Episode 5: What do I do if...I want to diversify my rural business?

00:00:05 David Lee, Host

Hello and welcome to Podcasts by Brodies. My name is David Lee, and in this series, we take an in depth look at some common and not so common questions and scenarios Brodies lawyers have faced over the years in each episode.

We talk to Brodies experts to hear their insights and experiences that allow them to find the right approach when asked that deceptively simple but often hugely complex question, "what do I do if?"

In this series, we're focusing on health and safety and on rural business, and in this episode, we hear from two highly experienced lawyers to address the question, "what do I do if I want to diversify my rural business?"

Clive Phillips is a partner in the rural business team at Brodies and Leigh Gould is a partner in the family and personal team.

Welcome to you both.

So, Clive first, what do we mean by diversification of a rural business and what are the main reasons why a rural business might diversify?

00:01:08 Clive Phillips, Partner, Brodies LLP

Yeah, thanks David.

Diversification in agriculture has been around for a long time and you know, in its traditional sense it was something which was really just an extension of the farming business.

A simple example would be selling eggs at the road end. But in recent years, that has changed quite a lot, and it's now a very broad spectrum from, diversification, which is linked to agricultural activity to other enterprises, which are significantly different from the core agricultural business.

There's lots of reasons why people undertake diversification and it can be about introducing new income streams into the business, and that's often one of the main drivers. It’s about trying to make the business more sustainable, in terms of the changing market conditions. It could also be about using underutilized assets that are available on the farm which are for example, you know a derelict building that can be converted and used for some commercial use.

The other great attraction of diversification is that it helps to solve the traditional conundrum of one farm and multiple successors. So it provides space for the next generation or other members of the family to develop in the business and perhaps take responsibility for different areas for themselves.

So lot of reasons for diversification and the spectrum of what it actually is, is quite broad now.

00:02:46 David Lee, Host

OK, what about how, Clive, give us some examples of how rural businesses are diversifying?

Whether that is setting up, as you've said, a completely new enterprise or developing something that's linked to what the farms doing already.

00:03:01 Clive Phillips, Partner, Brodies LLP

One of the great strengths of agriculture and farmers in particular is that they are hugely innovative, people tend to think of farming as very traditional, but in actual fact, farmers are very good at coming up with new ideas and being willing to adopt new ideas. So I mean diversification ranges, as I said from, the eggs at the road end to some quite imaginative uses, or enterprises such as, adventure holidays, farm shops, agritourism, renewable energy, battery storage, and commercial property development, commercial letting...

There is a bit of a kind of debate as to where diversification stops and the new enterprise starts but there is that kind of broad spectrum and I don't think it's really constrained actually, it's only constrained by our imagination and the commercial opportunities that are out there.

00:04:06 David Lee, Host

And also you talked about the who earlier on Clive, about sometimes multiple successors to a rural business, and actually diversification can help with that.

How important is it to think when you are setting up a diversification of the business or a new business who's actually going to be in charge?

00:04:26 Clive Phillips, Partner, Brodies LLP

I think it's very, very important. If you look at most of the successful agricultural businesses they have very clear areas of responsibility, particularly if they're multi generational or lateral in terms of brothers. And the successful ones are those have clear areas of responsibility and those areas of responsibility tend to align with their particular skills and, I think that's very much the same with diversification. What you can't have is everyone dipping in and out of it, no one having a clear responsibility for it, and perhaps the people being involved that don't have the right skills.

Most of these diversification enterprises also involve an element of skilling up, and learning new skills, new management responsibilities to take on, and so you need someone that's willing to do that and has been prepared to invest the time to do that.

So having clear roles is critical to their success.

00:05:37 David Lee, Host

And when it comes to thinking about future structures, what about the considerations about how this new business fits in with what you've got already?

And obviously the big question of where's the money going to come from?

00:05:51 Clive Phillips, Partner, Brodies LLP

If we take the last one first.

Where the money is going to come from is really important, because many of these businesses do require some startup capital in order to get going. Now that might be provided through the farm business itself and it might have access to funds, it might have access to additional borrowing, so some consideration would need to be given as to how is that money made available to this new enterprise? Are assets of the farm going to be secured in order to access debt to fund those enterprises? There are from time to time a range of grants that might be accessible.

In terms of structuring, there's always that question; is it part of the farm business or is it going to sit outside of the farm business? There's lots of things to think about there. You need to think about the ownership structure. Is it going to be within the farm business and owned by the farm business? Is it going to be outside the farm business, but absolutely mirror the ownership structure of the farm business? Or might it be outside the farm business and have a slightly different ownership structure and there can be lots of reasons for having different answers to that question depending on the particular circumstances.

That also kind of leads into ultimate succession as well, because, you need to think down the line. If you create different ownership structures, what happens further down the line when those ownership structures might start to diverge through succession. Leigh that might be something you want to want to pick up on?

00:07:50 Leigh Gould, Partner, Brodies LLP

Yes, thank you Clive.

When you are thinking about succession ultimately to this business on the business owner's death, then the most important thing is to write a will so that you are clear about who is going to get what. And where, as Clive suggests, you have a business which has been split into responsibilities given to particular family members, that can lead your succession and allow the family to understand where those parts of the business will ultimately go.

But it's not just about your will, it is also about the structure of the business. If you're going to keep the business and direct ownership of the original land and business owner, then that's quite simple from the point of view of succession on death, as there's a fairly simple handover. But you are the business, you are the sole trader, assets are frozen for period of time after your death, which can create difficulties for other family members and the continuity of the business.

A partnership, allows other family members to come in, that is a good structure to allow the family to run a business, but the will is not going to provide the entire answer as to the succession if a partner dies. It may be the partnership agreement actually provides for what happens if a partner dies and query whether that agreement is what the family want if it reflects what they want and how that interacts with the will, and also the financing of any handover of the business.

Some families will structure things in a company, and again sometimes it's actually the shareholders agreement in the company and not the owner's will, which really dictates what happens to that business.

So it's really important that people, when they look at this, they're thinking about the ultimate succession where they want this business to go and how that's actually going to happen and how it all ties together.

Lots to think about there, but there's lots of good planning which can be done to make that a smooth succession, which is really important for family businesses.

00:09:48 Clive Phillips, Partner, Brodies LLP

I would just add a commercial point to that as well, which is that, very often one of the drivers for diversification is an additional income stream to support the farm. And if you get a divergent ownership structure on the next layer of succession, you then find that that income that was there to try and support the core farm business is now going off in a different direction.

So you need to kind of think about what is the impact of that commercially on the original objectives of the diversification. Now those objectives may change, of course, but you know it needs to be thought through to understand where that might all go.

00:10:33 David Lee, Host

And when you're talking there about impact, Clive, you've got to think about impact on the existing business because if you set-up, let's say, agritourism was one of the things you mentioned, you've suddenly got a lot more people coming onto the farm, which raises kind of health and safety questions, I guess in terms of increased access, and also who's going to do all the work here?

Is it going to be a drain on existing resources and on existing management time? Is that sometimes overlooked a little bit in terms of diversification? How it's going to impact on the existing business and the existing personnel?

00:11:10 Clive Phillips, Partner, Brodies LLP

I think it is often overlooked. I think that people underestimate the demands of setting up these diversified enterprises. Very often they are almost in effect a new business, and if you think about starting any new business, it needs a lot of time and a lot of energy, and particularly from the people, the principals, who are developing that.

Agritourism is a really good example because it potentially has a big impact on family life because, its peak period tends to be the summer season. So when the rest of the family might be hoping for a few days away if they can between silage and something else, that might not be possible, and if they haven't thought through how they're going to resource all of that.

You've got to also think about you know might it take people away from other key activities during the year, such as calving or lambing, or harvest. Will people be available for those other enterprises at that time? So it does have a big impact.

And of course, issues like public access, taking people onto the farm, access issues over health and safety and all of that stuff you do need to really think through what that might mean for the rest of the farm business and for the life of the family as well.

00:12:53 David Lee, Host

And you've talked about some of the nitty gritty points there Clive, but there's quite a lot more - you've got to think about risk, you've got to think about insurance, you've got to think about rates, VAT, there's a lot to think about if you're going to go down this route isn't there?

00:13:04 Clive Phillips, Partner, Brodies LLP

Oh yeah, absolutely.

I mean insurance is really quite important, but I think that people often don't appreciate that they need to consider the insurance impact on the core business and then the insurance requirements, the risk that they want to ensure in respect of the diversification as well.

So there's two separate components to insurance. They need to consider how is VAT going to be handled? Is it part the farm business, is it not part of the farm business? What does that mean in terms of VAT? Are they able to run the two separate businesses, one being VAT registered, one not? Or are they both going to be VAT registered? And what does that mean in terms of VAT on their budgets?

00:14:03 David Lee, Host

And Leigh you'll know from the area you work in, different family members have different skills, they have different objectives.

How do you tend to find, whether it's in a rural setting or otherwise, how family members divvy up all these responsibilities? Is it a question of horses for courses and the family trying to identify which role suits which person?

00:14:27 Leigh Gould, Partner, Brodies LLP

Yes, and I think it's very difficult for families. This is a really sensitive issue.

They're living together, working together and there will be, inevitably, tensions among family members as to who is best placed to do something or who feels that the value of something in particular should be passed to them.

It requires a lot of very careful handling and picking through with the family and in the best-case scenario, everybody is at the table having that conversation and everybody knows where they are and where they will be left at the end of the day.

So it does require a lot of careful thinking and planning out.

00:15:07 Clive Phillips, Partner, Brodies LLP

There are of course some situations where the best decision, if it's a diversification of any of any scale, is to actually bring in outside management into that diversified business.

So that's another answer as well that sometimes emerges.

But you know most of the diversifications that we see tend to involve family members or they're of a nature of a renewable energy development or something like that, where the sort of day-to-day management demands are relatively light at least once the projects up and running.

00:15:47 David Lee, Host

Yeah, so you're talking about bringing in specialist skills there.

Just on some other fronts that you've touched on already, Clive – property? You said there may be disused buildings on a on a farm, but sometimes you might actually need to create new properties and also you've got to think about delivering services in to make sure that that business, if it's not part of the core farm can work effectively?

What should the considerations be around property and services, if you're looking to do this?

00:16:14 Clive Phillips, Partner, Brodies LLP

The fundamental decision really is if the land or the property is within the farm business and how is it going to be made available to the diversified enterprise?

If the diversified enterprise is a separate business, is the core business going to transfer land to that other business for its enterprise, or is it going to lease it? There's all sorts of considerations that you might have there in terms of where the family ultimately see that farm business looking at how they see it looking? So that that's one of the considerations.

And then, you get down to the more practical stuff. Is that house access going to be taken? Does it need a new access? Do you need to separate out access from the farm access because of you know competition between different types of users? And what are the services?

Are you able to get the connections that you need, both to water and electricity for example? Increasingly critical, of course, is Internet and we all know the challenges that we have with rural broadband. Is the business going to have a requirement for Internet access and how is that going to be obtained?

So there's quite a lot in all of that to be thought through.

00:17:45 David Lee, Host

And is planning permission always required Clive for a for a change of use for a diversified business.

00:17:51 Clive Phillips, Partner, Brodies LLP

Generally if it's a material at change of use, absolutely, and unless it is agricultural use. I won't profess to be a planning expert, but your eggs at the road end I don't think you need to worry about, but if you're going to get into commercial letting you absolutely will.

Take advice on planning before undertaking any of these enterprises, because what are the prospects of getting the consent that you need that will depend a little bit on the location of your farm and all those kind of usual planning factors.

00:18:38 David Lee, Host

Loads and loads to think about here.

One of the options Clive I think is setting up a special purpose vehicle when diversifying.

Can you say what is a special purpose vehicle and what the implications of setting one up?

00:18:52 Clive Phillips, Partner, Brodies LLP

Yeah, SPVs (special purpose vehicles) are frequently used. There's no real magic in them other than they are a separate company, a special purpose vehicle. They're set-up for the purposes of that specific enterprise, if you like.

What that then allows you to do is to create an ownership and management structure within that business that may be different from the farm business and it also has the advantage, assuming you set it up as a limited company, it also has the advantage of containing, the majority of the risks of that diversified business within that special purpose vehicle.

00:19:38 David Lee, Host

OK and to come back to you Leigh.

You talked a bit earlier on about succession and the considerations there. Nobody wants to think about death, and nobody wants to think about marital breakup and whatever when setting up a new business or a diversification of the existing business.

What are the key considerations that people really should think about if they are going into this kind of new venture?

00:20:02 Leigh Gould, Partner, Brodies LLP

Thanks David.

So yes we have spoken about the position on death and making sure that the will and the structure come sit together, but there's also inheritance tax to think about. That is the tax which is paid by your heirs when you leave the business to them.

If the business passes to your heirs, they are left with potentially a 40% inheritance tax bill to finance effectively out of that business. That can leave the business in a very difficult position. So it's very important for these families to make sure they are capturing all of the inheritance tax reliefs they might get.

There are very generous inheritance tax reliefs for farm businesses which allow you to hand on the business without that burden of tax. But when you diversify away from farming, you are not farming, so you lose that farming inheritance tax relief. There is an alternative relief for trading businesses, but you must be trading yourself and not simply letting out land.

And this is where it becomes quite difficult because most businesses as they diversify, become a mixed picture – bit of farming, bit of trading, might be a bit of letting land - and HMRC look very carefully at this and will often run the argument that actually you're not trading, when you diversify, you’re simply using your land and that doesn't get this inheritance tax relief.

Clive spoke about agritourism, which is a really interesting example here.

So holiday lets - you have properties on the farm which are no longer needed, so you set them up as holiday let accommodation. HMRC quite like to challenge those cases and they are winning court cases on this point. The point being, in order for a holiday let business to capture inheritance tax reliefs you actually need to be running something more akin to a hotel. It is not enough to let out holiday accommodation. You would have to be providing a very high amount of services in order to get inheritance tax relief, so it's worth looking at that quite carefully.

Clive spoke about SPVs (special purpose vehicles) and they're also interesting here, because often what's happening is you're splitting the land ownership from the operations. So you would have a company taking the risk of the operations, but ownership of the land remaining with someone else with another entity. When you do that, you split ownership and operations but you also split your inheritance tax relief in two and it goes from 100% relief to 50% in some cases, so that is also worth having a detailed look at.

So there are tax pitfalls when you diversify, but there's lots of good planning which can be done around that. It might be that you keep the inheritance tax relieved bit of the business yourself to hand on inheritance tax free when you die, and you're giving the other bits of the business on to family members during your lifetime and avoiding inheritance tax - if you survive the seven-year period.

You can separate bits of the business out, so if there's a bit which wouldn't get inheritance tax relief, you can put that in a separate entity so as not to taint the rest of it. And helpfully with inheritance tax relief, if you have a part of the business which isn't quite a trade for HMRC purposes, if it's just a small part of an overall trading business, you can get that relief overall. So that's very helpful and there may be other inheritance tax reliefs available.

There's a nil rate band and a mean residence nil rate band, which can be helpful. So lots of tax pitfalls to think about, but lots of good planning which can be done and to make sure that any reliefs are captured.

00:23:55 David Lee, Host

OK, so we've got a complex picture here, Clive, as we come to a kind of conclusion. What's actually out there to help you?

Again, you touched a little bit earlier on grants - what grants are available and what support what should you go looking for in terms of advice and mentoring, if you are thinking about diversification?

00:24:14 Clive Phillips, Partner, Brodies LLP

There are various consultants available who will help you navigate what might be available, but I think at the at the same time there's nothing beats a bit of diligence yourself to have a look at what is available.

There's certainly this food processing and marketing grant. There's been rounds of that previously and there is support for various agritourism initiatives. I think there's a bit of work to be done. And don't assume that the first answer is the final answer.

I think I would say is that there may not be big chunks of money - sometimes there is, but there may also be, smaller sums here and there which will support training for example, and support, mentoring, support, preparation of business plans, farm reviews, all that kind of stuff.

In terms of mentoring and advice, farmers tend to operate kind of in isolation. That's what they do; they run their farms themselves and they tend not to share traditionally.

They're thinking about how they run their business beyond perhaps market conversations. That's changed a bit in recent years with a lot more kind of benchmarking work where many progressive farm businesses are now comparing their financials.

What I would say on diversification is you probably cannot talk to enough people and I think the key ones are going to be; You need to talk to your lawyer to kind of understand some of the issues that we've talked about; You need to talk to your accountant to consider how the financials might work; You probably need to talk to your banker because you need to understand how that might impact on the existing lending and future lending requirements, but then probably critical to all of this is to go and speak to other people who are already doing this.

And there might not be people on your doorstep. If I think of some of our clients that have been very successful in developing new kind of enterprises on their farms, they've been willing to travel quite significant distances and, in some cases, will even go abroad to experience what farmers have done elsewhere and to bring those ideas home.

There are a number of more formal mentoring schemes available that people can participate in as they can with any business is just that probably traditionally farm businesses have never thought to engage with that. But they are there and available and worth taking up on.

00:27:21 David Lee, Host

OK, and I'm going to come to each of you just for a final word.

It's a very complex field here and Leigh, in terms of family and personal law, just a short, short piece of advice for anybody looking to go down the rural diversification route.

00:27:39 Leigh Gould, Partner, Brodies LLP

I think the most important thing it is to plan. Plan for the succession plan for capturing tax reliefs.

Part of diversification is having a viable business to eventually hand on. And that's really important, but how is it going to be handed on? Is there going to be any tax due on that?

So it's about careful planning.

00:28:01 David Lee, Host

OK, and Clive from you, a final word on where somebody should start.

00:28:06 Clive Phillips, Partner, Brodies LLP

Yeah, very similar David.

Having a sound business model at the outset is absolutely critical, and then I think getting professional advice at an early stage is really important.

What's very difficult for us is when people are parked their way down the track and then they look for advice and it can often be difficult to retrospectively say what structuring is required.

So I would say - good business model, get some early advice, even if you then go away, develop the project further and come back and then start to put it together, but at least get some kind of scoping advice at the outset.

00:28:54 David Lee, Host

OK, thank you very much to Clive and to Leigh.

In summary then plan well, make sure you've got a good business model and take advice, even if it means traveling a long way to get that good advice.

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