January 1977 Limited Partnershps in Texas Feedlots investor Characteristics Investment Incentives Fund Arrangemenjsl/z UBRARY Mm 1s wen Texas 581M University l lqauumw The Texais Agricultural Experiment Station J. E. Miller, Director, College Station, Texas The Texas A&M University System in cooperation with U.S. Department of Agriculture Contents IIICIILICIYIIS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. I‘\(IKN()\\IILJILJJI)(;A\IIERNrIPS . . . . . . . . . . . . . . . . . . . . . . IN'IIIt()IS)LI(I'III()I\I . . . . . . . . . . . . . . . . . . . . . . . . . . . . ()II(L~XNIZA'III(_)N. PURPOSE, AND LEGAL R E (t) U I R E .\I E NTS () F (JATIILE FEEDING FUNDS . . . . . . . . . . . . . . . . . . . . . . . . . .. (r)rgz1ni7;ati<)11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The (leneral Partnens Perspective . . . . . . . . . . . The Limited Partners Perspective . . . . . . . . . . . I\IIA_I()R CHARACTERISTICS ()F TEXAS (l/YIIIIIJIS FEEDINC FUNDS . . . . . . . . . . . . . . . . . . . Primary Activities of Limited Partnerships . . . Lintlenvritiiig (lommission Rates and (Hilwing Iiixpenscfs . . . . . . . . . . . . . . . . . . . . . . . . . "Perms of (HIermgs and Use of Proceeds . . . . . . Suitability’ Requirements . . . . . . . . . . . . . . . . . . . I_I(‘\"(’I'k1§l,'(‘ Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . (lash Distribution . . . . . . . . . . . . . . . . . . . . . . . . . \\’itl1(Irz1\vz1l Provisions . . . . . . . . . . . . . . . . . . . . . Remuneration and Dissolution . . . . . . . . . . . . . . N.) SOCIO-ECONONIICI PROFILE ()F SUBSCRIBERS ........ Age and Income . . . . . Primzny (Jccupzltion. . . . . . . . . . Investment Advisers . . . . Yezrr Initiated, Number, and "Pvpe of (S)ther Future Ill\’(i‘St111€l]i Plans and Iiund Length . Accuracy’ of Prospectuses and Suitability Requirements . . . . . . . . . . . . . . . . . .. INWIESIIINIENT (IIIITIYIRIA ()F SLIBSQRIBERS FUTURE LEGAL AND TAX (_Z(V)NSIDERLA,TI()NS Organiztttin>iial Expenses . . . . . . . . . . . . . . . . . . .. Purchasing Losses . . Rules for Public and (Iertztin Private S_Vl1(IICdlII()l1S . . Interest ....... Effect on Iilquity Cdpiikll Iiloxvs . . . . . . . . . . . . .. INIPLICIAIIIONS . . . . . . . . REFERENCES ........ .. 10 m c ? p-n k i h r-It-Iv-Ir-ub-I qflpApAgppk Limited partnership arrangements, commonly re- rred t0 as “cattle feeding funds,” were first established ' the Texas cattle feeding industry in the late 1960s 2 ce the cattle feeding industry requires relatively large '1 ounts of capital inputs, numerous Panhandle Plains edlot firms organized cattle feeding funds to raise uity capital and to increase feedlot utilization rates and rchandise management services. This study focuses _ the general arrangements and characteristics of these i. nerships, the socio-economic characteristics of the ited partners, and investor incentives in order to implications concerning the use of these public vestment offerings to finance cattle feeding operations. More than half of the 33 prospectuses examined organized specifically for cattle feeding, and most re a series of partnerships that could be formed under e registration. The average life of a fund was about 6 ‘ s. The maximum amount of capital specified by any e of the registrations ranged between $0.5 million and 4t million, but most were in the $5- to $l0-million ' ge. The general partners leveraged this capital by rrowing about $3 from financial institutions for each $1 capital supplied by the cattle feeding funds. Total cost raising capital through these limited partnership offer- }; approached 8 to 10 percent of the capital raised and “s borne by the limited partners upon activation of a ’ nership. Most partnerships were not activated un- A s subscriptions equivalent to $250,000 or more were d by a prescribed date. ' In managing cattle feeding funds, general partners empted to prepay expenses and defer the recognition rdinary income as a tax deferral incentive. With pro- ble operations, this practice would cluster the taxable . ome at the end of a partnership. These limited V» nership arrangements specified distribution policies ding taxable income during the life of the partner- ‘p as well as income distribution procedures upon uidation or termination of the partnership. The limited partners were assessed service fees I parable with typical custom cattle feeding charges. addition, most funds specified that the general part- r would receive a percentage of the profits of the ' nership for management services supplied, provided .- limited partners received cash distributions equal to or a stated percent above their original contributions. st funds allowed the limited partners to redeem their Highlights investment prior to termination of the partnership, but early withdrawals were generally subject to penalties. More than half of the limited partners subscribing to the Texas cattle feeding funds during 1972-74 were physicians, dentists, engineers, contractors, executives, managers, bankers, brokers, professional investors, or attorneys. The estimated average annual gross income per investor was in excess of $80,000. About 60 percent of all limited partners surveyed indicated that the tax deferral incentive was the primary criterion for investment in cattle feeding. Almost 31 per- cent ranked potential returns on investments as the most important investment incentive. Future investor de- mand for these funds will depend, among other things, upon the extent to which these funds provide tax or other benefits comparable to other forms of investments. Recent 1976 Federal tax legislation prohibits “farm- ing syndications” or limited partnerships from receiving tax deductions for prepaid expenses for items not con- sumed in the year purchased. The new ruling also limits total deductions to the amount of their capital “at risk,” and capital leveraging may not increase the level of de- ductible expenses. These two provisions nullify much of the tax incentives provided by past cattle feeding funds since they have been used to defer the payment of taxes. Consequently, the value of funds as a tax management vehicle may not be as great in the future compared to alternative forms of investments in cattle feeding. Al- though Internal Revenue Service (IRS) interpretations are pending, custom feeding clients who feed their own cattle apparently may continue to operate under the old income tax rules whereby prepaid expenses may be de- ducted from current income even though the items purchased are not used until the following year. Under these conditions, investors might feed cattle as individual custom feeding clients, rather than as li- mited partners, in order to retain tax benefits. As a source of capital these types of investors, rather than limited partnership operations, have been more impor- tant in terms of the growth, development, and operation of the large commercial feedlots in the Southern Plains. The recent tax legislation is not likely to have a major impact on the operation of large custom cattle feedlots unless these custom feeding clients do not fall into the legally permissible categories for claiming prepaid de- ductions. Acknowledgments The authors gratefully acknowledge the assistance provided by the Texas State Securities Board in obtain- ing copies of various prospectuses filed with the Board during 1972-74. Helpful comments and suggestions were provided by Agricultural Economics Department review committee members]. Bruce Hottel and Donald Farris and by Lowell Schake of the Animal Science De- partment. Helpful comments and suggestions were also provided by W. H. Scofield, Charles Sissons, and Fred Woods of the U.S. Department of Agriculture. 4 i. imited Partnerships Texas Feedlots Investor Characteristics Investment Incentives Fund Arrangements _. Increasing numbers and sizes of large commercial 3- feedlot operations during the last decade brought tincreasing demands for various resource inputs, ,2 ding operating and long-term capital (1, 2). With if advent of large commercial feedlots during the 's, cattle feeding became “big business,” requiring isticated management techniques not only in feed- and marketing cattle but also in acquiring the neces- f capital for maintaining and/or expanding feedlot op- “OHS. i During the late 1960’s, cattle feedlots in the Texas iandle-Plains were dependent predominantly upon ‘ cial institutions, private sources and other individu- profits and services rendered to custom clients, pub- istock offerings, and, to a small extent, limited ership arrangements (cattle feeding funds) for _‘ es of operating and long-term capital (1). Since lim- _,' partnership arrangements were not used by the cat- .1 ~ - a ing industry as a source of capital until the 1967- 11» riod, data were generally not available concerning ted partnerships or of investors in such cattle feeding i- in Texas feedlots. However, the number of limited erships increased rapidly in the Texas feedlot in- try from 1970 to 1974. Accordingly, a study was initiated to provide an in- th analysis of the organizational and structural acteristics of limited partnership arrangements in y feedlots for 1972-74. The analysis was also de- i; A to provide information on the socio-economic _ e of investors in cattle feeding funds, their invest- "t criteria and major occupation, and major incen- j» for investing in cattle feeding funds. 1w tively, associate professor and professor, The Texas Agricul- Experiment Station (Department of Agricultural Economics), lagricultural economist, U. S. Department of Agriculture, Eco- Research Service, Texas A&M University. ‘» lion of a trademark or a proprietary product does not constitute a tee or a warranty of the product by The Texas Agricultural » iment Station or the U. S. Department of Agriculture and does =»~ ly its approval to the exclusion of other products that also may itable. R. A. DIETRICH, D. R. LEVI, AND J. R. MARTiN* Data for this analysis were obtained from the vari- ous prospectuses filed with the Texas State Securities Board from 1972 to 1974. Data concerning the socio- economic profile of investors in cattle funds and related information dealing with investment strategies and criteria were obtained from a mail questionnaire to indi- vidual investors in Texas cattle feeding funds during 1972-74. Potential respondents for the mail question- naire were selected at random to represent two-thirds of the investors in Texas cattle feeding funds as filed with the Texas Secretary of State by the General Partners of the various funds. The mail questionnaire was forwarded to 1,634 investors throughout the United States. Total questionnaires returned represented more than 34 per- cent of the population sampled. Total useable question- naires represented 26 percent of the investors sampled or almost 18 percent of the total number of investors in cattle feeding funds on file in the Office of the Texas Secretary of State for 1972-74. The non-response bias of individual investors not returning questionnaires was not considered significant because the general param- eters of the investor data relative to age, income, in- vestment criteria, etc., did not differ substantially from previous research of non-cattle feeding agricultural lim- ited partnerships in Texas (3). Organization, Purpose, and Legal Requirements of Cattle Feeding Funds Organization Most cattle feeding funds are organized as limited partnerships. Limited partnerships are composed of one or more general partners and one or more limited partners. The assets of the general partner stand liable for the debts and obligations of the limited partnership. Each limited partner’s liability is limited to his invest- ment. His personal assets cannot be reached to satisfy the financial obligations of the limited partnership. Creation of a limited partnership in Texas necessi- tates a written limited partnership agreement specifying each limited partnefs share of profits (or losses) and the 5 agreement must be recorded with the Secretary of State. Limited partners cannot participate in management de- cisions nor can their names be used as a part of the limited partnership name. So long as these formalities are observed, the limited partners will receive limited liability. The general partner is frequently a corporation in cattle feeding funds. While the corporate assets may be used to satisfy partnership debts and obligations, the personal assets of the corporate owners are protected. In this manner a limited partnership may be organized so as to provide limited liability for all investors. The General Partner’s Perspective From the general partnefs perspective, a major purpose of cattle feeding funds is to raise equity capital, increase feedlot utilization rates, and generate revenue. ‘Feedlots generally generate revenue through (1) profits on feedlot owned cattle, (2) services rendered to custom clients, or (3) services rendered to cattle feeding fund clients. In some cases, equity capital is sought via lim- ited partnerships simply because feedlots are nearing their capacity to acquire debt capital. In addition, feed- lots may perceive the cost of acquiring equity capital through cattle feeding funds as being less expensive than the interest expense associated with debt capital. However, equity capital acquired via cattle feeding funds does not come free. Rather, state and federal reg- istration requirements, as well as brokerage commis- sions, constitute the cost of obtaining same. As a general rule, registration with the State Securities Board may require up to 6 months and cost $10,000 to $12,000. Federal Securities and Exchange Commission registra- tion may take up to 2 years, and all offering expenses may exceed $100,000. Major offering expenses include such items as legal fees and prospectus printing costs. In many cases, these offering expenses ultimately are paid from limited partners’ contributions. Sales commissions are typically 8 percent, the same as for mutual funds. Efforts are often made to reduce the cost of creating cattle feeding funds. For this reason, one or more lim- ited partnerships may be marketed under one prospec- tus. Investment in one limited partnership in no way obligates an investor to invest in other limited partner- ships marketed under the same prospectus. Marketing several limited partnerships under one prospectus has the eHect of lowering the acquisition costs of equity capi- tal. , Finally, it should be noted that limited partnerships may be viewed as something other than a vehicle for bringing outside capital into the industry. In some cases , general partners may see them as a method of marketing feedlot management services. This is a plausible viewpoint, given the various types and rates for com- pensable services provided under some limited partner- ships and as described in various prospectuses. The Limited Partner’s Perspective Regardless of the kind of investment, in addition to the rate of return on investment, investors are generally 6 interested in three things: (1) limited liability, (2) assurance that the investment is readily marketable ' times, and (3) income tax minimization and/or m ment. Investors may invest as direct owners uni tenancy in common type of ownership. While’ provides the desired income tax treatment, they are nerable to unlimited liability, and marketability of it; ownership interest may be a problem in a case of, death or divorce of one of the investors. t Investors may also choose to invest in either a y chapter C or a subchapter S corporation. Both keep clear (ensuring marketability) and provide the d ‘_ limited liability. However, a subchapter C type of i; ration does not provide the desired tax treatment}; cause capital gains and operating expenses and loss ‘-~ not passed through to the shareholder level. Whil subchapter S type of corporation does provide the) ferred tax treatment, it is seldom used in cattle f- funds simply because of the difficulty of raising n j amounts of capital with ten or fewer shareholders q of several initial qualifying requirements for subchf S income tax treatment. Another inhibiting factor subchapter S shares generally are not readily m ' ble. It is also possible for cattle feeding funds to ~- ganized as a general partnership. However, a >0 partnership does not provide either limited liabil' ' assurance that the interest will be marketable times . A limited partnership, on the other hand, provide all three of the desired investor characte ' __ A although the limited partnership agreement m verely restrict opportunities‘ to liquidate one’s ', ment prior to termination of the cattle feeding Unlike in the subchapter S corporation, the tax .0 ment provided by a limited partnership is not limit the number of investors. Thus, it is the form of bu) p‘ organization used most often by cattle feeding r obtain outside equity capital. Major Characteristics of Texas Cattle Feeding Primary Activities of Limited Partnerships An analysis of 33‘ limited partnership prosp _ or certificates dealing with cattle feeding on file Texas State Securities Board during 1970-74 rev that 55 percent of the limited partnership arrange) were organized to feed cattle only (Table 1). A one-third were organized to feed and grow cattle,’ the activities of the remainder, about 12 percen cluded feeding, growing, and breeding. Dep upon the cost/price relationship of feeder cattle, or forage costs, and feeding costs per pound of‘ “growing” feeder cattle often allows feedlots t, additional pounds of gain below feedlot costs on v or improved pastures prior to placement on feed 5 feedlot. Depending also upon nearby feeder cattle ‘Duplicate prospectuses, those with minor revisions, and pr drafts were not included in this study. 3 TABLE I. PRIMARY ACTIVITIES OF CATTLE FEEDING FUND IMITED PARTNERSHIP ARRANGEMENTS, TEXAS, 1970-74 Primary activity Feeding, Number of Feeding growing, g prospectuses Feeding and and Item examined only growing breeding Number ————— —— Percent ————— —- ‘~ umber and istribution of i - imary activity 33 54.6 33.3 12.1 ends, feedlots are able t0 effect savings by purchasing eder cattle prior to a price rise. nderwriting Commission Rates I d Offering Expenses Cattle feeding limited partnership subscriptions are . enerally offered to the general public on a “best efforts” asis through selected members of the National Associa- i» of Securities Dealers, Inc. (NASD). Some general -= tners also reserved the right to sell directly to the neral public at the commission rates received by the ASD dealers, generally from 7 to 8 percent (Table 2). ecified dealer commission rates varied by prospectus (ending upon numbers of subscriptions sold. _ Offering expenses, including legal, accounting, I ' ting and filing, were generally specified not to ex- O 2 percent of the offering price and were borne by partnerships formed on a pro rata basis. Offering I enses, as estimated in some of the prospectuses, var- ,1 from about $40,000 to $120,000. However, numer- ; '3 prospectuses specified that offering expenses were . j- to exceed a fixed amount, generally from $50,000 to f‘ 5,000. IBLE 2. UNDERWRITING COMMISSION RATES, BY MAXI- M AGGREGATE AMOUNT OF OFFERING PER PROSPEC- ,,CATTLE FEEDING FUNDS, TEXAS, 1970-74 Percent per unit of subscription per Under Over 1 prospectus 7 7 8 8 Other Total 3 ————————— —-— Percent ————————— —-— - - r $5 million 22.2 22.2 33.4 11.1 11_11 100.0 million to less gan$10million (2) 31.2 55.3 12.53 (2) 100.0 F million to $15 illion (2) 62.5 12.5 25.04 (2) 100.0 r$15million (2) (2) (2) 100.05 (2) 100.0 ' Total 5.7 34.3 37.2 17.1 5.7 100.0 neral Partner paid for NASD fees after receiving 5 percent of profits and in another instance W: percent of the cumulative profits on a quarterly basis. e specified in prospectuses examined. ' > were .0875 percent and 10.0 percent. eral Partner paid for NASD fees after receiving 6 percent of the »- proceeds. rate was .0875 percent. Terms of Offerings and Use of Proceeds Terms of the limited partnership offerings generally include statements concerning the maximum aggregate dollar volume of the subscriptions offered, the minimum number or dollar volume of subscriptions required to activate a partnership, and a minimum price per sub- scription. Included also generally were commitments to invest payments received within a specified time period, usually 90 days, or the custodian was to promptly return the funds if the minimum subscriptions to initiate a partnership were not received. Investor suitability re- quirements, in which investors represent that their fi- nancial status meets the minimum levels specified in the prospectus, are required in some states to insure that subscribers have the financial capacity to withstand risks associated with the programs specified. Approximately 44 percent of the prospectuses specified maximum capitalization levels from $5 million to $9.99 million (Table 3). The remaining prospectuses were about equally divided between those specifying maximum levels of $10 million or more and less than $5 million. While 72 percent of the certificates required sub- scriptions ranging from $250,000 to $999,999 prior to activation of a partnership, almost 90 percent of these specified minimum levels of $250,000 for formation of a partnership. Prospectuses specifying minimum sub- scription levels of $250,000 prior to formation of a partnership represented about 67 percent of the total, compared to 12 percent with minimum levels under $250,000, 5 percent with minimum levels over $250 ,000 and up to $999,999, and 16 percent with minimum ac- tivation levels from $1 million to $4 million. The predominant minimum subscription price was $5,000 with an allowance for additional subscriptions in increments of $1 ,000 (Table 3). The next most important minimum subscription price ranged from $2,500 to $4,999, followed by minimum subscription prices of $7,500 or more per unit. More than 70 percent of the registrations were or- ganized such that a series of partnerships could be formed under one offering or prospectus (Table 3). For example, 40 partnerships could theoretically be formed from one registration which had a specified aggregate, maximum of $10 million along with a specified minimum activation limit of $250,000 per partnership. The average specified life of a partnership was 6 years during 1970-74 (Table 4). Although the specified life of the partnerships ranged from 2 to 10 years, most partnerships were established for 5, 6 or 7 years’ dura- tion. Suitability Requirements Prerequisites of suitability requirements for invest- ing in limited partnerships were stipulated by more than 60 percent of the prospectuses examined during 1970-74 (Table 5). These requirements stipulated that investors must have either (1) a net worth exclusive of home, fur- nishings, and personal automobiles of at least $200,000 7 TABLE 3. MAXIMUM AGGREGATE AMOUNT OF OFFERING PER PROSPECTUS, MINIMUM UNIT SUBSCRIPTIONS, MINIMU ‘I SCRIPTIONS PER FUND, AND PERCENT ORGANIZED FOR SERIES OF LIMITED PARTNERSHIPS, CATTLE FEEDING TEXAS, 1970-74 Minimum subscription Minimum unit L. subscriptions Organi . Maximum to activate a fund series of i offering Distribution $250,000 $1 million $2,500 $7,500 arms per of total Under to to to and p 1i prospectus prospectuses $250,000 $999,999 $4 million $4,999 $5,000 _ over Yes . Percent l i Under $5 million 28.1 22.2 66.7 11.1 22.2 66.7 11.1 44.4 $5 million to less . than $10 million 43.8 7.1 78.6 14.3 14.3 71.4 14.3 85.7 g $10 million to $15 million 25.0 12.5 62.5 25.0 100.0 75.0 Over $15 million 3.1 100.0 100.0 100.0 Total 100.0 12.5 71.9 15.6 15.6 75.0 9.4 71.9 TABLE 4. TERM OF PARTNERSHIP SPECIFIED BY PROSPECTUSES AND USE OF PROCEEDS, BY MAXIMUM AGGREGATE A OF OFFERING PER PROSPECTUS, CATTLE FEEDING FUNDS, TEXAS, 1970-74 Proportion of initial net proceeds used for “@1212: “Z2129” per of Feeder Feed Non-feed2 prospectus partnerships cattle grain items Other3 ‘I’ Years Percent _ Under $5 million 6.00 67.6 31.4 1.0 I4’ $5 million to less than $10 million 5.75 57.2 35.7 2.3 4.8 1', $10 million to $15 million 6.62 65.0 34.1 .9 l4’ ~ . Over s15 million 6.00 60.0 38.0 2.0 <4’ , Total 6.05 61 .9 34.2 1.6 2.3 ‘ 1 Initial net proceeds include proceeds from offerings less NASD commissions and offering expenses. zNon-feed items include hauling and storage expenses, veterinarian expenses, and other direct expenses associated with cattle feeding. 3Leased grazing land or feedlots. 4None specified. or a combined net worth of $50,000, and a taxable in- come, some of which was subject (a) during the last tax year, or (b) estimates that it will be in the current year, to a Federal income tax of 50 percent or more; (2) a net worth exclusive of home, furnishings, and personal au- tomobiles of $100,000 or a combined net worth of $50,000 and a taxable income, some portion of which during the last tax year, or estimates that it will be in the current year, subject to a Federal income tax of 39 per- cent or more; or (3) generally stated that the suitability requirement was dependent upon the state in which subscriptions were offered or in other instances specified only an income tax bracket. The types or combinations of suitability requirements listed above were about equally split among the prospectuses containing such require- ments. Leverage Ratios Leveraging in the cattle feeding industry is a prac- tice whereby cattle feeders borrow capital from com- mercial banks and other financial institutions equal to about one-half to three-fourths of the cost of the cattle plus all or varying proportions of the cost of feeding. 8 p! Given a margin requirement of 35 percent, $150? be required in equity funds to finance an ent" which requires a total investment of $400 pe Margin requirements in the cattle feeding indus according to such factors as available collateral, _ experience, and potential market conditions. Leverage ratios specified in the Texas cattle. fund registrations during 1970-74 averaged 2.7:} 6). The leverage ratios specified ranged from 2:1,, and the average maximum leverage ratio was 3 Cash Distribution Approximately 41 percent of the registrati not contain specific cash distribution policies. 6-_ percent stated that cash distributions would bel discretion of the general partner up to 50 percen taxable income as it became available. Another‘, cent stated that cash distributions were not the first 3 to 5 years and thereafter could be mad; discretion of the general partner. The remaining f__ cent stated that profits would be distributed ongl nual basis and up to 50 percent of the taxable in’ it became available. v G FUNDS, TEXAS, 1970-74 I ABLE 5. SUITABILITY REQUIREMENTS, BY MAXIMUM AGGREGATE AMOUNT OF OFFERING PER PROSPECTUS, CATTLE FEED- Suitability requirements Maximum Prospectuses Net worth of $200,000 Net worth of offering specifying or combined net worth of $100,000 or net worth per suitability $50,000 and 50% income of $50,000 and 39% prospectus requirements tax bracket income tax bracket Other1 ; Percent a nder $5 million 22.2 l2’ 50.0 50.0 w million to less _ than $10 million 78.6 45.5 18.2 36.3 10 million to ~ $15 million 75.0 33.3 33.3 33.4 é er $15 million 100.0 <2) 100.0 <2’ Total 62.5 35.0 30.0 I 35.0 I enerally stated that the suitability requirement was dependent upon the state in which subscriptions were offered or often specified only an ‘l ncome tax bracket. None reported in prospectuses examined. ithdrawal Provisions v Withdrawal provisions, which generally specified nual withdrawal dates, pre-withdrawal notice fovisions, and penalties for early withdrawals were ecified in all prospectuses. The withdrawal provisions nerally allow investors to redeem their partnership terest on any anniversary date or on a specified annual Ate, provided a written notice is made to the General 3 tner by l.etter postmarked at least 30 days prior to the I uation date (the anniversary or specified date). Some " tnerships allow investors to withdraw their interests ' the last day of any quarter, provided a 30-day written R prior to the valuation date is given to the General if U161‘. Early withdrawals were generally classified as re- mptions during the first 3 or 5 years of the partner- pip, and the most common penalty was l0 percent of e original contributions. However, penalties may be as .; as 30 to 4O percent during the first 1 or 2 years _ ending upon guarantees and other stipulated condi- l» s. Revenues derived from such penalties were either ii redistributed to the remaining partners in the g tnership on a pro rata basis relative to their capital I, tributions, (2) allocated in total to the General Part- BLE 6. LEVERAGE RATIOS AND MAXIMUM LEVERAGE TIOS SPECIFIED, BY MAXIMUM AGGREGATE AMOUNT OF FERING PER PROSPECTUS, CATTLE FEEDING FUNDS, AS,1970-74 ca‘? Maximum Average offering Average maximum per leverage leverage prospectus ratio ratio p Ratio - r $5 million 2.7=1 3.4=1 Gmillion to less an $10 million 2.7:1 3.0:1 fl million to I 15 million 2.7:1 3.4:1 _ $15 million 3.0:1 3.0:1 Total 2.7:1 3_2;1 ner, or (3) allocated to the General Partner and the partnership interests on a specified proportionate basis. The valuation of the partnership interests in the various partnership assets (cattle, feed, and such) is based on the current market value at the close of the business day on the valuation date after reflecting profits or losses accredited to such interests. The net market value of the partnership interests is defined as the cur- rent market value minus the stipulated penalty and re- demption expense to the General Partner, which often range from $50 to $100. Further, the General Partner may also assess a management fee of, for example, 20 percent, against the assets of the redeeming partner in excess of the original contributions, plus prior distrib- uted profits, less the assessed penalties. The remaining interests in the withdrawing Limited Partners account are then paid out to the withdrawing limited Partner by the Partnership. Remuneration and Dissolution Charges assessed the Limited Partners by the Gen- eral Partner for services performed and ingredients con- sumed or used in the feeding program often include most or all of the following: buying services, feed pur- - chasing and storage, pasture leasing and backgrounding services, yardage at the feedlot, feed and medication, and management services. Charges for specific items varied by General Partner and according to feeding prac- tices in the general locale. Charges to the Limited Partners or remunerations to the General Partner which were quoted most frequently in the various prospectuses were (1) buying feeder cattle, $0.25 per hundredweight; (2) backgrounding feeder cattle, $0.30 per pound of gain; (3) pasture lease for growing out cattle, $0.18 to $0.20 per head per day; (4) feeding costs, stipulated as basic feed costs plus a mark-up not to exceed 20 percent on basic feed costs with the basic feed cost defined to in- clude a milling charge of $4 per ton; (5) medication charges, stipulated to include basic medication costs plus a percentage mark-up to cover breakage; (6) grain costs, 9 which often included a purchase fee of $0 .30 to $0 .40 per hundredweight for grain purchased from the feedlot or affiliated elevators, plus a $0.03 to $0.05 per hundred- weight monthly elevator storage fee. Some prospectuses also stipulated a yardage fee ranging from $0.02 to $0.05 per head per day. In addition, others stipulated a man- agement incentive fee of $0.004 per pound of gain not to exceed $2 to $2.50 per head and which, in most in- stances, was to be returned to the Limited Partners in the event of losses. Upon dissolution or at the close of the partnership, most prospectuses stated that the General Partner was to participate in net profits, provided the Limited Partners had received distributions equal to or a stated percent above their original contribution. Statements relative to dissolution and the order in which proceeds from the partnership were to be applied were generally as follows: (1) Proceeds were to be applied against any outstanding obligation of the partnership, (2) each Limited Partner and the General Partner, to the extent of their capital contribution, was entitled to receive payments in cash equal to, and in some instances up to 135 percent, their original contribution in the partnership, (3) after distri- butions were made as specified in (1) and (2) above, the General Partner was to receive payments ranging from 10 percent to 20 percent of the remaining assets in the partnership, (4) any remaining assets were then either divided on a percentage basis as 75 percent to the Lim- ited Partners and 25 percent to the General Partner or in proportion to their original contribution to the partner- ship. Some prospectuses specified that the General Partner was to receive a certain proportion — for exam- ple, 5 percent of the net income on a specified quarterly, semi-annual, or annual accounting date. Other remun- eration statements specified that the General Partner was to receive a stated percentage — for example, 12 percent of the cumulative adjusted gross income at a stated date, and thereafter the General Partner was to receive no other payments other than for services and resources utilized in acquiring, caring for, and feeding cattle. Socio-Economic Profile of Subscribers Age and Income Subscribers to Texas cattle feeding funds during 1972-74 averaged 50 years of age with an average annual gross income in excess of $80,000 (Tables 7 and 8). Two- thirds of the fund investors ranged in age from 45 to 64 years with another 22 percent in the 35- to 44-year group. These results are similar to those of a recently completed study of Texas Agricultural Limited Partner- ships The proportion of investors in the under 35- year and over 65-year ranges were relatively small since annual discretionary incomes for this group are generally not as high as for the 35- to 64-year group. Additionally, the suitability requirements of most funds are often too high for investors in the under 35-year age group. Although the estimated annual average gross in- come of all cattle fund investors surveyed was in excess 10 TABLE 7. AGE RANGES OF SUBSCRIBERS T0 TEXAS CA Q FEEDlNG FUNDS, 1972-14 Age range l *4 (years) Per ~ 5‘ Under 25 25-34 4.1 f 3544 22.3,. 45-54 T1 38.1 5 55-54 ’ 21.0’ 65 and over 7.7‘ g Total 100.01, TABLE 8. AVERAGE ANNUAL GROSS INCOME, TEXAS TLE FEEDING FUND SUBSCRIBERS,1972-74 Pe rcen Annual gross income of subscr Dollars Percent: Under 40,000 10.0 ~: 40,000- 79,999 43.9‘ 80,000-1 19,999 24.2 120,000-159,999 7.1 160,000-199,999 2.1 200,000 and over Total 100.0 of $80,000, more than 40 percent of the fund sub ‘ f1 reported annual gross incomes varying from $79,999 (Table 8). The second highest income the $80,000 to $119,999 group followed by the 1T, $40,000 group. More than 15 percent of the inv‘ reported annual gross incomes in excess of $120, i, Primary Occupation The primary occupation of over 90 percent cattle feeding fund investors in Texas feedlots y" 1972-74 was non-agriculturally related (Table largest category of investors , by primary occupa ' W physicians and dentists who comprised almost cent of the fund investors. The next largest v p, categories were engineers/contractors, follo executives/management personnel. Other prim cupation categories, which comprised from 5.5 r 7 to 7 percent of the fund investors, included ban w’ vestments, attorneys, retired individuals, sal t» farming/ranching. Respondents reported num” other primary occupations (Table 9). Investment Advisers Almost 60 percent of the investors in cattle ff funds relied on investment advice fron stocltbg prior to investing in cattle feeding limited p Hi arrangements (Table 10). Although some subsc cattle feeding funds relied on more than one inv -_ adviser, both financial investment firms and public accountants were used by about one-fifth cattle feeding fund subscribers. Attorneys and b7 were used by a small proportion of the fund subs LE 9. PRIMARY OCCUPATION OF CATTLE FEEDING ~‘ D SUBSCRIBERS, TEXAS FEEDLOTS, 1972-74 Imary occupation Percent i ician/dentist 19.3 neer/contractor 9.8 I utive/management 8.6 I king/broker/investrnents 7.0 "rney 5.9 i ired individual 5.9 (including automobiles) 5.7 a ing/ranching 5.5 I ufactu ring 4.3 W wife/self-employed ' 2.7 I _ estate/realtor 2.3 t’ tist 1.8 Irance 1.8 fr e feeding 1 .6 1 17.8 i Total 100.0 uded are such occupations as merchandising, publishing, adver- _. ng, restaurant operations, fisherman or seaman, home furnish- r and plumbing, architect, teaching and university administra- 4 , entertainment, accounting, trucking, quarry, and nurseryman I of which accounted for 1.5 percent or less per occupational +2 LE 10. INVESTMENT ADVISERS USED BY SUBSCRIBERS ‘TEXAS CATTLE FEEDING FUNDS, 1972-74 Type of investment ‘ adviser Percent of subscribersI p ey 7.2 p broker 58.4 ‘p ial investment firm 22.3 ied public accountant 20.2 1' or 4.4 i 4.2 1 1.4 ntage figures will total more than 100 since some subscribers ~ on more than one type of investment adviser. x 3e than 11 percent of the Texas cattle feeding fund i tors did not rely on investment advisers prior t0 ‘ting in feeding funds. Initiated, Number and Type of Other Funds v Almost three-fourths of the subscribers began feed- j ttle under a limited partnership arrangement dur- i 972-73 with more than 45 percent of the subscribers f 'ng feeding programs in 1973 (Table 11). Less than . rcent of the subscribers acknowledged involve- ‘.1- in cattle feeding fund programs prior to 1970. ever, a few subscribers reported investments in feeding limited partnership arrangements in the - 1950s wo-thirds of the respondents reported feeding cat- der a limited partnership arrangement as of Iune f; Of these, three-fourths of the investors reported pationin one fund, while 16 percent reported par- "Iftion in two funds (Table 12). Almost 3 percent of TABLE 11. YEAR IN WHICH TEXAS CATTLE FEED FUND SUB- SCRIBERS BEGAN FEEDING CATTLE UNDER LIMITED PART- NERSH IP ARRANGEMENTS Year Percent Prior to 1970 1.6 1970 5.1 1971 10.6 1972 28.6 1973 45.6 1974 ' 8.5 Total 100.0 TABLE 12. NUMBER OF TEXAS CATTLE FEEDING FUNDS PARTICIPATED IN PER SUBSCRIBER, JUNE, 1975 Cattle feeding funds per subscriber Percent 75.8 15.9 5.4 2.9 Total 100.0 hhJMd the subscribers feeding cattle as of June 1975 were feed- ing in as many as four funds. More than 68 percent of the cattle feeding fund subscribers also invested in limited partnership ar- rangements other than cattle feeding during 1972-74 (T- able 13). Limited Partnerships in real estate and oil and gas were the predominant non-cattle feeding funds fa- vored by cattle feeding fund subscribers. This is to be expected since agriculture, real estate, and oil and gas are the three major tax sheltered investments available. Future Investment Plans and Fund Length Since subscribers to Texas cattle feeding funds were surveyed in 1975, at a time when large financial losses had occurred and were still occurring throughout the cattle feeding industry, when equity positions were being eroded, and some feedlots were being closed along with bankruptcy of some cattle feeding funds, re- sponses to future investment plans in cattle feeding funds were not anticipated to be highly favorable. Sur- vey results revealed that more than three-fourths of the respondents did not plan to continue investment pro- grams in cattle feeding funds (Table 14). Further, more than 95 percent of the subscribers did not plan to con- tinue investment programs in cattle feeding funds in the event the U. S. Treasury imposed limitations on artificial accounting losses whereby losses derived from agricul- ture could not be deducted from nonagricultural income for federal tax purposes. Almost 8O percent of the respondents favored a lim- ited partnership cattle feeding program from 3 to 5 years (Table 15). The 5-year programs were desired by the highest proportion of subscribers, about 43 percent. Ap- proximately 3 percent of the subscribers desired limited partnership arrangements of more than 7 years duration. ll TABLE 13. PERCENT OF TEXAS CATTLE FEEDING FUND SUBSCRIBERS INVESTING IN NON-CATTLE FEEDING LIM- ITED PARTNERSHIPS, BY TYPE OF NON-CATTLE FEEDING FUND, 1972-74 hem Percent Limited partners investing in non-cattle feeding funds 68.6 Non-cattle feeding funds invested by cattle feeding limited partners: Real estatel 41-5 Oil and gas 36.6 Other2 21.9 Total 100.0 1 Real estate includes income producing properties such as shopping centers, office buildings and apartments, and non-income produc- ing properties as raw land investments for speculative purposes. I zlncludes cattle breeding, orchards and specialty crops, eggs, motion picture production, equipment leasing, radio stations, and mobile homes. Accuracy of Prospectuses and Suitability Requirements Approximately 82 percent of the respondents re- ported that the information contained in the prospectus was sufficiently detailed and accurate for making invest- ment decisions. The following are some representative suggestions from respondents who desired more de- tailed information in the prospectuses: 1) Background of all management personnel should be provided in greater detail. More information should be provided concerning the “track rec- ords of management and their financial handling ability.” 2) The General Partner (via the feedlot) should provide evidence that he has sufficient equity to withstand unfavorable feeding and market condi- tions. 3) Use of partnership capital should be spelled out in detail. 4) More detailed information is necessary on tax liabilities in the event of bankruptcy and when losses exceed investment. (However, if General Partners give this type of advice, such informa- tion may be interpreted as providing legal advice rather than investment information, and the General Partners could be subject to fines for practicing law without a license. This is the rea- son most prospectuses suggest that potential in- vestors consult their tax advisers or attorneys prior to investments in cattle feeding funds). Respondents were also asked toprovide suggestions concerning what changes, if any, should be considered in establishing limited partnership arrangements in the cattle feeding industry. Suggested changes in establish- ing limited partnerships most frequently mentioned were 1) Require greater participation by the General Partner in the cattle feeding funds and more 12 ‘TABLE 15. LENGTH OF CYCLE OF FEEDING PROGR TABLE 14. PERCENT OF SUBSCRIBERS PLANNING Q TINUE INVESTMENT PROGRAMS IN CATTLE PERCENT PLANNING TO CONTINUE INVESTMENT; GRAMS IN THE EVENT OF IMPOSITIONS OF" LIMITA, ON ARTIFICIAL ACCOUNTING LOSSES BY THE U.S._ SURY DEPARTMENT, TEXAS, JUNE 1975 I. j; Depending upon g marketing conditions > Item Yes No ———————— —— Percent—--—— Planning to continue investment program Planning to continue in the event of LAL1 16.8 76.0 7.2 4.5 95.5 1 LAL implies limitations on artificial accounting losses. SIRED BY TEXAS CATTLE FEEDING FUND SUBSCR JUNE 1975 Po If" Years 0f $11 4. l V. flmCTI-BWM“ over 7 Total loss/profit sharing by the General Partn the Limited Partners. '_ 2) Require financial statements from Genet‘, ner to Limited Partners on at least a semiffl or frequent basis. I 3) Permit withdrawal from partnership at the; any feeding cycle or at least within 12 after initiation of the partnership. 4) Provide a floor or limit on potential loss {If 5) Require brokers to obtain a working if" of the feedlot industry and to make "7 scene” analysis of the limited partne *7 rangement prior to offering subscriptions . to the public. i“ 6) Require General Partner to post a fideli-i and to post bonds to cover “down-side" ‘p; 7) Reduce leverage to minimize risks. 8) Assure that General Partner has adequa f and 5 years or more experience in c0 cattle feeding. r _ 9) Provide for greater liquidity and more op ing of partnership interests. More than 80 percent of the respondents e satisfaction with the existing investor suitab' quirements (Table 16). However, almost 12 pe, the subscribers, who were primarily in the $80,_ under annual gross income range, suggested n 11 requirements were too high. 5 i ABLE 16. TEXAS CATTLE FEEDING FUND SUBSCRIBERS' INIONS RELATIVE TO SUITABILITY REQUIREMENTS, NE 1975 “(Item Too high Too low About right Total p ———————— —— Percent ———————— —-— . bscribers' opinions ‘relative to suitability requirements 11.9 6.9 81.2 100.0 Investment Criteria of Subscribers a Subscribers t0 Texas cattle feeding funds were ' ked to rank their investment criteria from 1 to 5 , with 1 eceiving the highest rank in terms of importance. These _ iteria were designed to gain an insight concerning in- ntives or motives for investments in cattle feeding _- nds. The results, without regard to annual income ~ el, are shown in Table 17. “Tax deferral incentive” as ranked first by more than 63 percent of the respon- ents while “potential return on investment” was ranked st by another 31 percent. The overall results of Table 7 may be summarized as follows: “taxdeferral incen- ; e” was ranked first by the predominant majority of the pondents; “potential return on investment” was the ’ I er among the criteria ranked second although it also ~" eived considerable support for number one position; ability to pool capital” and “limited liability” were the lders among the criteria relegated to third and fourth ‘sitions; and “enjoy feeding cattle” was the predomi- 71 t choice for fifth position. BLE 17. RANKING OF INVESTMENT CRITERIA, TEXAS TTLE FEEDING FUND SUBSCRIBERS, 1972-74 1* Ranking Investment ‘ criteria 1st 2nd 3rd 4th 5th Total —————————— —— Percent —————-———-——— tential return ' investment 30.7 41.2 20.4 6.1 1.6 100.0 ility to pool - ital 1.6 9.8 31.7 51.5 5.4 100.0 _ deferral _ entive 63.2 25.3 6.7 3.5 1.3 100.0 10y feeding ttle 1.3 2.6 3.8 5.1 87.2 100.0 ited liability 3.2 21.1 37.4 33.8 4.5 100.0 Total 100.0 100.0 100.0 100.0 100.0 Ranking of primary investment criteria in cattle feeding funds by income level reveals two distinct pat- terns (Table 18). First, tax deferral incentives became more important as income levels increased. More than 86 percent of the respondents in the $200,000 and over annual gross income level revealed that tax deferrals were a primary investment incentive compared to 43 percent of the respondents in the lowest annual gross income level or under $40,000. Second, potential return on investment was the most important primary incentive for investors in the lowest income level while it was relatively unimportant for almost all cattle feeding fund investors in the highest annual gross income level. Other investment criteria including “limited liability,” “ability to pool capital,” and “enjoy feeding cattle,” regardless of income level, received only minimal support as a pri- mary cattle feeding fund investment criteria. Future Legal and Tax Considerations In recent years, concern has been registered about high income investors using limited partnerships to ma- nipulate their taxable income. At the federal level, 1976 legislation limits the use of agricultural and other limited partnerships in providing opportunities for such tax management. In one sense, it is somewhat ironic for such tax management to be criticized when done under the guise of a limited partnership , given that the Internal Revenue Code income averaging provisions are specifi- cally designed to provide relief for taxpayers with widely fluctuating incomes. In either case, taxpayers strive to stabilize income over the long run to achieve lower mar- ginal tax brackets. However, the inconsistency between permitting in- come averaging but denying certain tax management opportunities is more apparent than real. Income av- eraging is specifically permitted because the nature of our graduated income tax system would otherwise re- quire those with fluctuating incomes to pay more income taxes over time (as compared to taxpayers with relatively constant incomes). Thus, the philosophy behind income averaging is to avoid or lessen inequities among tax- payers. In a similar fashion, preventing and delaying certain deductions is also based on an equity philosophy. That is, certain deductions, if used abusively, can result in “milking” the tax laws. This in turn is inequitable from I BLE 18. PRIMARY INVESTMENT CRITERIA, BY INCOME RANGE, TEXAS CATTLE FEEDING FUND SUBSCRIBERS,1972-74 Investment criteria ual 1.» Potential Ability Tax Enjoy ‘F- return on to pool deferral feeding Limited _ vge investment capital incentive cattle liability Total , der$40,000 48.2 3.6 42.8 3.6 1.8 100.0 i ,0o0s79,999 _ 29.5 (1 l 65.5 1.4 3.6 100.0 ,1 ,o00-$1 19,999 28.7 3.8 65.0 11> 2.5 100.0 _20,000<$159,999 17.6 ‘l’ 76.5 I l’ 5.9 100.0 I = ,000-$199,999 16.7 "l 83.3 I" "l 100.0 »1 1,000 and over 6.7 <1) 86.6 "l 6.7 100.0 ‘hiAverage 30.7 1 .6 63.2 1 .3 3.2 100.0 e reported by respondents surveyed. x 13 the standpoint of other taxpayers, because they then are shouldering a relatively larger proportion of the total federal income tax burden. This was the apparent logic behind the 1976 tax law revision. _ The 1976 tax legislation could very well affect the ability of feedlots to utilize limited partnerships as a source of equity capital and/ or to increase feedlot utiliza- tion rates. Some of the major income tax changes are outlined and their implications discussed in the follow- ing. Organizational Expenses The expenses of organizing a limited partnership are no longer deductible when incurred. Rather, they must be capitalized and amortized over a 5-year period (or the duration of the limited partnership, if less than 5 years). For the most part, this change will affect the timing of deductions rather than the long run total in- come tax liability. This will, of course, be less advan- tageous to the taxpayer in that it will increase the pres- ent value of his income taxes over time. In short, the advantage of deferring taxes will be lost. Purchasing Losses Under the new law it is no longer permissible for a December investor to deduct a full year’s share of lim- ited partnership losses. Rather his deductible losses (if any) are limited to a proportion of the year’s losses based on the length of time he has been an investor. Histori- cally, cattle feeding funds have not involved the pur- chase of an interest in an ongoing enterprise. That is, cattle feeding funds start a new enterprise as a new group of cattle are placed on feed. Thus, legal change should have little effect on cattle feeding funds. Rules for Public and Certain Private Syndications Public syndications (for example, those registered with the SEC) and private syndications in which at least 35 percent of the deductions are reported by “passive” investors are subject to two new rules. First, a taxpayefs deductions are limited to the amount of capital he has “at risk". This likely will largely eliminate the use of non- recourse financing in limited partnerships. Second, “farming syndications” (including cattle feeding funds) cannot deduct expenditures for feed, seed, fertilizer, and other farm supplies until they are used. Disallowing the deduction for prepaid feed ex- penses likely will substantially reduce the investor ap- peal of cattle feeding funds because such deductions, when highly leveraged with non-recourse loans, provided the major vehicle for tax losses. Their inclusion in the new legislation may well affect equity capital flows into cattle feeding funds. The rules set out above specifically do not apply to “active” partners, such as farm managers, farm resi- dents, family members, and cattle feeders feeding their own cattle. They will continue to operate under the old income tax rules. In addition, public syndications ap- proved for sale by the SEC prior to ]anuary 1 , 1976, will operate under the old rules for 1 year. Logically, disallowing prepaid deductions has a greater effect on short term investment ventures than on 14 long term business enterprises. The financial advf gained by such prepayment is that of simple defe f tax liability to a future year. But if one makes the size prepaid deduction for each of several succ“ years, other things equal, his sole financial advant g one year’s deferral. Clearly this is true because the, paid deductions paid in year one would have beenf rent deductions in year two, prepaid deductions p a year two would have been current deductions in j three, etc. Thus, the tax advantages of prepaid exp a are not overly large for someone who is in the busine stay. Consequently, there is no great inequity in pe v ting these taxpayers to claim prepaid deductions. " r Interest The 1976 tax legislation also changed rules aff- deductibility of interest. Effective ]anuary 1, 197 individual taxpayefs total annual interest deducti; limited to $10,000 plus his net investment income. a limit may well affect investment decisions by tax = _ making extensive use of leverage. But interest not, ductible currently can be carried forward and ded if in future years. Again, however, delaying deducti will increase the present value of taxes paid over timj stated alternatively, will decrease the discounted '9 ent value of the projected after-tax income streamfi; - For cash basis taxpayers, deductions will - ' disallowed where interest is prepaid when such int; will not accrue until future taxable years. Rather,‘ _ prepaid interest, together with any “points” charg‘ loans (other than a homeownefs mortgage), musth ducted over the period of the loan. This may sub) tially eliminate the practice of prepaying interest as =31 management device. i. Effect on Equity Capital Flows f Any tax law change may potentially affect flo, equity capital, and the 1976 legislation is no excel? This tax package is broad and affects such traditio shelters as real estate, and oil and gas. Therefore, effect is difficult to assess at this date. In generalg ever, eliminating the deduction for prepaid feed,» a ing loss deductibility to capital “at risk,” and pl lower ceiling on interest deductions may well r l some out migration of equity capital from the cattle ing industry. Economic theory suggests, to the é) that such capital cannot be replaced from tradi‘ debt or equity capital sources at comparable costs,- the intermediate run, the net result will be fewer f) fed. Logically, this could then be translated into h fed cattle prices and the potential for increased i1‘- from feeding. In turn, this would likely generate r; of capital not previously available into cattle f“, enterprises. Increasing prices for fed beef could - ii crease the demand for forage fed beef. lmpl ications This analysis has focused on the characteris v limited partnerships in the Texas cattle feeding in in order to draw implications concerning the use of public investment offerings as a metms of financing cattle feeding (iperatioiis. Large scale grommercizil cattle feed- _ lot owners (iften face probleniis in (ibttiining an zidequzite and dependable source of \y’orking czipittil from financial institutions and other previously’ developed sources (1). Consequently, large commertriril feedlot firms often seek alternative means for dey’elopi1ig capital sources as cus- tom feeding. which has been imptirtzuit in terms of the growth, development and operation of these large feed- lots. The (levtilopiiieirt of limited partnerships in cattle feeding in the late 1.960s and ciarly’ 1979s provided feed- lots with antith er important source of crapital. Limited partnerships provide several desirable characteristics for feedlot management. The major ad- vantage is that fetidlot owners can zicquire cuiuity’ capital and maintain control of such czipital as specified in the respective prospectus. Cattle feeding funds, once estab- lished, gcénerally’ assure feedlots thatt a certain pr'()p()rtioii oftheir feeding facilities will be utilized during the life of the partnership. (ilustom feeding clients, in contrast, can exercise their option with considerably’ greater ease to enter or exit fiom a feeding einterprisc“ at the end of each feeding period (lot closeout). To the extent that feedlots were able to raise equity’ c-apital through cattle feeding funds, this tended to d (.‘(‘!'(‘LlS(? feedlot Ifldlltigtfiflfifiii con- cern with the lot utilization problems. However. as the immediate past has rey’e-.1lecl, cattle funds can provide this stability’ feature to the feeding industry’ in the longer run only if substrrihei’s to funds can I'(;‘t1l1Z€ returns from cattle feeding funds (fompziralilti to those from other forms of investmentps; While someyvlrat more.’ stable. and profitable returns t0 cattle fleeftling enterprises ’yvou1d likely’ encourage re- entry into cattle ftretliiig by prior (fUStOIfl clients m" fund subscribers‘, profit incentives are not al\y"a.y’s the sole in- vestment trriteriii. Nluch of the (lemand for cattle feeding fund investments will depend upon the extent to which tax benefits exist in connection with them —— more than 60 percent of all limited partnership respondents indi- cated that the tax (leferriil incentive was the primary’ criterion for their investment in (rattle feeding funds dur- ing 1972-74. It is not possible to assess the full impact of the recent 1976 Federal tax legislation on cattle feeding funds btécausti IRS interpretations are pending. How- ever, one of the major changes that affects “fzirming svn- dications” or limited Iiartnerships is that they will not be allowed to receive a tax deduction for prepaid feed and other expenses. This may have a substantial effect on cattle feeding funds because their value as a tax man- agement tool yvas in the deferral of tax liability to a future year. This was their primary’ tax benefit because any income (lerived by limited partnership operations has always been taxed as ordinary income, rather than at capital gain rates. "llhus, cattle feeding funds are not tra- ditional “tax shelters” because they involve only deferral and do not receive capital gain tax treatment. A major factor in terms of decreasing the use of cattle feeding funds in the future may be that, within a competitive framework, the potential tax management and/or income generating ability of funds may not be as great as (ither forms cifinyiestmcint in cattle feeding. (lus- tom feeding clients who feed their mvn ci-attlci apparently’ may’ continue to operate under the old income tax rules whereby’ ivrep-aid feed expenses may.’ be (leducted from current income. Thus, a high income investor might log- ically invest in cattle feeding as an individual custom feeding client rather than as a limitexl partner in order to deduct prepaid feed expenses and maintain the value of his investment as a tax benefit as well as an income generating one. This assumes he falls within one of the classes of tirxpay’ers for which this is permissible under the 1976 tax package. The recent tax legislation is not likely’ to have a majtii’ impact on the operation of large scale commercial cattle feedlots because 11o11sy’11dic-ated custom cattle feeders may’ still receive a tax deéductitm for prepaid ex- penses. Limite-(l. partncarshii) inyestinents have never’ cronstitutetl the rniritii‘ proportion of the total investment in cattle feeding, eyeii in the Southern Plains (l, 2). These large feedlots are heavily’ dependent upon the investments of custtinii feeding clients, but most custom feeding clic~nts are not "associated with syndicates and consequently’ may’ not be ttffectetl by’ the recent tax legis- lation (unless they’ are “passiye” investors or otheryvise do not fall into the legally’ permissible categories for (glainiing prepaid deductions, and so forth). There is conctcirn over the high and continuously’ increasing cwipital reqtiirteirieiits in agriculture ~—— over how the future capital requiremtintts will be met. How- ever, capital limitations (existing in connection with a 1)I'()fit21l)l€ enterprise lead to changing methods of financ- ing. Furthernu)re, the largta number" of investors with large (iuantities of capitatl that obyitiusly’ seek good in- vestment opportunities supports a hypothesis that the means of zicquiring capital is more of a limiting faet<>r than the availability’ of capital. This has llflpll(‘tltl()llS for financial institutions that currently" service COIIHHCTClLIl agricultural firms. Niziny’ of these institutions are knoyvl- edgeable about zigricriilturzil production opportunities and tire in a position to assess the iny’est1ne11t oppor- tunities and crommtlnicate the investment needs of ag- riculture. These institutions must continue to evaluate their services and to develop new and innovative finan- cial policies and services when necided. References (1) Dietrich, H. A., ]. R. Nlartin, and P. Vv’. Eiiiiigtliilil, 1972. The Capital Structure and PTIUIIIFIYIT Alanage- inent Practices of the Teras Cattle Feeding Industry. B-1128, Texas Agr. Exp. Sta., Texas Atxfyl Llniv. . 1974. Custom lileer/ing (I/icizts Lkiiig Texas’ F eedlots- -— Operational C h ararteri.s-tic.s'. iManagcunent Practicchs’, and Plceding Strategies. B-1148, Texas Agr. Exp. Sta., Texas AézM Univ. Abele, Teddy Merle. 1976. The Limiter] Partners-Iii}; as an zigricziltziral Investment illerliunz: A Loo/c at Investors’ and Their Oh/ectiixas’. Unpublished MS Thesis, Dept. of Agr. Economics, Texas ACSIM Univ. (4) Carlin, Thomas A., and \’V. Fred \Voods. 1974. 710x Loss Farming. ERS-546, Economic Research Serv- ice, U. S. Dept. of Agriculture, Washington, 1). C. (2) Q n1 lo All programs and information of The Texas Agricultural Experiment Station are available to everyone without regard to race, color, religion, sex, or national origin. The Texas Agricultural Experiment Station, -J. E. Miller, Director, College Station, Texas 6M—1-77 ease