Horses and the Law: Equine Syndication
This article was originally written for publication in the Aiken Horse Magazine.
Last year when Authentic crossed the finish line at Churchill Downs to win the 146th Run for the Roses, he set a new Kentucky Derby record. No, he did not post the fastest time or overcome the longest odds. His record was in ownership. Authentic’s victory meant that more than 4,500 people could now brag “I am an owner of a Kentucky Derby winner!”
While increasingly popular due to high profile horses like Authentic, co-ownership though syndication is not a new phenomenon. It has been used in thoroughbred racing and breeding for decades. Today, the strong growth of syndicates is not limited to thoroughbred racehorses and their sires and dams. Due to the ever-increasing financial investments required to be competitive in top level eventing, show jumping and other disciplines, syndication is becoming increasingly used with sporthorses.
Through the power and creativity of syndication, more and more equine enthusiasts are becoming part of the horse world and that is creating opportunities to expand equine sport all over the world. By sharing the risk and cost of ownership, participants in amateur and professional equine sport can build a more stable operating model. However, syndicates are sophisticated legal entities. If not formed and managed correctly, the syndicate’s leaders can face significant liability and financial risks, and the co-owners may incur unexpected losses as well. It is important that all parties understand the requirements of the applicable federal and state laws, potential tax matters and the practical aspects of achieving financial and operational success with a syndication program.
Before we dive into the deep end, let’s review the basics. What is a syndicate in the equine world? Whether the syndication is for a broodmare, stallion, racehorse or sporthorse, the concept is essentially the same. A group of investors come together for joint ownership of one or more horses pursuant to a contract. The contract – the Syndication Agreement – establishes the terms and conditions, duties, rights and responsibilities of the co-owners and the syndicate’s Manager. The co-owners’ interests are known as “fractional interests” in the horse. An ownership interest in the syndicate generally stays with the horse through thick and thin until the horse is sold or the syndication entity is dissolved.
Equine syndication first gained popularity in the 1970’s as a tax shelter vehicle for racehorse ownership and breeding rights. The high-profile syndication of that era was Secretariat’s breeding syndication for a record $6.08 million dollars (well over $35 million today). Its purpose was to help the Chenery family address a serious estate tax problem. Since then, the federal tax laws have changed significantly in favor of investment, and there are more flexible ways to own assets and operate businesses such as limited liability companies (LLC). Today, a syndicate is generally set up as an LLC with a Manager handling the day-to-day operations supported by a team of professionals. The other co-owner participants are Members of the LLC and they have a limited role. The usual LLC “operating agreement” that governs the rules, policies and procedures for the company is the modern syndication contract.
While the broad contours of syndicated co-ownership are straight forward, the details of a putting a successful syndication together can be complex. The legal issues at the forefront are federal and state securities laws. If the parties want to avoid registering the syndication LLC with Securities and Exchange Commission and regulation under the Securities Act of 1933 and state securities laws, the syndicate must be structured to meet an established exemption or other accepted standard. The key organizing principles include having co-owners participate in some fashion with the business; making sure the co-owners share a common purpose; and, treating all fractional owners alike in the Syndication Agreement.
By contrast, when a person buys stock in a corporation, he generally expects the stock’s value to rise or fall based on the actions of others; not his own participation in the company. That is the basic legal definition of a security. Investments in securities are highly regulated to protect investors from fraud and abuse by promoters and distant corporations. If a large company plans to issue stock or any security, it must follow complicated and expensive legal requirements or face serious criminal and civil liability. The same liability exposure can arise for equine syndicates if they do not follow state and federal legal requirements. For investors who only wish to own a fractional interest in a racehorse with the singular goal of collecting a share of the winnings, there are several companies who sell shares in racehorse syndicates as securities. Authentic’s syndication company, myracehorse.com, is a good example of a securities model for fractional ownership of racehorses.
Fortunately, there are established ways to create a syndicate and not run afoul of the Securities and Exchange Commission or state regulators. The overarching theme in setting up the structure is the more connected the co-owners are to the business the better. Examples of meaningful involvement include participating in owner meetings, opportunities to visit the horse at events, exercising voting control over naming or retaining the Manager, continual and regular contributions to the costs of training and care of the horse, and other relevant experiences. There are many other issues to address such as managing investor expectations, financial transparency, and qualifying potential co-owners prior to starting the syndication. The syndicate’s leadership working with an experienced attorney can put a plan together to address these issues effectively.
If you are exploring an investment in a syndicate for a racehorse or sporthorse, it is vital that you obtain a copy of the Syndication Agreement and have it reviewed by a competent attorney. You should also obtain a written explanation of all of the financial requirements for long-term participation and learn the exit process is in case you need to withdraw from the company. Lastly, as with most such things in the horse world, you should accept the reality that investing in equine syndications is more suited for enjoying the experience than making lots of money. It is the thrill of being part of an equine athlete’s competitive journey that makes co-ownership in a syndicate so attractive for most investors.
If you are considering syndicating your competition horse, there are important points to address in the planning. At the outset, you need to understand how much money you need to get started and what the annual cost to operate the business. The costs include acquisition of the horse, compensation to professionals, care and travel of the horse, entry fees, taxes, registrations, and the normal costs of operating any business. As you build your business plan, factor in your goals and purposes for creating a syndicate – e.g., paying off debt, generating income, future breeding rights, purses, risk and cost sharing – and how syndication can achieve those goals. The next step is calculating the number of potential co-owners you need and the cost for each unit of fractional interest. This will to determine the number of investors needed to launch the syndicate. When you are ready to market the syndicate and talk with potential investors, you need to understand the legal guardrails when making representations and warranties regarding co-ownership and the potential performance of the company. In addition, although not required, I recommend that syndication clients have their fractional co-owners affirm that they are “Accredited Investors.” Accredited Investors are people who meet the standards outlined in Regulation D, Rule 506, promulged under the Securities Act of 1933, as amended. That is a mouthful of legalese, but it is important. Essentially, if a person is an Accredited Investor, it indicates a certain level of financial sophistication and that helps protect the company in many ways from claims by a disgruntled fractional co-owner. Other important planning matters include the disclosures and disclaimers for the company’s website and marketing materials, and in its governance documents. Finally, as noted above, make sure all co-owners have common rights and interests in the company.
The leader of a syndicate needs to consider several operational matters at the beginning to better assure long-term success. If he is not experienced in operating a syndicate or is not a qualified equine professional, he should hire an experienced and trustworthy person to be the Manager and lead the organization. A Manager needs wide latitude in the day-to-day operations coupled with strong accountability to the co-owners on major issues. He needs to be able to hire trainers, riders, vets, and make important business decisions without being micro-managed. That being said, the Manager should provide regular updates on progress with the horse and be transparent regarding the finances with the co-owners. A good practice for large syndicates is to have an advisory committee made up of fractional owners to keep regular contact with the Manager and act as the liaison to the larger membership to keep everyone up to speed. Some syndicates and Managers are moving to a “club” model that focuses on the horse ownership experience and equestrian lifestyle as a central part of being a co-owner. A club syndication often organizes trips for the co-owners to travel to training sessions and competitions, and hosts owner social events. As a result, the co-owners build relationships and become more connected to the horse and the horse world. The marriage of equine investment and hospitality is a compelling approach to small group syndication. It is a good model to generate repeat business from people who want more from their equine investment experience.
Modern syndicate structures can present good solutions for owners who want to share the costs and risks of campaigning a racehorse or sporthorse and horse enthusiasts who want to be part of the equestrian world. With proper legal planning and good business practices, the experience can be rewarding for everyone involved. And, you never know, your horse could be the next great one….
Jim Ritchie is head of Ritchie & Associates, LLC and an avid horseman. He represents business and equine law clients across the Carolinas. For more information visit tryonequinelaw.com or call 864.527.5955. © Ritchie & Associates LLC