From the September 2007 issue of Wealth Manager Web • Subscribe!

September 1, 2007

A Day at the Races

When financial advisors discuss how they've helped clients "reach the winner's circle" or "cross the finish line," they're usually referring to how their long-term planning techniques have paid off. Along the way, they also may have talked clients out of pinning too much hope on a "long shot"--advising instead that they heed such tried old truisms as "slow and steady wins the race." But what do you tell the client who actually wants to invest in a racehorse? Can she realistically expect to see a reasonable return on her investment, or will she be left standing at the gate?

"Don't jump the gate when your otherwise level-headed client says he wants to buy a share of a racehorse," cautions CFP Thomas J. Schneider, of Financial Consulting Group Inc. in Farmington, Conn. "It could be okay for the right individual. Clients who've worked hard are entitled to reward themselves, providing they don't get carried away. In any case," Schneider advises, "find out whom he's listening to. What's their background? What's the goal? Is it a business investment or a hobby? How much is it going to cost? Is there a business plan or a handshake? An exit strategy? Can I, as advisor, take part in discussions and review agreements?"

Philip Lukens of The Lukens Financial Group in Denver, Colo.--who counts a leading breeder as a client--agrees. "Examine the worst-case scenario. Can the client absorb the loss? If he can, it may be a worthwhile investment." Lukens points out that thoroughbreds almost always "have value" within the industry. "A horse does not need to win top races to be significant," says Lukens. "In some cases, a racehorse can be a more stable investment than real estate. A thoroughbred will often have breeding value once its racing days end."

You might even get an overnight success. Consider Afleet Alex, a horse that was purchased at auction by a five-member partnership in 2004 for $75,000. About one year later, it won the Preakness Stakes and then the Belmont Stakes--two of the three Triple Crown components. Afleet Alex was retired in 2005 but continues to reward the partnership as it earns stud fees of $40,000 each--nice work if you can get it. So far, the horse is responsible for 150 offspring, providing quite a lucrative annuity to its owners.

But on the flip side, there is the case of Green Monkey. This horse was sired by Forestry for a $125,000 stud fee. Its bloodline includes 1990 Kentucky Derby champ Unbridled. Green Monkey was purchased for a record $16 million in 2005 as two rivals bid the auction price skyward after the colt turned in a nearly flawless audition on the track. However, the horse has yet to run a race, and the reason for this has never been made clear.

Then there was Cigar, who earned about $10 million on the tracks before his handlers learned he was sterile and useless as a stud. And then there's the consideration of racing accidents, which can have disastrous results.

"You've got to like the sport and like taking risks," says Chuck Zacney, who used "extra money" from his medical-billing company to launch the aptly named horseracing partnership Cash Is King, the purchaser of Afleet Alex. "You've then got to get an experienced manager to run the team and let him do his job." Zacney, who had been involved in racing partnerships before, was able to sign trainer Tim Ritchie. In addition to supervising training, Ritchie was instrumental in selecting the horse and jockeys.

"Many fantasize about owning a professional sports team," says Dan Metzger, president of the Thoroughbred Breeders and Owners Association (www.toba.org), a national trade group for thoroughbred owners based in Lexington, Ky. "Some fulfill this dream by getting involved in racing. Just as there are many paths to the winner's circle, Metzger adds, "there's no direct profile of a racehorse owner. They cross all lines."

Founded in 1961, TOBA aims to maintain the economics, pleasure and integrity of the sport and among other things, recruit new owners. Other leading associations include the National Thoroughbred Racing Association (www.ntra.com) which focuses on the business of racing and the American Horse Council (www.horsecouncil.org) which represents all segments of the horse industry in Washington.

Do you have a client who might want a piece of the action? TOBA's The Racing Game (www.theracinggame.com) is a program that identifies and attracts new investors to thoroughbred ownership, giving them an opportunity to meet approved advisors. Names of prospective owners are entered into a referral database. Profiles are then matched with advisors based upon indicated objectives and ideally, a partnership can flourish.

Metzger advises anyone contemplating entering the business to take a long-term perspective. "Three-quarters of owners lose money and are in it for fun, excitement, social aspects and camaraderie. While most new owners are fans who have already had rewarding careers outside of racing, once involved with a racehorse, they often forget the basic business principles that made them successful and get caught up in the romance and excitement. It's not a perfect science."

"Horses can definitely captivate one's psyche," says Mark Hall of Market Street Advisors in Smithfield, N.C. "The question to ask is: 'Does your client have real knowledge or horse sense or is he using this as a way to chase a dream?' Individuals can get into this as a hobby or business, as there are perks."

"Owners like to take business associates to the track to watch their horse," says Chris Venis, president of Capitol Hill Thoroughbreds (capitolhillthoroughbreds.com) in Hillsborough, N.J. In business since 2003, Capitol Hill forms horseracing partnerships offering entry points as low as $2,500. Its latest success is Jersey Peach, which won this year's $125,000 Jersey Breeder's Handicap at Monmouth Park--a race exclusively for horses bred in the Garden State. Overall, Jersey Peach has earned about $250,000--small change compared to the lavish purses of races like the Santa Anita Stakes, but no matter the amount, each participant shares equal amounts of excitement and prestige. Other states such as New York and Pennsylvania have similar programs to encourage in-state development of the sport. New York's program hit pay dirt in 2003 when the state-bred Funny Cide won the first two races of that year's Triple Crown and was the first ever New York-bred horse to win the Kentucky Derby.

"A business person can take clients to their box at the ball park, but they can't get into the locker room," says Venis, who's had a lifelong love affair with racehorses. "Here, partial owners get special parking, track access and barn tours, and photographs can be arranged."

Despite the annual crush of the rich and famous at tracks like Churchill Downs and Saratoga, horse racing's countless minor owners and breeders compete almost year-round at tracks across the country, making up the backbone of the industry. Says Hall: "Racing is an industry that does well in nearly every economic climate. When the economy's good, lots of people look at investments like these."

Nevertheless, "this is a highly unregulated business. There's no SEC-type enforcement," warns Jonathan Green of Targeted Financial in Woodbridge, N.J. Green, with his father Leonard, a CPA, counts more than 400 clients in the horse industry. Together the father and son own over 100 horses and have won more than 1,200 races--most through their racing operation, D. J. Stable of Holmdel, N.J. "Always attend an auction with a trainer and medical personnel," Jonathan advises. "Don't base a decision solely on what the horse has done on the track. The investment has to literally be checked from top to bottom, including x-rays." Racehorse physicals are more thorough than most executives' annual checkups. Green suggests getting a trainer who's "on his way up and is hungry to make a name for himself." He also advises would-be owners to become as educated about the sport as they possibly can before signing a check.

While each racing partnership operates differently, every horse is usually run as a separate Limited Liability Company. Owners generally receive winnings in proportion to the size of their share, but they also must chip in for their relative expenses. Monthly boarding and care for a racehorse can run from $2,500 to $4,000. Then there are training and travel costs, veterinary bills, insurance and taxes. Depending on the partnership, some costs are factored into the monthly expenses while others are paid for on an item-by-item basis. If the trainer is a member of the partnership, he usually absorbs the training fees, but each of these items should be noted in the agreement. For smaller partners, like those at Capitol Hill, monthly costs can be as low as $75.

"Getting into racehorse accounting is like opening a can of worms," says Louis Fister, Jr., of Fister, Williams and Oberlander, CPAs in Lexington, Ky.--only half-jokingly. "Deductions can include training and entry fees, travel costs, insurance and veterinary bills. Racing is a very high-risk activity," cautions Fister, who specializes in equine tax matters. "But racing is what drives the market. That's where pedigree lines establish their value."

Because there are specific tax rules relating to racehorse ownership, the American Horse Council annually publishes a 1,000-page Horse Owners and Breeders Tax Handbook. It explains the Internal Revenue Service Code as it pertains to the horse industry including:

o Business versus hobby issues

o Summaries of important court decisions

oForms of doing business, depreciation, record keeping and accounting rules.

"There are a number of legal issues involved in racehorse ownership that can make or break an investment," says Ron Hurst, head of the sports, entertainment and amusement practice at Philadelphia-based law firm Montgomery, McCracken, Walker & Rhoads. "It's most important to have a proper legal structure in place with an ownership agreement that clearly delineates owners' rights and responsibilities and how the organization will operate and be managed." If you're lucky enough to own a winner, you may also face a number of other legal issues such as intellectual property rights covering trademarks and breeding. "Safeguarding these can help your investment last well beyond your horse's racing career," says Hurst.

So what about protecting your asset? "Your investment is basically a 1,500- to 1,800-pound animal on a foundation of four thin legs, and like all athletes, racehorses are frequently injured," says Chris Marnitz, principal of Marnitz & Associates in Lexington, Ky., which specializes in equine-mortality insurance. While there is no health coverage for racehorses, there is life insurance. Lead underwriters include Lloyds of London, The Hartford and Great American Insurance Company.

There's also liability. Horses can get nervous--especially in crowds--and have been known to kick, bite and get loose. "The owner is liable in these cases," says Marnitz, who often recommends coverage of up to $10 million to cover mortality and liability for individuals, partnerships, corporations or syndicates as well as those working with independent trainers, breeding farms and other related groups.

"Racing is often the entry point for most owners," says TOBA's Metzger. "But it's often not the finishing point. The way to win in this game is not to lose sight of your expenses and risks against your revenue. Aim to be realistic."

[SIDEBAR]

Modern horseracing traces its roots to England's King Charles II. After he was crowned in 1660, Charles imported North African stallions, set racing rules and even jockeyed his own horses as racing on tracks became the main way to judge a horse's ability and develop the breed. As the science of horse breeding advanced, the phrase "thorough bred" entered the lexicon as a reference to a horse's pedigree. Today it is widely accepted that all thoroughbreds descend from these Barbary Stallions brought to England in the mid to late 1600s. In time, more tracks appeared across England, and as horse racing showed profit potential, the nobility became increasingly involved in breeding.

Joseph Finora is a freelance writer currently at work on a sports-based novel.

Reprints Discuss this story
This is where the comments go.