an LLC worth it? In 1997, we formed a limited partnership so I and the other children could become limited partners. As limited partners, we no longer had to pay Social Security tax on farm profits. And, I could draw Social Security.
In 2003, we merged with the Nedrows and formed an limited liability corporation to give us partners more legal protection from lawsuits. But there was a cost. New York State now charges the partnership according to our gross sales. It cost about $3,000 in 2008. I wonder if an LLC is worth the expense.
11. What if a partner dies? Our agreement says that, upon a partner's death, if the partner didn't directly will the capital account to another partner, the capital account will be returned to the business and a note issued to the estate for the January 1 certified capital account value.
However, new partners can be brought in if desired by unanimous vote. We probably don't want too many partners. But if a partner's children want to stay close to our profitable business, I suspect they'll be voted in as limited partners.
12. Partnership meetings are required. Our agreement requires a membership meeting each year in January once the previous year's books are completed. A great deal of effort is put into preparing the annual statements. As I said earlier, it's the report card for the whole year.
Monthly financial meetings for all local partners are held on the second Wednesday at 3 p.m. Progress is reviewed and priorities are set for going forward. John Mueller, our general manager, leads these meetings.
13. The annual report: What's inside. Our financial report is probably one of the most complete in the industry. It includes a multi-year balance sheet; inventory reports of real estate, cattle, feed and machinery; year-ended operating statement; average equity for each partner as of the first of each month; profit distribution statement; a full list of all partners, address and present value of their capital account; certificate of value; print-out of the farm's total capital account; plus an up-to-date depreciation schedule.
14. The partnership owns the real estate. Many partnerships keep the real estate and partnerships separate, which makes non-real estate ownership issues confusing. We keep things simple. When the partnership owns the real estate, the partnership pays all the costs. No decisions are necessary as to who, pays what and how much?
15. Again, keep books as simple as possible. Even with two equal-sized 1,000-cow dairies, Willow Bend runs everything through one set of books. A record of all income, less all expenses each month, is all we need.
16. Calendar year accounting works beautifully. We'd never think of closing the books at any other time of year. Doing books in your slack season is ideal.
Put on a protective roof
A simple, but complete partnership contract is essential. We spent extra money by hiring a well-respected lawyer to help us draw up our 50-page partnership contract, which we'll probably seldom refer to. But we got the simple contract we were after.
Our Farm Credit accountant/consultant helped us design a simple partnership contract. The lawyer accomplished his job to protect us from all unseen occurrences with 50 pages. It may yet prove to be money well spent.
Minimal, but essential, insurance is needed. We've always believed in "self insurance". But both farms are covered with a 3-million dollar liability umbrella. With all our machines on the highways we would not dare to skip liability coverage. But for other insurance, we go with the minimum. Here are some specifics:
• Machinery insurance: Self-insurance is dangerous for our big chopper. We really should have fire insurance on it. Since we've never had a new car, we don't carry auto collision insurance.
• Building insurance: Our lender requires fire insurance on our milking centers and attached barns. The rest are self-insured.
• Cattle insurance: They're self-insured. Free-stall cattle spread over two farms aren't a very great fire risk.
• Life insurance: You might think we'd have the business insure the key partners. But we don't. We try to keep our net worth high enough to take care of any widow and family.
To keep a roof on the partnership and keep "the wolves away from the door", we're very careful with debt. A business is very vulnerable to hard times if the percent net worth (equity/assets) is less than 60%. We're much more comfortable at 70% or 80 %. Above 80% is "coasting", and time for a new venture.
For a copy of Mueller's full presentation, e-mail email@example.com