Business Real Estate

Business Real Estate Order Description Your response needs to state the problem, critical issues to be addressed, alternative solutions including their attributes and potential outcomes, and your position supported by the facts of the matter and supporting information including financial analysis as needed. Do not restate information already provided in the case study. Double-spaced, 1" margins, 12-point Times Roman font. ________________________________________________________________________________________________________________ Research Associate Melissa Lam prepared this case under the supervision of Professor William J. Poorvu. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2002 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www. hbsp. harvard. edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. WILLIAM J . POORVU The Cardon Family In summer 1998, freshly graduated from Harvard Business School, Wil Cardon made the difficult decision to join his father, Wilford, in the family’s investment and real estate business instead of taking his dream job, an associate position at a premier investment company in the Midwest. Having made the decision to join his father, Wil wholeheartedly threw himself into running the family firm. Three years later, during the summer of 2001, Wil found himself at a crossroads. The elder generation of three brothers running the business had taken a step back and were preparing to turn over the reins to the younger generation. The business included Broc Hiatt (a cousin who had been CFO of the firm for the past 6 years), Tom Burton and Brent Bowden (sons-in-law of Wil’s two uncles), and Greg Davis (an HBS classmate whom Wil had recruited in 1999 to join the company) along with other non-family professionals. In addition to passing on the business, Wil’s father and uncles were also passing on a tremendous amount of family responsibility. The three brother’s families now had 21 direct descendents in Wil’s generation. Including Wil’s three aunts’ families, who were not owners of the business, this number grew to 39 and grandchildren numbered over 100. As owner of his family’s portion of the business and steward of his extended family’s financial fortunes, Wil grappled with many pressing issues. First, what was the business? Like many real estate enterprises, properties or assets were owned in many individual partnerships. About 20% of the family’s investments were outside of real estate. In the beginning, Wil’s grandfather had started off with full service gas stations. His father then took over and was immensely successful in land investment and development and eventually became an operator of convenience stores. The early 1990’s had been a near disaster for the family with virtually every S& L in Arizona filing bankruptcy. The business, along with several partnerships, had taken down $250 million of debt for buying land and expansion. Along with almost all real estate related businesses in Arizona during the late 1980’s and early 1990’s the Cardon’s had to negotiate a number of deals to survive. Several peripheral businesses were closed. Yet, the business made it, albeit at a lower level of activity. Wil considered what Cardon was good at and how the family’s values affected their decisions. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 2 Second, how could he structure the company so that he, Broc, Greg, and the others were fairly compensated without making those outside of day to day management feel they were not being treated equitably? The family values played into this decision as well. For instance, even though their sisters were not owners, the brothers had always felt a financial responsibility to help them and did so from time to time. Finally, where was Wil in his personal career development? Having given up his dream job, did he really want to commit to this business or did he want to pursue his other interests? He had always considered someday becoming active in politics. Family History After a long odyssey, Wil’s grandfather started the Cardons in the real estate business through the ownership of gas stations. Wil described his grandfather’s upbringing: My great grandfather was born in Mexico as part of a large Mormon family who had been sent by Brigham Young to colonize the southwest. Pancho Villa ran the immigrants out of Mexico in the early 1900’s and the family migrated and settled just north of Tucson, Arizona. He lived in a tent with a dirt floor most of his early life and at a young age, 12, he went to work in a dairy to help support the family. He was a very industrious, boot-strapping individual. His oldest brother Parley planned for the family to get out of poverty through education. ‘Every Cardon through college,’ became the family mantra preached by Parley and their mother. The system was as follows. One would attend college while the others pooled their money to pay for tuition and books. Upon graduation, the increased earning power of those with university degrees would increase the wealth of the pool. Of nine immediate brothers and sisters, five earned Doctorates with the other four earning at least a Baccalaureate degree. This was during the 1930’s and 1940’s from a family that did not have any financial wealth. They had enough money so that when Parley was a senior, my grandfather started as a freshman at the University of Arizona. When Parley graduated, he accepted a job in Washington, D.C. Although he was a good swimmer, he drowned in the Potomac River that summer. To this day no one in the family knows quite what caused him to drown. It took most of the money in the pool to bring his body back for burial. This happened during the very early 1930’s. My grandfather now faced the challenge of finding a job and paying for his education during the depression. He found a solution by working at a gasoline station next to the University. In a short time he became the lessee of the gasoline station and passed the bar before he finished law school. He finished up law school at the University of Arizona but he knew he didn't want to practice law and became a jobber (gasoline distributor) for Shell Oil Company in a small town called Stafford. After a few years there, the family moved to Phoenix and he became the jobber there. At that point, my grandfather began to build and own full service gasoline stations as well as deliver the product. Wil’s dad, Wilford Cardon, grew up imbued in the family business. As far back as he can remember he helped to build stations, deliver product, and do the accounting. He followed his father to business meetings and construction sites. Recounted Wilford: This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 3 We worked – when everybody else played, we worked together. He had three sons, all three of us in the business. So I had myself, and two younger brothers. In total in our family there are six children; three girls, three boys. We worked with our father before school, after school. We would milk cows in the morning together, we’d build stations in the afternoon after school together. I was driving gasoline trucks when I was 12 and 13 years old. I was running complete service stations when I was 16. I mean, he just would put responsibility on us – he had a great, tremendous capacity to delegate responsibility. He just said make your own mistakes. There’s your job. Here, I’ll help you. I’ll be your backup, but it’s your business. So I was hiring, firing, and running people at an early age…responsible for the business. Wilford left home to attend college and to go on a church mission to Brazil, but was always involved in the business when he was at home. In his mid 20’s he attended law school in Washington DC. According to Wil: “my grandfather called him, and said: ‘I have an offer to sell the business. Either you come home and run it, you're the one with the potential to run it, or I'm going to sell it.’ My father knew he did not want to practice law and that eventually he wanted to return to the family business. So he cut his graduate education short and returned home to become partners with his father and brother, Elijah.” During the short period of time Wilford worked with his dad, they transitioned the service stations into a real estate business. Wilford recalled: “Dad was very strong on petroleum. We would build service stations. That was his vision. We would buy larger tracts of ground. I came back in '65. He died in '69. We had four years together. Instead of a one acre piece on the corner for a service station, we bought twenty acres. This was a big thing, and it was two or three years before he died. And he agonized over that. We bought that piece for $200,000, $10,000 an acre. We later sold it. We kept the front, and sold the rest for a little bit over a million. So it was a good real estate deal.” Evolution of Business The Cardon’s business grew. The gas stations were positioned to catch the self-service craze that swept the country. Said Wilford: “Within five months after my Dad died we built our first selfservice station. Eventually we changed the whole business to self-service. That was very, very successful, and allowed us then to expand. We blossomed into industrial real estate, commercial real estate, land investment, a home building company and lots of other businesses. We've been involved in probably 150 businesses.” The advent of air conditioning allowed comfortable living and drove the growth of the southwest, particularly Arizona. The land investment that started around the gas stations grew to larger and larger deals. Said Wilford: “But in high growth areas like Arizona, land is where the money is. It's grown so fast that it's been a great place to be in the land business. The other aspect of that, of course, are section 1031 exchanges. In other words, we could sell by arranging to transfer the equity into another piece without paying tax on it. We have probably a zero basis in about everything we do because of all the years and years of 1031 exchanges.” The land investment required making big bets that would not pay off until the land was sold. To supplement their income stream and augment their gas stations even further, the Cardons opened convenience stores as part of the gas stations. The convenience stores served as a cash cow to fuel the land investment business. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 4 Evolution of Family At the same time the business grew, the Cardon family involvement grew as well. Wilford and Elijah became partners with their younger brother, Craig, a few years after the death of their father. Wilford described their relationship: Elijah has been more involved in the service stations and construction area. Although Craig never went to law school, his thinking is similar to an attorney’s. As a result, we've had Craig in most of the legal aspects of what we do. He coordinates the attorneys. And he was very good in our workouts. That's where he really did his best was in our workout. Although we all work in each other’s area at times, I've taken on the business development and real estate. I feel very comfortable leaving the business in any of the other two partners' hands. It's not that we're compartmentalized, although each one deals with separate parts of the business. We overlap completely if we need to. And during that partnership, each one of us has served a church mission for three years, which means we've left the country. I went to Brazil, Craig went to Italy, to Rome, and Elijah went to Hamburg, Germany. And during that time you're completely doing church service. You don't come home; you don't attend board meetings. During these missions, the Cardon family grew exponentially. Recounted Wil: My family has eight children. We started off with me, the oldest, then a sister, five years younger, and then we adopted a boy in the US right before we went down and lived in Brazil for three years. While in Brazil, unbeknownst to my father, my mother was out looking for children. He'd go to meetings, and she'd be out looking at orphanages, and adoption agencies. In the last year we ended up having several children come through our home. We never knew who was going to stay – my mother helped a lot of families adopt children, but five of them stayed with us. I have five Brazilian brothers and sisters. I'm 31, I have a sister who is 26, a brother and sister who are 25, another brother who's 24, and three who are 21. Wil Cardon Wil was also brought up to be involved in the family business. In the summers, he would work on the crew helping to construct convenience stores. He traveled often with his father and attended meetings to evaluate potential real estate and private equity deals. However, as Wil recounted, his post-undergraduate experiences were somewhat non-real estate oriented: I knew I wanted to go to business school. I knew that the language of business is accounting. So I applied to accounting firms, and had a couple of job offers with, at that time, the Big Six. At the same time, the guy who had once run our home-building company called and began talking to me about starting a sub-prime auto finance company. He asked me to come back and join him. I thought that was an interesting opportunity, so I went back and did that, and for two years. It was a great experience. Being the second guy in the shop meant I had plenty of responsibility. I was in charge of setting up all of the systems and office personnel for collecting and he was in charge of purchasing the cars and leasing them. I built a pretty good team and did everything from raising money to repossessing vehicles. It was a great business learning experience. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 5 After going to Stanford, working, going on a mission to Portugal and getting married, Wil entered Harvard Business School. At HBS Wil was offered the opportunity to his “dream job” at a prestigious Midwest real estate investment firm. At the same time, Wil’s Dad offered Wil the family business. Wil recalled: I had a tough decision. I think that was one of the toughest, if not the toughest decision so far in my life. I remember coming and speaking with Professor Poorvu. I tried to decide whether to go to Transwestern Investment Company, and work with some people who were the top of the real estate business nationally, or go home. My father and I spoke about the choice quite a bit. He did not want to unduly influence my decision but also wanted to make sure that I understood the ramifications of what I did. He said that in a three to five years he wanted to be leaving the day-to-day activities of the business and wanted to turn it over to someone. I had always known that eventually I wanted to go back and work with the family business, at least for a little while, and see what I could do with it. Wilford’s father explained his rationale. I really have liked this business. My father died at 59. When I was in my late fifties I made some decisions that I really did want to turn it over to the next generation and go out and do some other things. There are thousands of kids that I know that still need help in Brazil, Chile and all over the world. We’ve now set up and implemented a program for kids to go back and further their education in these countries. We’ve gotten thousands and thousands of kids on scholarships. Every year we bring kids up to get their MBAs here, and then send them back to their countries. Our goal was to get a hundred MBAs back into Brazil. We have over one hundred of them who have gone through and are now back down there. He also explained his view as to responsibility in the family. Wil is going to manage my assets. When I say ‘mine,’ I mean my family’s assets. I talk with him a lot about stewardship. I view assets as a stewardship. I don’t view them as mine. Assets are like a great painting. You can’t own them. You can possess them for a while, but you can’t own them. We’re all going to die. We’re all going to leave with nothing. We speak often about why we are here on earth. I talk with him a lot about the use and purpose of money and wealth. My belief, which he shares with me, is that people are given various talents. Some people sing well; some play the piano well; some are great painters; some are given the talent to manage assets well. Some people can’t manage their way out of a paper bag, but they can sing beautifully. And that’s just the way life is. Those who are given the talent to manage assets well have the responsibility to use those assets to bless the lives of others. In my view everything in this earth, including our lives and all that we possess, belongs to God. He created everything. We can possess His creations for a while, but they belong to Him. We came into this life with nothing; we’ll leave with nothing. Those who are given the talent to manage assets well have a responsibility to use that talent and those assets to bless the lives of God’s children as He would. The talent to manage assets well is comparable to the talent to sing well. If one is given the talent to sing beautifully, but only sings in the bathtub every day, never using that talent to bless the lives of others, nor allowing others to grow and expand, then the talent to sing becomes a thing that cankers one’s soul. It’s of no value to anybody. But if one uses the talent to sing for the purpose of blessing others, to build our fellow travelers here on this earth, then it’s a beautiful thing. If one uses his ability to manage assets to bless and elevate others, then he will be using God’ creations for their intended purposes. If one uses his talent to manage assets well for self-aggrandizement and ostentatious purposes, eventual sadness will be the result. I’ve seen too many rich people on their deathbed cursing This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 6 their children. “Oh, you’re just waiting for me to die so you can get my things!” You know, that’s a crazy way to live. My sister’s son, Broc, is a very good manager. He has been with us 15 years. He was with us all through the workout. Broc started working with us as a part-time person while he was going to college. He earned his degree in accounting, and rather than go to work for others, he’s been with us all the time. He has all the capacity in the world to go out any time he wants and do anything. Anybody with whom he deals always comes back and says, “Is he going to stay with you?” He gets job offers all the time. But he understands the family concept, and wants to cast his lot with us. So I want to be extremely fair with him, and help him in every way that I can. And this concept of lending him some equity is a good one. Broc’s a scrambler. Broc’s and my personality are very similar. I think Wil is going to do just fine. He has the capacity to do great things - he has the contacts. He is a network builder. His thinking processes are different from mine. I caution him. I say, “Where are your weaknesses?” as I often question myself. Wil’s potential weakness is “ not seeing the water clear to the end of the row.” You can start lots of rows of cotton with water, talking about irrigation, which is something we understand in Arizona. You can start lots of rows with water. And he has the capacity to start row after row. So he’s going to be very good in getting things started. But you’ve also got to be sure that water gets clear to the end of the row. And that’s where he maybe needs to concentrate. He’ll become very good at getting the water to the end of the row as he concentrates on it. The toughest thing I’ve faced in business is passing the family business from the second to the third generation. The reason is from the founder to the siblings - that is, from my father to the three brothers - we were all raised in the same home. Of course we had questions of whether or not the girls were going to be part of the business, of whether or not the sons-inlaw were going to come into the business, but we worked all those out, because we were all raised in the same home. My sisters, and I, and my brothers ate at the same breakfast table; we worked together as a family. And so we understood each other, and the differences between us we could read pretty well. The sibling relationship is the longest relationship on this earth. I will be with my brothers and sisters longer than with my parents, or longer than with my children. Our relationship requires work, but it’s a known quantity. At the cousins’ level, that is, when you move from my generation down to my children, the cousins are all raised in different homes. Wil was raised in a different home from Broc, or from any of the others. There are twenty-one cousins raised in at least three different homes. Consequently they possess different values taught by different parents. Also there were only six children in the second generation compared with twenty-one in the third. Twenty-one adds a whole new dynamic. How to get it from that second level to a third generation is by far the most complicated and toughest issue to solve. In addition, to the complexity in transitioning from the second to third generation, the business faced the challenge of coordinating three different family ownerships with a common group of assets. Each brother desired the ability to make business decisions independent of each other as to whom and how their ownership would be managed. At the same time, Wil harbored some ambitions outside of the business: I have some political aspirations. So I'm trying to set up a model where people can take time off to go spend time doing things other than business…if the business doesn't suffer from it. So again, it's that separation of capital…I'd like to run for office some time. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 7 Succession A family business is a challenge to manage from one generation to the next. Wil and his family grappled with issues of equity and merit, between siblings and in-laws, family members and professionals who work in the business and those who do not. According to Wil: At HBS I took the Family Business class. Using John Davis’ model, we think of ourselves in three overlapping circles – family, business and ownership. We have family members who fall in every conceivable category of this diagram. I am in all three of these circles. Some of my siblings will have ownership but I doubt that they will ever join the day-to-day managment of the business. Some family members, like Broc, find themselves in two of the circles – family and business, but not ownership. Others, like Greg, are involved in the business but do not fall in either the family or ownership circles. Under this structure, Wil did a lot of thinking about how to handle the business: Recently we have been changing our business so that the ownership piece is evolving from an inheritance to more of a meritocracy. We are evolving into a private equity model. And in this model, those in top level management take a carry. In this way, those who work in the business are more equitably compensated for their efforts while at the same time justly rewarding the capital it takes to produce that reward. As a result, Wil came up with the proposed management structure in Exhibit A to present to the three brothers. A family as large as the Cardons added extra complexity. Wil reflected: We have family councils where we discuss issues. But we never want decisions to be made by committee. So for each family group, one person is the representative and makes the decisions. For my family, that is me. For Craig’s family, it is Tom Burton, a son-in-law and for Elijah’s family it is Brent Bowden, a son-in-law as well. The Buckeye Deal In early 2000, a broker brought to Wil and Broc an interesting land deal. Located in Buckeye County on the west side of Phoenix, this site was located in a growing area 20 minutes west from downtown. Half of the Phoenix area’s 39,000 new housing starts were on this side of town. This 289 acre site on Airport Road became available and Wil and Broc thought with some negotiation they could pick up the piece for somewhere around $10,000 to $15,000 per acre (see Exhibit B). The seller was a family trust that needed some liquidity to settle some family issues. The land had the potential for a variety of uses including: retail, office and residential. Moreover, all of the surrounding land was being developed and hopefully the growth in the area would be the rising tide that lifted all the land values. Properties surrounding this site were being sold for upwards of $32,500 per acre for some larger tracts or $3 per foot for the smaller parcels, which translated to $120,000 per acre. Wil stated that they was able to get the inside track on this property for several reasons: One of our strengths is our relationship with brokers. Based on our history and our performance we often get the first look at deals. We have been able to get this preference over the years because of our reputation in Phoenix. We perform and we close when we say we This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 8 will. Others might put something in escrow and then figure out the financing. We pay cash and can move quickly. Our combination of strengths allows us at times to get a substantial market discount. We could probably turn around and sell this land for double what we paid for it the next day. Our exit for this land, however, is to sell it for $2 per foot or about $100,00 per acre (ten times our purchase price) over a five to ten year time period. As land developers, the value that Wil’s company adds is not immediately apparent: We don’t pretend to be developers. In general, we do not develop anything higher than a curb. In the business we are the “entitlers” of the ground. We buy pieces of property and get it set up so that it is a turnkey property for developers. We figure out what the best and highest uses are for a piece, what the requirements are from the municipalities, and figure out water and sewer. We work with engineers and know the drainage and physical restrictions to a piece of property. We work with the city and municipality so that all the approvals and permits are in place. We pay for the environmental impact studies. We get the development agreements. We have relationships with the city, county and state. We have experience and the resources to get projects planned. A piece of raw ground generally only has more than marginal increases in value when you can flush a toilet on it. Otherwise it is generally only good for agriculture purposes. In this particular deal, there was a list of outstanding issues that Wil needed to evaluate before they went forward with the deal. ! Use – There was a flexible general plan that allowed multi-family, commercial and light industrial. However, for a property that was divided by a highway, what were the best and highest uses. Would an apartment developer want to build next to a highway? What would the city want to see on the piece as a part of their general planning? Which of these uses would provide the greatest financial return? ! Utilities – Wil needed a public utility to provide the power to the development. Power plants were going in to the East and West. Wil noted that while access to power should not be an issue, there would be costs associated with it. ! Water – Phoenix, Arizona was a desert. Water generally came from underground aquifers. In Arizona, a developer needed to prove that he had an assured water supply for 100 years. Not only did the water supply have to be of adequate quality, but the developer also had to make sure that it would be replenished continuously. Preliminary tests showed that the water was spotty in areas. A drilled test well on a neighboring property got good quantity and quality of water. However, one mile to the south, a different property had been drilled and had shown bad water samples. Wil thought that the local public utility would be able to supply the water and issue the necessary Certificate of Water Supply. ! Sewer – Equally important was sewer. A denser development would require more than septic tanks, it would need sewer lines. Getting sewer lines entailed working with neighboring land owners as well the municipality. Wil thought that he could secure a development agreement with the city of Buckeye to take care of both the sewer and the water. Wil needed to negotiate upfront the impact fees that the developer would ultimately pay. ! Access – The broker was telling Wil that the adjacent property, a massive planned community being built by the developer DMB, would receive an off-ramp next year. An off-ramp was key to increasing the property value since it would provide easy access to the property. Buckeye County passed an ordinance in 1988 for an interchange and the change of access was This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 9 approved by the Arizona Department of Transportation but the funding, and therefore the building of an off-ramp, really depended on DMB. Wil anticipated that he would be able to piggyback off the work of the developer of the adjacent property. ! Annexation – Annexation required getting the land incorporated into a city. There was currently a climate of favorable land designation. While doing business with a county was easier than doing business with a city – fewer advocacy groups and private citizens -- there were also advantages to working cooperatively with the city from the beginning. There were no development agreements for this property. The next step was to create a preliminary plan. Wil had to decide on the timing of the annexation and master plan approval. ! Exit Strategy – Was there a developer who would be willing to purchase this high density, multi-use property from Wil? Would they be willing to pay 8-10X what Wil paid for the same property? While the business plan for these land deals was simple – buy land at a low price, sell at a higher price based on entitlement improvements and growth in the area -- Wil knew from experience that it was often difficult and time-intensive. Could all these issues be worked out? Would the market in this area still be there in five to ten years? With no cash flow from a piece of raw land, Wil had to make sure that he would be able to fund the taxes and other costs over time to hopefully sell it for a profit. Wil estimated that entitling the land could cost over $150,000 to third parties and additional costs to fund salaries and expenses for those in his business working on the project. Was he willing to absorb these costs? While there were a few outs, including a 30 to 60 day feasibility period to review easements and other issues, Wil knew that if he put a lot of other conditions on the purchase, he might lose the deal. The ability to close quickly was what got him the first look and the below market price. On another level, Wil wanted to finalize the arrangement he had presented to the three brothers and this land deal would be a good test case as to how it might work. It would involve coming to grips with many of the issues raised in his proposal. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 10 Exhibit A New Organization Proposal Guiding Principles 1. Management should be rewarded for management and Capital should be rewarded for capital. An “arms length” relationship should be maintained between Capital and Management. 2. All management is not equal. 3. Objectives of capital providers need to match risk profile. Capital should be matched to appropriate investments and risk levels. 4. Management and Capital desire partners not employees. (ie.Hunt family has employees while the Baker family has partners) 5. Control, ownership and financial rewards will be independent of each other and not necessarily equal. 6. Capital invests Capital. Management directs management. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 11 Asset and Management Classifications Issue: Current assets require different work and management levels. Solution: Create Three Classes of Assets with different compensation structures for management of each class of asset • Mature Assets – assets that are fully matured and ready to be exited • Growing Assets – assets that have had some management on them completed, yet still have some management left to be done • New Assets – investments made in future assets that are expected to produce above par returns Mature Assets These assets are fully matured and are (1) ready to be exited or (2) not appreciating above a 9% hurdle rate and Capital desires to hold them. A management fee will be paid to Management for the maintenance of assets under a Mature Assets Agreement. Fee: 1.0% of assets placed in Agreement Terms: Paid monthly from distributable cash or capital contributions Review: Annually This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 12 Growing Assets Assets in this class have not reached maturity. They have had some of the work associated with a typical promote completed. A management fee will be paid to the Management entity for the maintenance of assets under a Growing Assets Agreement. A transaction fee or promote will be paid to Management entity with intent to motivate Management to maximize assets appreciation. (1) Management Fee: 1% of assets placed in Agreement and either (2a)Transaction Fee: 0.5% – 1.0% of all assets liquidated each calendar year. or (2b) Carry 5% - 10% carry on profits* *Profits defined as liquidation proceeds (net of all costs and commissions) minus original valuation agreed on by Management and Capital. New Investments Structure Allocation of Promote: •Capital Allocation •Sourcing •Closing •Value Enhancement •Monitoring •Exiting •Brand Equity •Advisory •Fund Raising Each investment is a new Limited Partnership with General Partner determined at time of investment. The GP receives no financial reward from the LP. The GP can be removed, with or without cause, upon the affirmative vote of a majority (> 50%) of the Limited Partnership interests then outstanding. Limited Partnership interests interface with GP and receive management reports from GP. LAND LLC OR ACME INC. CAPITAL G.P. L.P. MANAGEMENT ENTITY $ 80% of L.P. 20% Promote including 1% Mgmt Fee (repaid from promote) Admin. Support $ Stock Management Liability This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 13 Distributions Distributions The Partnership’s net distributable proceeds from operations, dispositions, and financings of Investments and other events giving rise to distributable proceeds will be distributed to the Partners as follows: • First, to the Capital, until they have received a 9% cumulative return on an annual compounded basis on their unreturned capital contributions; • Second, to return to the Capital their unreturned capital contributions; • Third, 50% to the Management and 50% to the Capital until the Management has received an amount equal to 20% of all amounts distributed to the Management and Capital under (1) and (3); and, • Fourth, 80% to the Capital and 20% to the Management. Example Assumptions $1,000,000 investment in ACME Inc. Twelve months later ACME is liquidated Total proceeds from liquidation equal $1,200,000 Distribution of Proceeds (1) $90,000 to Capital (2) $1,000,000 to Capital (3) $30,000 to Management and $30,000 to Capital (4) $40,000 to Capital and $10,000 to Management Total distributions Capital $1,160,000 Management $40,000 Allocation of Promote Proposed division of carry. Total Promote – 20% Allocated by: Capital Allocation Sourcing Closing Value Enhancement Monitoring Exiting Advisory Brand Equity Fund Raising Allocation determined by Management This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 Brands Retail 14 Co-Investment by Management Allowed (Strongly Encouraged) Capital provide loans to co-invest in the limited partnerships and are personally guaranteed with full recourse to all of borrower’s personal assets. Terms: Interest Rate: 8%, compounded annually Term: Life of limited partnership Amount: $3,000,000 credit line (Not to exceed 10% of total capital invested, allocated by management) Security: Individual loans secured by personal assets of individuals obtaining loan Buy Out Provision A Standard Buy Out exists between Limited Partners. Example • Moving party submits a valuation and terms of buy out. • Within 30 days, non-moving party (by simple majority vote) determines whether they agree with the moving party’s valuation and terms. (i) If non-moving party agrees with the moving party’s valuation, non-moving party notices moving party of non-moving party’s intent to buy or sell. (ii) If non-moving party disagrees with moving party’s valuation, then each party selects an independent appraiser to value the limited partnership. (a) If these valuations are within 10% of each other, then an average of the two appraisals is taken to determine the binding value. (b) If the valuations are not within 10% of each other then both appraiser agree on a third appraiser whose value is binding. Thirty days after a binding value is determined the non-moving party notices the moving party of its intent to buy or sell under the terms given by the moving party. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Brands Retail 802-196 15 Source: Company document Management Issues Issue: Allocation of promote to Management Management will determine allocation of promote among themselves. Issue: Budgeting of Management Fees Management will determine allocation of management fees. Issue: Office Management Management will determine salary levels, benefits and run the accounting, business development and real estate staff. This document is authorized for use only by Jarren Smith ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. 802-196 -16- Exhibit B Youngker - Buckeye Source: Company document