How you choose to structure your farm operation is an important risk management decision. But, choosing isn’t always easy. There are several types of business entities, each with its own pros and cons, and states have different requirements for different business structures. Also, depending on where your farm is located, there could be different requirements at the municipal level as well. In addition, it can be difficult to switch your legal structure after you've registered your business. So, choosing correctly at the start is crucial. You need to consider your business and personal financial needs, risks and ability to grow. Your choice can significantly affect the way you run your farm business, impacting everything from liability to taxes to control over the farm and succession planning. What you have to decide is which structure gives your farm the most advantages to help you achieve your goals; whether it personal financial goals, organizational goals, or community impact goals.
In most states, you will register your business with your state’s Secretary of State’s office (unless you’re a sole proprietorship or a general partnership because those businesses don’t have to register), and in most states you can file online. Most states and many cities also have a business or economic development office that can provide information about choosing a business entity structure. For example, Maryland’s Department of Commerce’s website at https://open.maryland.gov/business-resources/starting-a-business/ has information about how to choose a structure, how to register your business, how to determine if you need a business permit or a license, how to establish a tax ID/Federal Employer Identification Number (EIN) and how to develop a business plan.The Ag Law Education Initiative’s publication library has a guide to farm business structures under the Agricultural Liability section: https://umaglaw.org/publications-library/ . Virginia’s State Corporation Commission has information about the different types of business entity types at https://www.scc.virginia.gov/clk/busdef.aspx as well as links to information about how to register a business and how to submit required annual reports.
Below are brief descriptions of the most common types of business entity structures. For more information about the different types of business structures and choosing a business entity structure for your farm, see the additional resources at the end of this chapter, and, of course, speak to an attorney and/or accountant. Information about how to find an attorney is below in the “Additional Resources” section.
A sole proprietorship requires no formalities whatsoever to form. It also offers no protections against liability. Selecting the sole proprietorship business structure means you're personally responsible for your company's liabilities. As a result, you're placing your own assets (e.g., you family’s home or car) at risk, and they could be seized to satisfy a business debt or legal claim filed against you. It can also be difficult to obtain funding as a sole proprietor precisely because there is no protection for your assets.
A partnership is owned by two or more individuals. It requires a signed agreement to define roles and percentages of profits. There are two types: general partnerships, where everything in the business is shared equally (the partners share equally in managing the business as well as the profits and losses); and limited partnerships, where only one partner has control of the business, while the other partners simply contribute to and receive only part of the profit as spelled out in the partnership agreement. Partnerships carry a dual status as a sole proprietorship or limited liability partnership (LLP), depending on the entity's funding and liability structure. A partnership allows the partners to share profits and losses and make decisions together within the business structure. The partners will, however, each be held liable for the decisions made, including the actions of the other business partners.
Limited Liability Company
A Limited Liability Company (LLC) is a hybrid structure that allows members of the LLC to limit their personal liabilities and protect their personal assets while enjoying the tax and flexibility benefits of a sole proprietorship or a partnership, depending on the number of members in the LLC. Under an LLC, members are protected from personal liability for the debts of the business, as long as they do not act illegally, unethically or irresponsibly in carrying out the activities of the business. The LLC itself pays no federal income taxes.
Because the law holds that it is its own entity—separate from its owners—a corporation carries the least amount of personal liability risk. This means that creditors and customers can sue the corporation, but they cannot gain access to any personal assets of the officers or shareholders. The corporation also has its own legal rights. It can sue on its own behalf to recover damages. It can own and sell property, and can sell the rights of ownership in the corporation in the form of stocks.
There are several types of corporations:
- C corporations are owned by shareholders and are taxed as separate entities.
- S corporations avoid double taxation, much like partnerships or LLCs. Owners of S corporations also have limited liability protection.
- B corporations, otherwise known as “benefit corporations,” are for-profit entities structured to make a positive impact on society. For more information about benefit corporations see https://www.bcorporation.net/en-us/
- Closed corporations, typically run by a few shareholders, are not publicly traded and benefit from limited liability protection.
- Not-for-profit corporations, exist to help others in some way and are rewarded by tax exemptions. See more about not-for-profit corporations below.
A cooperative is owned by the same people it serves. Its offerings benefit the company's members, who vote on the organization's mission and direction. Cooperatives offer tax advantages similar to an LLC. They’re not usually taxed on dividends paid to members, so members are only taxed once on their income from the cooperative and not both individually and as the cooperative.
More about not-for-profit corporations
Many urban farms establish their farm as a not-for-profit organization because they want to give back to their community, and the federal and state governments encourage these charitable organizations by providing benefits to them. Not-for-profit organizations can be associations, trusts or corporations. The benefits of setting up a farm as a not-for-profit include a not-for-profit property tax exemption, the ability to apply for public or private grants (which don’t have to be repaid) and to be able to request tax-deductible contributions. Incorporation (becoming a corporation) is necessary, however, to also limit the liability of your organization’s board members and obtain personal liability protection for general and advocacy activities that are in line with the not-for-profit’s mission.
Starting a not-for-profit corporation is just like starting a for-profit business—there are steps that you need to take to set your business up for success:
- A key step is to clearly state the organization’s charitable purpose in terms that will satisfy the requirements for not-for-profit state and federal tax-exemptions. Start by researching other not-for-profit farms’ mission statements, especially farms that are similar to the one you want to establish. Then, be able to state the purpose of your farm, what population it will serve, and the role that your farm will play in your overall charitable mission. For example, the farm’s income might directly support charitable activities like providing low-cost fresh food for the community or maybe the farm will provide education about agriculture. Fulfilling your farm’s mission will be the reason behind every business decision made and action taken. It will also assist you in developing your business plan.
- Research state laws and procedures for incorporating as a not-for-profit. You might start by asking your local library for resources on how to start a not-for-profit. There are lots of books on how to start a not-for-profit, for example, “How to Form a Nonprofit Corporation” by Anthony Mancuso walks you through all of the federal issues. Many not-for-profit groups successfully incorporate without legal assistance, while some do consult with an attorney and others rely entirely on an attorney’s services.
- Consider the pros and cons of utilizing not-for-profit status. The benefits mentioned above are balanced with a lack of individual ownership, which may be a concern for the day-to-day functioning of the farm and/or for farmers who want to pass land on to the next generation. The property of the not-for-profit corporation is owned by the organization and managed by its board of directors, not by any individual or group of individuals.
- Write a business plan. A business plan explains in detail how your organization plans to accomplish its mission. It provides a way to review and plan operational issues, including the costs to start the not-for-profit, how the organization will obtain future funding, and how everyday activities will be managed such as who will be in charge of making decisions about what the farm grows or which growing practices the farm will use, etc. You will also need to include parts of your business plan in your federal application for tax-exempt status and future fundraising. You will need to demonstrate to funders that your organization is making a difference, so your business plan should include how you will determine the farm’s impact and whether it’s meeting its stated mission. Again, your local library may have resources to help guide you through writing a business plan. Also check with your local Extension Office to see what resources they may have. There are also resources available online to help people prepare business plans, and you might find that there is assistance also available through not-for-profit organizations or clinics whose mission is to assist small start up businesses.
- Create your organization’s bylaws. Bylaws set up the corporation and how it is to be run. They may incorporate much of what you set out in your business plan, but they will definitely include provisions for who is eligible to be on your board of directors, what the board members’ duties and powers are, how members are elected and what is the process for removing a board member. Generally, you will need to file a copy of your bylaws as part of your articles of incorporation and to apply for federal tax-exempt status.
- Choose a name for your not-for-profit and research to make sure it’s not already being used. A simple online search is a good place to start. You can also search the U.S. Patent and Trademark Office’s Trademark Electronic Search System (TESS), for free, to make sure that you aren’t infringing on any trademark: https://www.uspto.gov/trademarks-application-process/search-trademark-database
- Complete and file your organization’s “articles of incorporation” as directed by the state. Usually it will be the state where the farm is located. Check your state’s Attorney General or Secretary of State for information about what’s required.
- Get your Federal Employer Identification Number (EIN). You can apply for the EIN at the Internal Revenue Service's (IRS) website: www.irs.gov (search for “Apply for an employer identification number”).
- Once you get your EIN, file for state and federal tax-exempt status. It’s the federal determination made by the IRS that determines whether your organization qualifies as a 501 (c) (3) or other charitable tax-exempt organization recognized under the Internal Revenue Code (the federal tax laws). So, you will need to file for federal tax-exempt status in order to avoid state taxes. Seek assistance from a tax professional, especially starting out, to make sure you are filing the required documents by the required deadlines.
- Appoint your organization’s initial directors and hold an initial board meeting. Your board is crucial for fulfilling various positions and legal obligations within your organization. Typically, your board will start with at least 3 people and will grow as the organization grows.
- As with any business, obtain the necessary business permits and licenses to carry out the activities of the farm.
If it is important for you to have sole or primary control of the business and its activities, a sole proprietorship or an LLC might be the best choice for you. You can negotiate such control in a partnership agreement as well. A corporation, however, is constructed to have a board of directors that makes the major decisions to guide the business. A single person can control a corporation, especially at its inception, but as the business grows, so does the need to operate it as a board-directed entity. Even for a small corporation, the rules intended for larger organizations – such as keeping notes of every major decision that affects the company – still apply.
If you need to obtain outside funding sources, like investor or venture capital and bank loans, you may be better off establishing a corporation, which has an easier time obtaining outside funding than does a sole proprietorship. Corporations can sell shares of stock, securing additional funding for growth, while sole proprietors can only obtain funds through their personal accounts, using their personal credit or taking on partners. An LLC can face similar hurdles, although, as its own entity, it is not always necessary for the owner to use their personal credit or assets.
Licenses, permits and regulations
In addition to legally registering your business entity, you may need specific licenses and permits to operate. Depending on the type of business and its activities, it may need to be licensed at the local, state and federal levels.