Dateline: 11/4/97

A Primer on Limited Partnerships

I’d heard of Limited partnerships before but never got involved in them until last year. In simple terms, a limited partnership is a venture capital company in an industry or business with high start up costs and/or allowable tax write-offs, structured so that the investor can take those write-offs and losses and use them to reduce his or her personal income tax. In contrast, investing in common stocks of such businesses allows you to share in the profits, but not in the tax write-offs of the business.

You’ll find limited partnerships in the oil and gas exploration field, in film production, in farming and, until recently, in computer software development. The government has just removed the tax breaks for software development. Of course, while an investor in a limited partnership expects tax advantages in the early years of the enterprise, she would also expect to make a profit in the maturity years. But as venture capital investments, there is a higher risk.

Last year I bought my first Limited Partnership, the NCE Oil and Gas (1996) Fund. NCE has been in business for almost a decade and each year has issued a new exploration fund. Each one has been successful because of its conservative approach to drilling (drilling in established and productive regions only - no wildcatting) and not only that, the Bank of Montreal was willing to finance the purchase 100%. Interest on the loan is tax deductible.

The repayment of the financing was to be achieved through tax savings and oil and gas royalties from wells successfully brought into production. After a year with the fund I have yet to put a penny into it. Everything has been paid for out of my tax savings and the fund’s royalties.

Opus II Cranberries Limited Partnership

This year the big new Limited Partnership being promoted is cranberry farming. In the spring, Opus Cranberries completed its first offering. They have just introduced their second venture, Opus II.

Cranberries are usually thought of as a seasonal fruit - Thanksgiving and Christmas. Wrong! Cranberries are a year round product due to its versatility and usefulness as a juice crop. In fact, cranberry juice and blends are the second largest juice consumed in North America after orange juice. 34.2% of juice consumed is orange, 9.4% is cranberry juice & blends, followed closely by apple juice with 8.9%.

The largest purveyor of cranberry juice and the largest buyer of cranberries from independent farmers is Massachusetts based Ocean Spray, followed by Safeway’s Lucerne Foods, Northland and Cliffstar. (Yeah, I never heard of those last two either!)

Cranberries are an unusual crop in that they require boggy wet growing fields, a temperate climate and land capable of sophisticated water management. The fields are developed by leveling the area and surrounding it with dikes and ditches. During harvest, the fields are flooded and the cranberries, which float, are harvested by skimming them off the water.

Developing these fields is much more expensive than most crops ($30 - 40,000 an acre as compared to $10,000 an acre for conventional crops) and the plants take two and a half years to grow to the productive stage. Once in production, however, maintenance is lower than other crops and they enjoy a high profit margin (60-70% of gross sales). A cranberry plantation will have a productive life of over 60 years.

British Columbia is rich in peat and other bogs ideally suited to growing cranberries. In fact, B.C. cranberry farms yield 180 barrels an acre compared to the next best producer, Massachusetts, which yields about 140 barrels an acre. B.C. produces 95% of all cranberries grown in Canada.

Opus II has purchased 78 acres of land on Barnston Island near Vancouver, B.C. to develop, right adjacent to the first Opus farm. Its management team includes professionals in cranberry agriculture with years of experience and expertise. President is Joe Rogers with over thirty years experience in large scale agri-business operations, including Imperial Ginseng which he grew from 43 acres to 600 acres with annual revenues over $18 million. Vice President of operations is Barbara Larson, P. Ag., connected for many years with Coast Cranberries and active in cranberry research with Ocean Spray. Advisory Board members include Deborah Henderson, Ph.D., an expert on entomology and pest management and Bernadine Strik, Ph.D., Professor of Horticulture at Oregon State University and also a researcher for Ocean Spray.

The Partnership Structure

So how does it work? Minimum investment is $25,000, but we’ll look at a $35,000 investment because the numbers work out to nice round sums that way and lends itself to some creative financing options. Of the $35,000 investment, half goes towards buying bonds, the other half to Limited Partnership units. The farming write-off tax benefits accrue to the LP units, so those are left outside your RRSP. The bonds are brought into your RRSP to give you a further tax advantage. $5500 is required to be paid upon subscription, of which $5000 is a down paymnent on the bonds and $500 a down payment on the LP units. Another $5000 or so is due on March 31 every year from 1998 to 2000. For the remaining years you are required to pay interest only on the balance owing ($850 a year) with the balance of $ 17,000 payable in the tenth year. The $850 a year in interest (tax deductible) is offset by a similar amount earned by the bonds (tax free).

These sound like big numbers and big outlays, but creative financing, reinvestment of tax benefits and profit distributions make it easily affordable for most people. In the first year alone, if you pay the $5500 up front and put the entire $17,500 of bonds into your RRSP, you get a tax deduction of $2513 for farm losses and $17,500 for the RRSP. At a 40% marginal tax rate, you get a tax refund of over $8000! If you are in the top tax bracket, you get over $10,000 back from the taxman., enough to cover the next two years payments. The further tax benefits each year cover the fourth year’s payments and at the end of the ten years, you redeem the bonds and do an RRSP swap to bring the LP units into your RRSP for the bonds. Not only that, you have a tidy little investment that should generate continuing income for the rest of your life.

What if you don’t have $5500 to invest? If you have over $17,500 in your RRSP, you can start with an RRSP swap at the outset. You liquidate $17,500 of investments from your RRSP replacing them with the bonds. That money comes to you as cash. You pay the $5500 owing from that amount. The remaining $12,000 is invested outside your RRSP and along with the tax savings, covers your costs for the next several years. Again, the cost to you is negligible.

It sounds like a sweet deal to me, and I am taking a good hard look at it. With the stock markets in turmoil, maybe swapping stocks for a cranberry farm investment is a good idea. You get tax write-offs, an interest in prime agricultural land in B.C., an interest in a producing profitable farm operation and a steady stream of income in later years. I’m still crunching the numbers and I need a few more questions answered, but my gut feeling is that this is a good deal.

Disclaimer: I am not a professional investment advisor and the opinions in this article are based on my admittedly rudimentary and unsophisticated analysis. Investors are advised to consult their broker and go over details of this investment to their own satisfaction. (If you live in Vancouver, I can put you in touch with my broker. Email me for more information.) All responsibility for any investment losses you might incur from your investments is entirely your own.