Succession planning in farming businesses is rarely straightforward, and in a significant number of cases, there’s a debt component involved. Whether the business is currently debt-free or already carrying liabilities, the transition from one generation to the next often necessitates some form of financial restructuring.
Here are three common scenarios where debt funding plays a role:
Scenario One
The business has no existing debt. However, as part of the succession plan, the incoming generation needs to compensate their parents and/or siblings for land or equity. This introduces a new debt burden that must be carefully managed.
Scenario Two
There is existing debt in the business. As ownership or management transitions, this debt may need to be transferred, refinanced, or increased, particularly if the business is expanding or if asset transfer is involved.
Scenario Three
Mum and Dad begin stepping back from the day-to-day, but remain involved, while the next generation ramps up operations and growth. In this instance, both generations are working together, but often, the parents still hold land assets and therefore remain tied to business liabilities.
Why Debt Funding Matters in Succession
In all three scenarios, debt funding plays a pivotal role in shaping the feasibility of the succession plan.
A key part of the planning process is determining the appropriate asset compensation for the older generation, particularly around retirement needs, as well as balancing this with the financial goals and capability of the working family members. This includes assessing whether the business can sustainably manage the resulting debt into the future.
The Role of Debt Analysis in Succession
Sustainable debt analysis isn’t just a financial modelling exercise — it’s a core part of decision-making that affects all stakeholders. At Sprout, we typically refer to Year-In-Year-Out (YIYO) debt levels, that is, the level of debt the business can reasonably carry in an average year without undue stress.
Setting a realistic YIYO debt target helps determine how much equity can be transferred, what compensation non-working family members might receive, and how the business can maintain operational viability.
When Should You Engage a Debt Advisor?
Early. A debt advisor should be brought in once the initial goals and priorities of the incumbent generation are understood. These early conversations shape everything that follows, including how succession will be structured.
It’s common for the incoming generation to have limited experience managing debt. This is where a trusted advisor becomes critical, helping to provide financial education, scenario planning, and clarity around what carrying debt actually means for the business long-term.
Key Considerations When Structuring Debt in Succession
- Sustainable YIYO debt levels: What can the business afford to repay over time without compromising growth or resilience?
- Security position: How will loans be secured under the new structure?
- Equity position: What percentage of the business does each party hold post-transition?
- Release of security: Will parents still own land, or is there a plan to release or reduce their exposure?
- Ownership of the trading entity: Who owns and controls the day-to-day operations?
- Compensation strategies: What are the financial arrangements for siblings and retiring parents?
- Bank implications: How will second mortgages or cross-collateralisation affect borrowing power?
Succession planning is not just a family discussion — it’s a financial strategy. Sustainable debt planning allows both generations to move forward with confidence, knowing the business is structurally sound and future-ready. Engage early, seek advice, and ensure the numbers support the vision.
If you’re considering succession and need clarity around debt structuring, Sprout’s team is here to guide you through the process.
