"Neither a borrower nor a lender be." This might have been sage counsel in Shakespeare's day, when Polonius tendered the advice to his son, Laertes, in Act 1 of Hamlet. It might remain sound financial guidance today as well, but it does not reflect the realities of living in the 21st century. For the vast majority of consumers and business owners, an infusion of outside capital is necessary to buy any big-ticket item--a home, a farm, livestock, equipment--or simply to deal with bills and wages in the face of an erratic cash flow.
This usually means securing a loan from a traditional lender such as a bank or mortgage broker, imposing on family or friends, or relying on credit cards. Working capital also can be raised by luring investors. Each approach has its pros and cons.
At the high end of the spectrum, multimillion-dollar Thoroughbred operations thrived for years on borrowed capital, but institutional interest in lending has plummeted as banks merge or close. The problem is the traditional business model for equine activities that worked for years is now broken.
Horse breeding, and to some extent racing and showing, are cyclical income producers. Expenses are incurred throughout the year for stud fees, board and training, veterinary and farrier care, wages, insurance, transportation, and so on. Income, on the other hand, is generated sporadically by horse sales.
Standard business practice over the years has been to borrow money to smooth out the rough spots and then repay the loans when horses are sold. In most cases the horses themselves serve as collateral--the property pledged by the borrowers to guarantee the loans. And therein lies the problem.
For a variety of reasons, mainly the general economic collapse here and abroad, markets are flat, buyers are hard to find, and horses are not worth as much as they used to be. As prices spiral downward, sales generate less money than expected, borrowers are less able to repay their loans, and banks start filing lawsuits for loan defaults. Prominent Thoroughbred owners Ahmed Zayat and Stonewall Stallions, for instance, are among the borrowers sued for alleged defaults in recent months by Fifth Third Bank, to the tune of some $50 million.
But what about everyone else?
The vast majority of horse owners do not need to borrow millions of dollars to finance a racing stable or breeding operation. They do, however, need to secure a mortgage for a farm, or borrow a few thousand dollars for a horse trailer or truck or to buy a horse. Financing still is available for many of those borrowers, with the caveat that lenders are being far more selective before approving any loan. Lenders are scrutinizing loan applications as never before, reevaluating the volatility of collateral (especially horses), and requiring higher credit scores.
There is no guaranteed path to securing a loan for a horse business, but if there is a secret to the process, it is emphasizing the "business" aspects of the loan ¬application. Banks loan money as an investment, with the expectation of getting repaid with interest. Most loan officers are unfamiliar with the horse business, and a comprehensive business plan that educates while establishing the profitability of the activity is a necessity.
The Small Business Administration (www.sba.gov) provides a wealth of helpful information. Although little on the SBA website applies directly to horse activities, the information is an excellent starting point for anyone seeking financing for a new or expanding enterprise.
The SBA advises individuals to base lending decisions on the Financial Six Cs:
- Character: The moral obligation of the borrower to pay his or her debts;
- Capacity to Pay: The ability of the borrower to pay the debt;
- Capital: The total of equity and debt in the business (a low debt-to-asset ratio suggests financial stability);
- Collateral: Assets owned by the borrower but promised to the lender to secure the debt (the lender retains a security interest in the collateral and can foreclose in case of a default; horses as collateral might be a problem);
- Conditions: Economic conditions, location, competition, and the health of the industry; and
- Confidence: A subjective decision--is the borrower trustworthy?
A borrower establishes the Six Cs with a business plan. The SBA offers step-by-step guidelines for writing a business plan, online workshops, and links to samples of successful business plans. In general, the business plan should include the following:
- A cover sheet;
- A statement of purpose;
- Information about the business, including a description, marketing plan, list of competition, operating procedures, personnel, and insurance;
- Financial data, including a list of capital equipment, a balance sheet, a profitability analysis, income projections, cash flow estimates, and a list of assumptions that form the basis of the financial projections; and
- Other supporting documents, including personal and business tax returns for the individuals seeking financing, resumes, a list of potential investors, and letters of intent for anyone committed to do business with the proposed enterprise.
If this sounds like a lot of trouble, it is. But a loan application for a fledgling horse business must compete with hundreds of other loan applications, many from borrowers who have done their homework.
An added benefit of a comprehensive business plan is that it forces an evaluation of the proposed business based on factual information rather than the borrower's initial excitement. Enthusiasm is important, but it is not a substitute for a well-thought-out business plan. One of the ironies of the business loan process is lenders want to see proof that the business can generate enough income to repay the loan before the business is up and running. A sound business plan is the next best thing.
Options for financing a horse business if a traditional bank loan is unavailable include a home equity loan or line of credit, borrowing from family and friends, and credit cards.
Your home can be used as collateral for a loan or line of credit. Both amount to a second mortgage on the property, with the principal difference being how the money is distributed to the borrower. With a home equity loan, the amount of the loan is paid out when the loan is approved, and the borrower makes monthly installment payments. A home equity line of credit, on the other hand, is a revolving line of credit. This means that the holder can borrow up to the limit of the credit line, repay the loan, and then borrow again without having to apply for a new loan.
Home equity loans and lines of credit are attractive because they often have relatively low interest rates and can be easier to obtain than traditional loans. The risk, and it is a big one, is the borrower can lose his or her home if there is a default.
Borrowing from family and friends is problematic at best, as litigants on Judge Judy, People's Court, and a host of other television reality shows can attest. A written loan agreement that includes the amount of the loan, terms for repayment, identification of any collateral, and a reasonable interest rate, is essential to avoid hurt feelings and to protect relationships.
Using credit cards to support a business endeavor is ill-advised at best and catastrophic if the business fails. Credit card companies generally charge outrageous interest rates and credit card defaults can damage a borrower's credit rating for years.
Another possibility is to finance through the seller. An owner anxious to sell might be willing to act as a surrogate banker and accept time payments for a horse. (Seller financing also is possible for equipment, land, and almost anything else.)
A written financing agreement is important in this situation and should include the selling price of the horse or other property, the terms of the transaction (down payment, monthly payments, and any interest charged by the seller), when title and registration papers will be transferred from seller to buyer, who will maintain mortality insurance, and which party bears the risk of loss if the horse is injured or dies before the full purchase price is paid. Even if it's not required, mortality insurance for the horse should be considered by the buyer to protect the investment.
Finally, some creative stallion owners and syndicate managers are modifying traditional breeding contracts due to the economy. Stud fees generally are due and payable in the fall of the year in which a mare is bred. But some contracts now allow a mare owner to pay the stud fee after the resulting foal is sold as a weanling or yearling. If the foal is sold for more than the stud fee, the mare owner keeps the excess. If the stud fee exceeds the foal's selling price, the mare owner is responsible for making up the difference.
Depending on the nature of the horse business, it might be possible to avoid going into debt altogether by enticing financial investors. W. Cothran Campbell, for instance, popularized Thoroughbred racing partnerships in the 1970s, and winner's circle photographs often looked like mob scenes when dozens of investors showed up after a Dogwood Stable horse won a race. The popularity of partnerships has ebbed and flowed since then, but the idea of sharing the financial risk with other like-minded individuals rather than with a bank still appeals to many business owners and horse enthusiasts. (Watch a partnerships webinar that our sister publication held at www.BloodHorse.com/webcast.)
Joining a partnership also is a viable option for someone who wants to have a stake in the horse business without shouldering the entire financial burden and risk.
Traditional financing is more difficult to obtain than in the past, but it still is available for many borrowers, especially when nonequine collateral is offered. Financing from noninstitutional sources is limited only by the imagination of the lender and borrower and is a viable option in many situations. In any case, good preparation prior to seeking a loan is essential.
About the Author
Milt Toby is an author and attorney who has been writing about horses and legal issues affecting the equine industry for more than 40 years. Former Chair of the Kentucky Bar Association's Equine Law Section, Milt has written eight nonfiction books, including national award winners Dancer’s Image and Noor. He teaches Equine Commercial Law in the University of Louisville's Equine Industry Program.