Farm Horizons, December 2019
By Myron Oftedahl
Risk management can be described as controlling your exposure to risk. This could be anything from storm damage to your buildings, crop loss, injury claim, and many more.
What can you do to avoid a financial loss because of some form of damage?
I just attended a webinar by Farm Commons, and the statement was made that insurance is the first line of risk protection. We carry auto insurance; fire, wind, and liability insurance on the buildings and contents; health insurance; often, life insurance; and maybe dental insurance. I know of some farms that have a policy in the event of a disabling injury, and we are offered some disability coverage through Social Security.
Social Security is divided between old-age, survivors, and disability insurance tax and medical coverage, or Medicare. That should make you stop and think old age, survivors, and disability insurance.
The majority of farms in Minnesota carry crop insurance; you get to choose the coverage level, and whether you add specific hail coverage or some of the other policy add-ons. Often this has become a requirement of your lender, in order to secure your annual operating note. If I am doing a mid-year balance sheet, I will use the insured value for the crop insurance for each crop as the asset value of the growing crop.
When it comes to fire, wind, and liability insurance on the buildings and contents, be sure to consider if you are covered for replacement value or depreciated value. Usually this insurance is based on a dollar amount per square foot for the buildings. The level that is first offered will be close to replacement value of the building based on square footage. You may choose to insure for less; if so, you need to understand that many companies require a minimum percentage coverage.
One thing that you should do is meet with your insurance agent and go through the list of buildings, machinery, and contents that are detailed in the policy. Is the list accurate?
You may find that you are paying for insurance on a piece of machinery that you no longer own, or that you now have a piece of machinery with no insurance coverage. Some policies do not require a machinery list. Usually, the lender will request to be a mortgage holder listed on the policy if they have a loan on machinery or vehicles. You may also purchase a separate liability coverage, or an umbrella policy to give you additional protection.
What is true of insurance costs? We pay them with the hope that we never will collect on them. We purchase health insurance in an effort to control our medical expenses. Will you ever collect on your life insurance policy? No, you buy it to protect your family, or to protect the business if you operate under a partnership.
Are there other ways that you can have some liability protection? Yes, either with an LLC, or a Limited Liability Company/Corporation. Both have some rules that need to be followed. An LLC must file with the secretary of state, must have an operating agreement or by-laws depending on which entity you choose, and both must have an annual meeting with minutes prepared.
In order to maintain the liability protection from an LLC, you must keep business and personal income and expenses separate. You cannot pay the cable bill from the LLC checking account one month because the personal checkbook isn’t home.
I encourage all of the farms that I work with to form an LLC if they own any semi-trucks, and especially if they haul any grain for hire. If you are hauling your neighbor’s grain and have an accident with the semi, and don’t have the semi under the LLC, you have now exposed the farm assets and your personal assets to any lawsuit that would come out of that accident. Doing your neighbor a favor could cost you the farm and your personal assets in the event of a lawsuit.
An LLC can be a good choice if you are looking at a farm transition; either will allow you to spell out how the business will be run through the operating agreement for an LLC or the by-laws for a corporation. We can be specific about who is responsible for what, who contributed what to the business, how distributions of income will be made, how to resolve disputes, and how to exit the business.
Businesses fail most often because of the four D’s; disagreement, disability, divorce, and death. Two of those should be resolved by communication. I had first written “can be resolved,” but that is not always the case. Disability is because of an accident or health issue. Death is something that we all face, we just hope that it is not premature.
A corporation or an LLC operate under some different tax rules, so make sure that you understand them before you jump in and form one. Also, understand that sometimes the law changes, and you may not like what the changes do to the entity that you formed.
Case in point, many farms around Glencoe formed corporations in the late ‘70s, and they were formed with the corporation owning the buildings, machinery, and the real estate. See the issue? Because the real estate is owned by the corporation, we do not receive the stepped-up basis through the estate. The recent tax changes do not make a corporation as attractive as they used to be because of the higher tax structure.
So, a corporation is easy to start, but difficult and often expensive to close. Be sure that you understand the pros and cons of an entity before you form one. Don’t do it just because it looks cool to have a business name that ends with LLC.
Another way to avoid risk is to be an active marketer. What do I mean by this? Having a marketing plan and then following it.
Too often I hear, “ I didn’t sell because I thought it was going to $5 corn.”
Write a plan, and then follow the plan. Once the plan is written, it is easier to follow, because you have already done the analysis and the thought process; you don’t need to rethink it every time that you check the grain prices. Many grain marketers that I have heard will say that the farm wife is the better grain-seller, and the reason for this is that she didn’t have the blood, sweat, and tears the attachment to the crop. Psychologically, we get emotionally attached to the crop, and it becomes harder to let go of it, so we make all kinds of excuses, and that often leads to poor marketing decisions.
There are a lot of other examples that I could use for risk management. We have different degrees of risk tolerance, and that is OK. Ultimately, risk management is how to protect yourself from a loss of some type. Preventative maintenance could be an example of risk management.
Be safe, be profitable.
If you have questions, contact a Farm Business Management instructor, and they can help you sort out what your risk level is at, and the best way to protect yourself.