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Four Approaches To Valuing Sweat Equity

A common challenge that we encounter in succession planning is the concept of sweat equity and the opinions vary as widely as to the definition of it. Recently one old codger that we began working with put his opinion very bluntly. He summarized it as follows, Boys, if you can t prod it or poke it, ride it or smoke it, ain t real and you can t use it. On the other hand we have worked in situations where the parents want to give a multi-million dollar farm to one child because they have worked on the farm since graduating. We thought we’d take the opportunity to share with you some common rationales that we have seen farm families use to justify fairness to other siblings in completing their succession plan.

Ned Needshalp found himself in a pickle when his hired man of 15 years, Steady Teddy, retired. Ned operates a sizeable grain farm that has very high seasonal labour requirements. Ned is 55 years old and was faced with the decision to downsize, quit or begin training new help. His son Fred expressed an interest in the farm but was concerned about the capital requirement and risk associated with purchasing the entire operation. They reached an agreement in which Fred would work on the farm for a salary they agreed upon $50,000 per year, $30,000 of which Fred uses to live upon and $20,000 which remain invested in the farm with a 7.5 per cent return.

This investment is kept track of and if Fred decides to take over the farm some day this will form part of his down payment.

S. Jobbs has held a number of prominent executive positions in the corporate world. He has climbed the corporate ladder two rungs at a time, however felt torn between continuing his prominent corporate career and returning to the family farm. After much soul searching Jobbs decided to give the farm a chance. His parents, in

an effort to encourage and support his decision, felt that a fair approach to the situation was to offer him the same executive salary he was making in the corporate world. His drawings from the farm were only a quarter of the salary, however it was expected that he pays fair market value for the farm. Similarly to the previous example, the difference between the salary and the drawings would remain invested in the farm.

Ed Jimcated ran a successful farm his entire life on a Grade 9 education and was successful doing it. He placed little value on formal education. In an effort to keep his son Ed Junior on the farm and avoid the cost of sending him for post secondary education he offered his son the value of the education in equity in the farm. Ed had two other children which he sent to the big city for some schooling and it cost him $15,000 in room, board, tuition and books in addition he figured $25,000 per year was missed if the children had been working full time. He offered Ed Junior $40,000 per year for five years a total of $200,000 with a 7.5 per cent return if he would stay home and work with him on the farm for five years. At the end of the five years this sweat equity could be rolled into ownership on the farm or he could take his money and run.

Kary Kepitgoin is a fourth generation farmer and can t imagine selling the farm on his watch. He wanted someone in the family to take over the operation and was willing give it all away to see the operation continue on. There was one problem his wife wanted some sense of fairness to the children who decided not to farm. Their son enjoyed the farm work however had very realistic expectations of profit on the operation and because they were at established jobs his wife was not willing to take the risk with out some certainty that they would own the necessary assets for a sustainable farm in the future. Kary and his wife agreed that they would sell the farm in the future at a reasonable price that would easily cash flow and the difference between this price and market value would be called sweat equity. This was discussed with the other siblings and everyone was in agreement.

In summary, the four situations demonstrate four different examples of calculating sweat equity. The decision to use on not to use sweat equity is very individual, however if you are going to use sweat equity it is important to pre-determine its value. Where we have seen major problems is in situations where open discussion has not taken place and there are vastly different expectations of sweat equity value and terms within the same business team. ”

AndrewDeRuyckandMarkSloanemanagetwofarmingoperationsinsouthernManitobaandarepartnersinRightChoiceManagementConsulting.Withover25yearsofcumulativeexperience,theyoffersupportinfarmmanagement,financialmanagement,strategicplanningandmediationservices.Theycanbereachedat [email protected]

and [email protected]

or204-825-7392and204-825-8443

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If you can t prod it or poke it, ride it or smoke it, it ain t real and you can t use it

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