Structuring the Business


There are many types of direct farm businesses, such as farmer’s markets, roadside stands, U-pick operations, agri-tourism businesses, Community Supported Agriculture (CSAs), mail order/Internet sites, and delivery service to homes, restaurants, schools, or institutions.

 

A direct farm business may consist of one of these types, or a combination.  For example, a farmer might sell products at the farmer's market on Saturday and to a CSA during the week.  Or a farmer could run a U-pick pumpkin farm, a roadside stand that sells foods made from pumpkins, and a bed and breakfast.  But in any case, the type of direct farm business selected triggers different legal considerations.  These considerations are covered within the different chapter topics throughout this Guide.

I. Business Planning Resources

Feasibility Studies and Business Plans

The first step in the process of establishing a direct farm business is planning.  It’s a mistake to rush into a direct farm business without first determining the nature of the business and what it will cost to establish it.  Begin by asking: "Is the business I am proposing feasible?"  The Illinois Department of Commerce and Economic Opportunity (ILDCEO) has published a comprehensive guide to starting a small business, which includes the basics of how to conduct a feasibility study.  The feasibility study portion of the comprehensive guide is available as a separate appendix.    

The second step in the planning process is to develop a written business plan.  The main advantage to writing out a business plan is that it will force farmers to think carefully about each aspect of their proposed business.  It will also help identify weaknesses in strategy and flag areas in which additional help and expertise may be needed.  Appendix B of the ILDCEO guide contains information on developing such a plan.  The Illinois Entrepreneur Network also offers a step-by-step guide to developing a business plan. 

1. The Illinois Farm Beginnings Program offers training opportunities for those interested in establishing sustainable, small-scale farming operations.  Programs involve business planning seminars, on-field farm days that offer hands-on training, and one-on-one mentorship programs.  The general website is available here.

2. Business Planning Assistance is available from Small Business Development Centers (sponsored by the Illinois Entrepreneur Network and the Illinois Department of Commerce and Economic Opportunity (ILDCEO).  The general website is available here.

3. The Guide to Direct Farm Marketing, published by The National Sustainable Agriculture Information Center, through the Appropriate Technology Transfer for Rural Areas (ATTRA) program, details several direct farm business alternatives, including case studies, and provides resources for further reference.

4. The Initiative for the Development of Entrepreneurs in Agriculture program (IDEA), sponsored by the University of Illinois Extension, provides educational support and technical assistance for those interested in alternatives to commodity agriculture, including direct farm marketing.  The website, contains a directory with links for further resources on business planning, market and product development, and technical management of a farm, among others.  The site also contains fact sheets that summarize many of these issues.

5. A particularly useful outgrowth of IDEA is the MarketmakerTM website, which brings together agricultural supply chain partners.  It specifically helps direct farm marketers by improving knowledge of where food consumers are located and how they make food-related purchasing decisions.  The site provides searchable and map-able demographic, consumption, and census data that a producer can use to identify potential markets.  Producers can also list themselves for free on Marketmaker, and become part of a searchable database that individual consumers, retailers, and restaurants use to find suppliers.

6. How to Direct Market Farm Products on the Internet, a 50-page guide published by the Agricultural Marketing Branch of the USDA in 2002, contains information on reasons to consider internet marketing, how to develop a marketing plan, how to research the market, and how to set up and market a website.  The appendix contains examples of actual direct farm marketers on the internet.

Assumed Name Registration

Direct farm business owners often adopt an "assumed name" for their business (e.g., Sunnyside Farm) when they do not wish to conduct the business in their real names (e.g., Jane and John Doe Farm).  All assumed names must be registered, but the type of business entity farmers choose will determine where the registration paperwork is filed.  The Illinois Assumed Business Name Act requires sole proprietors and general partnerships (discussed below) to file a certificate with the County Clerk in the county in which the business is being operated and publish notice in a newspaper of general circulation in the county of registration once a week for three consecutive weeks (805 ILCS 405).  Failure to obtain the certificate constitutes a Class C misdemeanor for each day of unregistered operation.  All other business entities with assumed names must file an application with the Illinois Secretary of State.  Each type of business entity has a separate assumed name application form.  The forms are available at the Illinois Secretary of State’s website, among the forms for each type of business entity.

 

One of the first steps in establishing any business is deciding the business entity – that is, the formal legal structure under which the business will operate.  Typical farm business entities include the sole proprietorship, partnership or limited partnership, corporation (for-profit or nonprofit), S corporation, limited liability company (LLC), and cooperative. 

Although this section touches on the tax implications of business form choice, the subject is discussed in more detail in the “Taxation” chapter of this Website.  Because the law treats certain forms of businesses differently than others, the following generalized information should not be considered a substitute for consulting with a qualified attorney and/or accountant prior to choosing a business form.  Consulting with a professional is important because the entity selected affects potential tax and legal liabilities, as well as business succession and estate planning.  In addition, each form varies as to setup cost and complexity.

For those interested in learning more detail about entity choices for the farm business, the National Agricultural Law Center at the University of Arkansas published in 2002 An Overview of Organizational and Ownership Options Available to Agricultural Enterprises.  The article is divided into two sections.  Part I covers general partnerships, limited partnerships, limited liability partnerships, and limited liability limited partnerships.  Part II covers limited liability companies, corporations, and cooperatives.  Although not specifically aimed at direct farm businesses in Illinois and therefore not a substitute for advice from legal counsel in Illinois, the overview is nonetheless helpful in understanding the legal and tax implications of the various business entities. 

 

The sole proprietorship is a business owned and operated by one individual[1].  The majority of farms are owned as sole proprietorships, as they easily are formed and administered.  If a sole proprietorship operates under an assumed name (e.g., John Doe operates a direct farm business using the name "Green Acres" instead of "John Doe's Farm"), the business must register with the county in which it operates. Registration requirements are explained elsewhere in this Guide in the section on Assumed Name Registration.  A sole proprietorship must also register with the Illinois Department of Revenue for tax purposes. 

Under a sole proprietorship, the law treats the owner and the business as one and the same.  This makes the owner personally responsible for the legal and tax liabilities of the business.  Therefore, a creditor of the business can force the owner to sell personal assets in order to pay the debts and obligations of the business; on the other hand, assets from the business may be used to satisfy personal debts (an action normally prohibited in most other business entities).  Additionally, the individual owner is taxed personally on the profits generated by the sole proprietorship, which makes filing taxes somewhat easier.

[1] In a very limited exception, spouses may co-own a sole proprietorship. This can impact filing and paying taxes, but otherwise makes little difference.

 

The Business Corporation Act of 1983 governs the formation and operation of corporations in Illinois (805 ILCS 5).  The structure of a corporation can be complicated, but basically, a corporation consists of two separate parts: a board of directors and shareholders.  Shareholders finance the corporation’s existence by purchasing stock in it; each stock share represents an ownership stake in the corporation, though individual shareholders typically have no say in the day-to-day operations of the corporation.  Rather, shareholders elect a board of directors, which is responsible for making all decisions related to the corporation’s affairs.  As a result of their position, members of the board of directors owe certain fiduciary duties to the corporation.  A corporation is formed by filing articles of incorporation with the Illinois Secretary of State.  The articles of incorporation dictate the management of the corporation’s affairs and outline the issuance of shares to shareholders. 

The corporate form is advantageous in some respects: the corporation is a separate legal entity from its owners (shareholders), who are therefore not personally liable for the corporation's liabilities and debts.  On the other hand, incorporation is time-consuming and expensive due to the paperwork and filings required by the statute.  Further, there are many statutory and administrative formalities that must be followed when operating the corporation.  Owners who fail to follow these formalities may lose their personal liability protection.  Finally, corporations are subject to “double taxation” - the government taxes the corporation on its profits and the owners/shareholders pay individual income tax on profits distributed as dividends.

The Internal Revenue Service Code classifies corporations as either "Subchapter C corporations" or "Subchapter S corporations."  The IRS considers all corporations C corporations unless shareholders elect S corporation status.  Electing Subchapter S status with the IRS, if certain requirements are met, may avoid this double taxation problem.

S-Corporations: S corporations elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes to avoid double taxation.  A corporation elects S corporation status with the IRS by filing Form 2553.  Only after the IRS accepts the registration may the corporation file its taxes as an S corporation.  Although avoiding double taxation is appealing, an S corporation can be difficult to establish due to many restrictions.  S corporations can have no more than 100 shareholders and all must agree to the S corporation status.  All shareholders must be U.S. citizens or resident aliens and only individuals, estates, certain exempt organizations, and certain trusts can be shareholders.  The S corporation must be a U.S. company.  Finally, an S corporation may have only one class of stock with limitations on the type of income that holders of that stock receive.  Despite these limitations, the smaller scale of many direct farm businesses may make S corporations an attractive option.

Close corporations: Close corporations are a form of corporation in which the stock is “closely held” by only a few individuals or families and is rarely, if ever, purchased or sold.  Illinois law allows these entities to avoid some of the formalities of regular corporations while continuing to protect individual owners from liability.  To be a close corporation, two basic requirements must be met: (1) the corporation’s Articles of Incorporation must state that the corporation is being organized as a close corporation, and (2) the corporation must place certain restrictions on the transfer of all its issued and outstanding stock shares.  Once formed, the close corporation form gives its shareholders wide latitude to manage the business, primarily by permitting broad shareholder agreements and allowing shareholders to operate without a board of directors.  Therefore, the close corporation may be a desirable option for stable businesses owned and operated by a few individuals, perhaps family members, instead of public shareholders.

A partnership (also known as a general partnership) is an association of two or more persons who combine their labor, skill and/or property to carry on as co-owners of a business for profit.  The Uniform Partnership Act (1997) ("UPA") governs the formation of partnerships in Illinois (805 ILCS 206).  There are no formal requirements for formation of a partnership, and one may be formed by default if more than one person is carrying on a business.  The entity itself is not taxed; instead, tax liability passes through to the partners in pro rata shares.

One key difference between a corporation and a partnership is that in a partnership, each partner/shareholder is an agent of the business and thus has the authority to enter into binding obligations (such as contracts and other business transactions) on behalf of the partnership.  Moreover, all partners are personally liable jointly and severally for the debts and obligations of the partnership.  This means that if the partnership lacks the assets to pay the debts, creditors may force the partners to pay the partnership’s debts out of their personal assets.  If one partner has no personal property, creditors can force the other partners to personally pay the full debts of the partnership, even if they were not personally responsible for the debt.  Another disadvantage is that if one partner dies or leaves, the partnership might automatically dissolve, depending upon the circumstances of the partner's departure.  In addition, partnership shares are not freely transferable and create special concerns for both business succession and estate planning.  Despite these limitations, general partnerships are a common form of business organization, especially among family members, due to their simplicity and tax status.  From a liability perspective, however, other forms of partnership may be more desirable.

The limited partnership (LP) addresses the problem of exposure of the partners to unlimited personal liability by separating the partnership into two classes—general partners, who remain personally liable for the partnership's obligations; and limited partners, who possess the same personal liability protection as the shareholders of a corporation.  Although the limited partners are shielded from personal liability, the partnership remains liable for the actions of the general partner's wrongful act or omission, or other actionable conduct.

The Uniform Limited Partnership Act (2001) governs the formation of limited partnerships in Illinois (805 ILCS 215).  Among the requirements for formation and operation of an LP are filing a certificate and annual reports with the Illinois Secretary of State.

One of the benefits of an LP is that limited partners may deduct their losses for taxation purposes up to the extent of their investment, an advantage not available to shareholders of corporations.  Limited partnership interests also are freely transferable, but are subject to filing requirements and fees.

The limited liability limited partnership (LLLP) is another business entity authorized by the Uniform Limited Partnership Act (2001) (805 ILCS 215).  Unlike in the LP, in the LLLP, the general partners in an LLLP are not personally liable for obligations of the partnership solely because they are general partners. The liabilities of the LLLP are the partnership's alone – similar to a corporation. 

The LLLP must file the same certificate with the Illinois Secretary of State as an LP, but must elect LLLP status on the form and attach a statement indicating that the LP is an LLLP.  Furthermore, each partner must consent to the filing of the business as an LLLP. 

The formation of a limited liability partnership (LLP) is governed by Article 10 of the UPA (805 ILCS 206). There is no separate statute outside the UPA concerning LLPs.  Under Article 3 of the UPA, all general partners in an LLP are shielded from personal liability for the debts and obligations of the partnership, regardless as to how the debt or obligation is created.  The partnership remains jointly and severally liable, however, for a partner's wrongful act or omission, or other actionable conduct, so long as the partner is acting in the ordinary course of business of the partnership or with authority of the partnership.  This liability shield for partners is one important benefit of the LLP over the general partnership form.

To form a LLP, partners must first create a general partnership.  Once formed as a partnership, members of the partnership must vote to amend the partnership agreement to become an LLP.  The LLP then files a statement of qualification with the Illinois Secretary of State.  An LLP often is called a registered LLP because of this filing requirement.  A renewal statement must be filed each year.  Although not overly burdensome, the filing and fee requirements are one of the downsides to pursuing an LLP business form.

Limited Liability Companies (LLC)

The Limited Liability Company Act governs the establishment and operation of LLCs in Illinois (805 ILCS 180).  An LLC enjoys the benefits of both the LP and a corporation.  Members of an LLC enjoy limited liability against claims and debts of the LLC and the favorable pass-through tax treatment of an LP.  Yet they have more management flexibility because they can elect to manage the corporation themselves or designate managers through the articles of organization.

The Illinois Secretary of State has published a 16-page Guide for Organizing Domestic Limited Liability Companies, which provides helpful information on the articles of organization, filing the articles of organization, organizing the LLC, other required filings, and forms and fees.

LLCs, LLLPs, and LLPs are all very similar in that they provide three main advantages: liability shields for owners and managers, beneficial tax status, and flexible management options.  They  differ primarily as to how they are created.  Depending on the specifics of the direct farm business, one model may offer greater benefits than the others.  Therefore, it is important to speak with an attorney or a tax specialist when deciding which business form to use.

A cooperative is a user-owned and controlled business that generates benefits for its users and distributes these benefits to each member based on amount of usage.  Common reasons for forming agricultural cooperatives include improved marketing or access to markets and increased efficiency in delivering to markets.

In Illinois, the Agricultural Co-operative Act governs the formation and operation of an agricultural cooperative (805 ILCS 315).  The Act requires an agricultural cooperative to be an association of eleven or more persons, a majority of whom are residents of Illinois and engaged in the production of agricultural products.  The association may engage in cooperative activity in connection with a broad array of activities, including producing, marketing, or selling agricultural products; harvesting, processing, and storing agricultural products; manufacturing, selling or supplying the machinery; equipment or supplies in relation to these activities; financing of these activities; and providing business and education services for bona fide producers.  The cooperative may only admit members, or issue capital stock to, those persons engaged in the production of agricultural products and/or cooperative associations.  Finally, there are some very detailed rules restricting how and why profits can be distributed.  An attorney familiar with cooperatives can provide specific details.

Cooperatives can be complex to establish and operate because they require coordinating numerous individuals.  Moreover, there are several legal documents necessary to running an effective cooperative, including an organization agreement securing financial commitments and patronage, articles of incorporation to be filed with the Secretary of State, bylaws governing the management of the cooperative, marketing agreements between the cooperative and its members, and membership applications.  The details of operating a cooperative are beyond the scope of this Guide, but several online publications provide good general information on establishing a cooperative, including the legal aspects of the operation: