Wednesday, November 23, 2016

Transparency: Partnership Division

A couple of recent events have spurred my interest in transparency. First, there's the ongoing saga of Donald Trump's business dealings around the world and his not very transparent, or real, charitable efforts. And then there was an online exchange with Terry Finley, the manager of the West Point Thoroughbreds partnership operation. Terry was asking me about the finances of the New York Thoroughbred Horsemen's Association (NYTHA) -- which are in fact available to any NYTHA member who wants to see them -- but the question brought to mind my own concerns about the finances of horse racing partnerships.

As I pointed out about three years ago, partnerships are a big deal in racing. At this year's Saratoga meet, for example, some 41 different public partnerships made a total of 211 starts, and that's not even counting "partnerships" that are just groups of friends or business acquaintances and that don't market themselves to the general public. They range from high-end groups like Dogwood (now winding down as Cot Campbell, the inventor of the genre, cuts back), Centennial, West Point, Team Valor, Eclipse or Lady Sheila, where the buy-in cost is in the high five or even six figures, to operations like my own Castle Village Farm, aimed at the everyday racing fan, and where the buy-in is as little as $1,000, or even $500 for those signing up for a second partnership.

Whatever the size or level of a partnership, a prospective partner should be able to look at its financial reports and get a sense of what her money is going for. Later in this piece, I'll review a few financial reports that Castle Village Farm distributes to its partners each month and that our team (business manager Jean Zorn and sales manager Joe Wall as well as myself) thinks give the right level of transparency, so the partners can see what their money is being used for. But first, let's look at the many ways that a partnership promoter can make a profit. That's important for a prospective partner, since, as we've seen, the typical race horse doesn't earn enough to pay for itself. To the extent that the partnership promoter makes a profit, that increases the likely loss for the other partners. Sure, some horses do well, but, for every Twilight Eclipse or Ring Weekend in West Point's stable of more than 70 horses, how many are there that have not come close to earning their keep, much less repaying their purchase price? A fair division of income between promoters and partners is necessary to keep the partners in the game long-term; people who feel they're being cheated are unlikely to return, even though they understood from the outset that race horse ownership is not exactly a safe investment.

So how do the promoters make money? There are only a few proven and oft-repeated approaches (leaving aside for the moment the tactic of simply stealing the partners' money, as notoriously practiced by the late, unlamented Karakorum Racing Stable).

First, a partnership can mark up the price of a horse that it has purchased. It's not uncommon for the high-end partnerships to pay, say $100,000 for a horse at auction and syndicate it to partners at a value of perhaps $250,000 ($25,000 per 10% share). Certainly, there's risk and expense involved in making the purchase. The partnership will typically hire a bloodstock agent (for a fee of 5% of the purchase price), pay vets and others to evaluate the horse, and carry the risk from the fall of the hammer at the auction until the horse is fully syndicated. And the partnership has (mostly) legitimate marketing costs, tailored to their intended clientele. For example, I once attended a Centennial marketing event at a Palm Beach club, complete with wine, hors d'oeuvres, Bill Mott and Jerry Bailey. None of that comes cheap. But whatever the markup is, it should be fully disclosed.

Alternatively, a partnership can take a percentage of each partner's initial capital contribution in lieu of or in addition to marking up the price of the horse. At Castle Village Farm, for example, we take 10% of that initial partnership contribution to pay our sales manager, 5% for the expense and expertise involved in selecting horses, and 3% for our thoroughbred retirement charity, Castle Village Cares (which also gets 1% of all our horses' earnings). That's a  modest 18% in total, and it's fully disclosed in the partnership business plan and partnership agreement.

Second, a partnership can take a percentage of a horse's earnings off the top, before distribution to the partners, or it can retain a percentage of the horse, without the obligation to pay that percentage of the horse's expenses. These amount to the same thing. Again, to use an example I'm familiar with, at Castle Village Farm, we take 5% of the first $100,000 in gross purses earned by each partnership, 10% of the next $100,000, and 15% of anything over $200,000.

Next, a partnership can charge a management fee, in addition to or instead of a percentage of purse earnings. The management fee may, or may not, have any relation to actual overhead costs. At Castle Village farm, for example, that fee is $535 per partnership per month, and reflects actual costs like office rent, preparing annual tax returns for each partner, etc., but does not include any compensation for the management team. Other partnerships do it differently; the important thing for would-be partners is that they know whether a fee is charged, what it's for, and how much it is. Similarly, some partnerships, including ours, charge for additional out-of-pocket expenses that are outside the scope of what's covered by the regular management fee. At Castle Village Farm, we call that "partner liaison" expense, and it is whatever it is each month, and is fully disclosed.

Finally, a partnership can take a percentage, either of the gross or of the profit, when a horse is sold. A percentage of the gross seems to me to be problematic, for why should the partnership promoter get, say $5,000 when a $250,000 yearling is dumped in a $50,000 maiden claimer? In my opinion, the better practice is to take a percentage only of the profit, if any, on the sale. Most times there won't be any, but that's the nature of the game.

Now, as for transparency. At a minimum, prospective partners should know how much they're on the hook for, and in what categories. As the West Point website says, the most common question new folks ask is "how much does it cost?"(Although at that site, you have to sign up for a sales pitch to get the information.) Most partnerships are limited liability companies or limited partnerships, not sold on public markets, so there are few, if any, legal disclosure requirements. In some cases, the financial disclosure provided by partnerships is excellent, in others, it reminds me of the Wall Street law firm where I once worked, which sent each client a monthly bill that simply stated  "To our fee" and listed a (quite large) dollar amount.

As an example of what I think is adequate transparency and disclosure, here's a summary of what Castle Village Farm provides its partners and makes available to anyone asking about the possibility of joining us.

First, we provide a capital account for each partnership, showing the total amount of money that came in as partner contributions, the amounts deducted for sales costs, finder's fee and thoroughbred retirement (see above) and the cost of the horse (actual cost, no markup). In a new partnership, any excess is used to pay the horse's expenses, thus delaying any potential cash call. In our claiming partnerships, if a horse is claimed, we typically retain any excess of the claim proceeds over the amount used to buy a replacement horse in the capital account, in case that next horse in the partnership ends up being sold for less than we paid for it.

Second, each time a horse runs, we send partners a purse statement. To take an example, on October 17th this year, our mare Lemme Rock won an optional claimer at Finger Lakes. The race was worth a total of $17,400, so our 60% win share was $10,440 (gross purse). Then the statement shows that there were a lot of deductions: (1) fees deducted by the track -- principally for the local horsemen's organization and for jockey insurance -- totaled $361.30; (2) the jockey, the trainer and Castle Village Farm management each got 10%, or $1,044 each; (3) the mare's groom got $100; (4) Castle Village Cares, our thoroughbred retirement arm, got $104; (5) the trainer charged $25 for the raceday groom and pony fee; and (6) getting win pictures for each partner and mailing them cost $350, for total deductions of $4,072. So, from that $10,440 purse, the partners were credited with net of $6,368 -- more than enough to pay the bills at Finger Lakes and put aside something for the mare's winter vacation, but not really a bonanza. And each partner received a statement at the end of the month showing exactly the amounts just described.

Third, these purse statements then become part of the basic financial document sent to partners each month -- our Accounts to Partners. To continue with the same example, our Accounts to Partners for the Lemme Rock partnership for October showed that we'd started the month with $8,031 in the bank. Added to that was the $6,038 net from the October 17th race. So the partnership's available cash was a total of $14,399.

From that the statement shows deductions of $1,798 for training fees (we pay $58 a day at Finger Lakes); $373 for expenses paid out of pocket by our trainer such as the farrier, feed supplements, etc.; $265 in partner liaison expenses (see above); and $535 for our administration fee, for a total of $2,971. Obviously, keeping a horse at Finger Lakes is a lot cheaper than at Belmont, and there were no vet expenses that month, but still, keep in mind the winner's share was only $10,440.

So that left a total of $11,428 in the Lemme Rock partnership's operating account. Normally, at that point we'd retain two or three months' projected expenses and distribute the excess directly to the partners. But since the Finger Lakes season ends in November (if it hasn't already with multiple bad-weather cancellations) and we want to give Lemme Rock, who has four wins this year, some well-deserved time off, we retained that in the partnership so partners won't have to pay any cash calls before she starts racing again in the spring.

Just to be fair, let's also look at the Account to Partners for a horse that wasn't as successful. Our NY-bred colt Proletariat, winner of two races and $71,683 from 13 lifetime starts, had been on an injury rehab assignment in South Carolina and returned to Belmont in October. So, no purse earnings at all. Instead, here's what the Accounts to Partners for that partnership, consisting entirely of expenses, looked like.

(1) $770 for the first 11 days of the month training in South Carolina at $70 a day; (2) $883 for expenses, including van rides to the vet, shoeing, feed supplements, etc.; (3) $1,900 for training at Belmont (at $95 a day); (4) $185 for trainer expenses at Belmont; (5) $286 for vet bills in South Carolina; (6) $720 for the van from Camden to Belmont; (7) $265 in partner liaison expenses; and (8) $535 for the Castle Village Farm administrative fee, all for a total of $5,544. That's about as expensive as it gets for a horse in a month, but at least the partners know where the money went. Then each partner is billed her pro-rata share of that total. There are 42 partners in Proletariat, so the average cash call was $132, and specific partners' shares ranged from a high of $298 (5.38%) to a low of $23 (0.42%). I guess that's why we say we're an affordable partnership.

The important thing about these numbers is not the amounts, but rather that we disclose them, clearly and promptly. I may love our horses and hang out with them, but I never forget that it's the partners' money that pays for them.

So, Terry and everyone else out there: I hope you'll all be equally forthcoming about the finances of your partnerships. All of us, from Castle Village Farm to Centennial, Dogwood and Team Valor, provide good customer service. We (not speaking for the others, just CVF) take our partners to the barn and the training track to see their horses, we let them know when the horses are running, assist with licensing, get paddock passes for friends and family, and otherwise help partners enjoy the racing experience. How much a partner should pay for that experience is a matter for each individual to decide. In our case, the support and the experience comes at a pretty low price. For some other partnerships, a lot more.  But how can prospective partners decide if it's worth it unless the financial aspects of a partnership are transparent? I'm hoping that many of the partnership managers will join me in opening the books. Perhaps we could even set up a reference library on OwnerView. In any event, transparency is almost always the right thing to do. As most economists will tell you, markets only work efficiently when there's sufficient knowledge. Let's not keep partners and prospective partners in the dark and let's not feed them horse manure instead of facts.

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