Financial Makeover

From Sylvia Porter's Personal Finance Magazine 11/1986

PHOTOS by Peter Papadopolous

Saving the Family Farm

A summer of shriveled corn crops prompts a critical question for Paul and Gail McPherson: continue to work their land or sell out?

By Laurel Sorenson

At the two-story steel grain bin, farmer Paul McPherson jabs three start buttons.

Corn harvested last fall streams from the downspout into an empty aluminum truck. Grain dust puffs up. It catches the early morning light, surrounding the hopper with a golden hue. Peach orchards stretch up the distant hillside.

The beauty of the setting is lost on McPherson, who is occupied with more pressing concerns: "Heat's pushed peach harvest up," he thinks. "Packing plant better be ready. Irrigation system for trees on the fritz; must check. Hasn't rained in weeks. Corn's dying."

At 44, he's a wiry man with a slow voice and a fast walk. He checks his watch. It's 8 a.m., and he wonders where the fruit pickers are.

His wife Gail, 40, a former English teach, drives up. She has just taken blueberries to a customer 12 miles down the road, prepared shortcake for lunch, readied their three children for swimming, and set up the retail fruit stand on the farmhouse's front porch. What needs doing now? They confer briefly, one of many conferences the couple will hold throughout the day. And then she is off again.

Paul turns to the pickers, now gathered in the lot, and assigns them to orchard duty.

So starts a July day at Maple Lawn Farms, Inc. the family-owned fruit and grain farm in southern Pennsylvania's Susquehanna Valley has estimated assets of $2.3 million. Its 1,400 acres yield corn and peaches, along with minor crops such as apples, blueberries, cherries, strawberries, nectarines, and apricots. Most of these fruits are packed for wholesale shipping, primarily to the East. The rest goes to city folk, who drive up to pick Maple Lawn's sun-ripened fruit straight from the orchards. Corn goes to regional feed markets in Pennsylvania.

In a good year such as 1984, these crops and associated activities produce sales of $590,000, with net income of $40,270. But such ample figures cannot be counted on. Last year, for example, a 70-degree Christmas prompted some 15,800 peach and nectarine trees to bud early. Ten days later a frost dropped temperatures below zero, withered the orchards, and helped slice 1985 sales to $416,320. Net income was $1,223.

This year, the problem is not cold but heat. Drought doesn't threaten the orchards which are irrigated, but it does affect the corn, which is shriveling on the stalk.

Other problems, from an occasional barn fire to rock-bottom grain prices, make this a precarious way to earn a living. Yet the land has sustained four generations of McPhersons, conservative Scottish Presbyterians who have armed it since 1867. Paul, who assumed management of the arm at age 19 when his father died, has faced worse times. And today, one eye on the cloudless sky, he refused to worry. "It's beyond my control," he shrugs.

Instead, he and Gail mull over marketing programs that can increase the farm's profit margin. They experiment with new crops. They try techniques that increase yields, last year winning first place in the Pennsylvania State Corn Yield Contest. And they rigorously control costs for both farm and family, an effort even the children share. All three children-Gretchen, 13, Hugh 11, and Sarah, 7-work on the farm for hourly wages. It gives them a knowledge of business far beyond their years, plus some measure of financial independence. "I have money in the bank," says Gretchen proudly. "And I buy lots of my own clothes."

These arrangements tie the farm so intimately to the family that it is tough to discern where farm finance leaves off and personal fiancne begins. Paul and Gail, for example, draw combined salaries of just $7,600 from the business, which is structured as a corporation. "The corporation owns most of our cars, points out Paul. "It also owns our house; I live there as a condition of employment."

Like many owners of closely held businesses, the McPhersons usually feel the business needs cash more than they do. They spend $8,000 on new computers for farm records, but only $500 on a used car for the family.

As a result, goals common to others are irrelevant to Paul and Gail. Instead of hefty savings or even a retirement program, they seek estate plans, insurance programs, and long-range business strategies, which will help them to squeeze as much profit as possible from their assets. They believe these financial supports would put the business in the best possible shape for the next generation.

But the dry summer and a spate of gloomy headlines about the state of agriculture had prompted the McPhersons to ask themselves a more difficult question: Should they sell the farm? :Not today or tomorrow, but maybe when the market for farms and farm commodities is hot again. The McPhersons have begun to look at Maple Lawn differently-not as a way of life or a labor of love, but as an investment, much like a share of stock. As a result, they are asking investors' questions.

"Where are the opportunities? What is the best use of our assets and our cash flow?" Paul asks. "Right now, the market for selling is terrible, so it's a terrible time to et out. But nothing in agriculture ever goes one way for long. I intend to ride this thing back up…and I wonder, should we position ourselves now to change our asset structure then?"

Dedicated as they are to Maple Lawn, they both have professional skills useful in other careers. Gail holds a master's degree in English from Colgate University; Paul has a degree in agricultural business administration from Penn State.

Sylvia Porter's Personal Finance Magazine asked Robert E. Segal and L. Terry Lazarus, certified financial planners and professional partners based in York, Pa., to help answer some of the McPhersons' questions. The planners visited the McPhersons twice, first to gather financial statement, then to tour the farm. At a third meeting, held in the planners' York offices, they made their recommendations.

Is It Worth It?

Lazarus and Segal asked Robert Clofine, a York attorney, to join the session.

First, Segal tackled the issue of whether the farm is actually worth the McPhersons' time and money. By determining a specific rate of return for the farm. Segal gave the McPhersons a way to compare it with other forms of investment. He set the farm's corporate net worth at $2.3 million and estimated its average annual cash flow at $150,000, thus yielding 6.5 percent. If Paul were to put a more accurate market value on his own skills-paying himself, say $40,000 instead of $6,400-cash flow would shrink and the rate would drop further, to 4.8 percent. "On the surface, this shows that you could do better with our money in a certificate of deposit," said Segal.

But the farm can't be considered in mere dollars and cents terms, like an investment, he said. The McPhersons get many intangible benefits from the farm: the freedom of self-employment, high community status, and the satisfaction of carrying on a family tradition. "As we see it, the real question is not whether you should continue to invest in agriculture," Segal said. "Rather it's how can you increase cash flow?"

To raise cash, Segal asked the McPhersons to consider diversifying by beginning a new sideline business: selling their computerized cost-control and cash-flow tracking system to other farmers. Gail has been running the system for the farm, handling everything from Maple Lawn's payroll to its customer newsletter. "We are tremendously impressed with the sophistication of that system, Segal said. Such a sideline would improve the use of the existing asset, adding cash without adding expenses.

Paul and Gail immediately demurred. More powerful rivals are struggling to sell computer services to farmers without much success, Paul said. That's partly because many farmers don't take to the idea of expanding recordkeeping procedures with electronic gadgetry. But the couple bounced back with another idea. There's more potential outside agriculture," said Gail. "We could do mailing labels, or payrolls for small businesses." Paul agreed: "For that, people may pay."

Segal encouraged them to pursue that avenue.

Insuring for Security

Next Segal outlined a problem common to small companies: Lack of backup for a lead man or woman. "If Paul dies or becomes disabled, the business could become rudderless," he warned. The resulting drop in sales and income could damage the farm. Gail agreed that though she is skilled at retailing and advertising, she doesn't have the production knowledge that Paul does.

So-called "key-man life insurance" eases the potential difficulties of such a situation, Segal said. This provides a company with a single infusion of cash (upon the death of a "key man"), which can be used to hire and train new management. Maple Lawn's $50,000 worth of such coverage on Paul is insufficient, Segal said. Also they have no insurance to cover continuing business expenses that would result if he became disabled.

Lazarus suggested that the company secure up to $250,000 worth of key man coverage on Paul, which would mean yearly premiums of $2,810. The couple should also look into "overhead" insurance to cover continuing expenses for the business, should Paul be disabled. That insurance provides $10,000 monthly for 15 months at an annual premium of about $2,800 a year. He also suggested that Paul and Gail raise the levels of their personal life insurance from $53,800 and $10,000 respectively to $250,000 and $100,000.

Lazarus also recommended that Maple Lawn update the $100,000 policy it holds for Paul's 73 year-old mother, Mabel McPherson, which is intended to provide the corporation with money for transferring the estate at the time of her heath. By simply moving to a more modern policy, the company could double her coverage for virtually the same $5,600 annual outlay in premiums. Such magic is made possible with new policies that statistically reflect higher interest rates and longer life expectancies, Lazarus explained.

The Next Generation

Segal reviewed the McPhersons' current agreement for the farm, a corporation owned by Paul and his mother. The agreement calls for Maple Lawn to buy Mabel's 54.75 percent stake in the corporation upon her death, effectively transferring complete control to her son as the sole remaining stockholder.

Segal notes that such a corporate structure and buy-sell agreement could lead to tax problems if the IRS decides to treat members of the same family as the same person. These "attribution rules" allow the IRS to attribute one person's property or income to another. In the McPhersons' case, the IRS might claim that the portion of farm stock now ascribed to Paul is actually his mother's. That and other potential entanglements could lead to a larger estate and much high taxes for Paul's mother.

The relatively low value placed odn the farm stock also invites an IRS challenge, he added. "This is a scenario for protracted litigation and possibly, enforced liquidation," Segal sai. "You need a fresh approach."

Segal outlines several courses of action open to the McPhersons, ranging from rewriting the agreement to recapitalizing the company. He recommended that they engage an experienced estate attorney to help select and execute the best option. Segal also suggested that Paul's mother begin giving away assets now, trimming the size of her estate. For instance, she might give her stock in the farm to Gail and Paul, ending her voting control of the company, but also reducing her estate taxes. Without this and other estate-planning steps, the McPhersons could see their inheritance evaporate, Segal warned.

He urged Paul and Gail to review their own estates, as well. Paul's simple will, drawn in 1973, leaving everything to Gail, isn't suitable for such a complex estate. Gail's homemade will is also inadequate, he added.

Increasing Personal Holdings

As a final note, Segal asked the McPhersons to consider drawing a distinction between farm and family finances. Though Paul holds farm stock, the corporation itself holds virtually all assets. The McPhersons' low salaries mean that personal financial rewards have been minimal.

To address this imbalance-aside from granting themselves a raise-Segal suggested that Paul and Gail transfer assets from the corporation to themselves. Two tactics could accomplish this: (1) Buy buildings from the corporation via an interest-free demand note, rent the buildings back to the company, and take the depreciation as a personal deduction for 1986, thereby diverting corporate cash flow for personal use; or (2) borrow against their land, channel part of the cash into investments that would guarantee repayment of the bank loan in full, and use the rest for other purposes.

Segal cautioned that both strategies are considered "aggressive" by the IRS and could easily meet with a tax challenge. The McPhersons would have to decide if the potential benefits outweighed the risk, he said. Such benefits include the opportunity to diversity. With more cash to call their own, the McPhersons might find it easier to broaden their investments beyond agriculture.

Neither Paul nor Gaila needed much time to consider these suggestions before deciding against them. "seems like kicking the Irs in the teeth and asking what they'll do about it, Paul responded. Nor did he support the idea of transferring assets from the corporation to himself. "Just putting it into one picket out of another," he shrugged.

Two Months Later…

By the end of August, Paul and Gail McPherson were calling it a long and frustrating season. Rain finally arrived, but not before half of the corn crop fell to drought and the federal government branded their county a disaster area. Later, rains came in such torrents that their peaches began to peel on the trees. That further cut profits, as did an unexpected surplus of fruit on summer markets.

At one point, the McPhersons could get just $4 per 40-pound box of peaches, far below their break-even l evel of $8 to $10 a box. The prospects for corn, which would be harvested the following month, were equally grim. Paul expected a price of roughly $1.90 per bushel from the nation's overflowing grain markets, compared to his projected cost of $3.27 per bushel.

With such a gap between income and expenses, not even their government price deficiency payment-an estimated $40,000-can stem losses. The actual bottom like remains uncertain because of too m any unknowns, from the market to the weather.

Workdays continue to run from sunup to past sundown. As a result, the McPhersons have had little time to act on the family's new financial plan. They know what they'd like to fix first, however: the estate agreement. The couple has already visited with Paul's mother, Mabel. She is in full accord on revising the agreement to transfer the farm more smoothly to her son.

Meanwhile, the McPhersons have continued the overhaul of their insurance, begun prior to meeting with their financial planners, Segal and Lazarus. Paul increased his personal life insurance to $100,000 of coverage; Gail, to $150,000. They were also able to up date Mabel's corporate policy, providing an additional $100,000coverage without additional premium.

Paul is still ambivalent about taking out the $250,000 key man insurance that Lazarus recommended. So in the meantime, he has taken out a temporary month-to month policy for that amount, for which he pays a $44 monthly premium.

At the moment, the McPhersons are not pursuing overhead insurance for the business, because they don't believe it to be a pressing issue.

The McPhersons continue to mull over the idea of a sideline business based on their computer expertise. But simply finding the hours to develop a sideline is an obstacle. "I don't think it's a panacea," Gail says.

What about selling the farm? That remains a wrenching question. By Paul's calculation, Maple Lawn's rate of return stands at less than 1 percent. But he is not yet ready to surrender the farm his family has held for four generations. He is especially unwilling to sell at the bottom of the agricultural cycle, when he knows he'll get a depressed price. And he is reluctant even to grapple with such a long-range issue while swamped by so many short-term crises. "I've got to do one thing first," he says firmly. "Survive this year."

Laurel Sorenson is a Chicago writer and contributing editor of this magazine.

Food for Thought: December, 1, 1986, for Sarah's 8th birthday, the McPhersons visited Ms. Sorenson and toured Chicago with her. The children saw the size of city apartments, witnessed action on the floor of the Chicago Board of Trade, saw the famous water tower, the Wrigley Building, the river that turns green from vegetable dye each St. Patrick's Day, rode to the top of the Sears Tower, and took a moonlight carriage ride through the city.

The farm's still here, but Sears no longer owns the Sears Tower.