Questions and Answers,Global Cash Flow, January 12,2010
Q: Why are you assuming that the $4MM capital contribution made to Sequoia Properties in 2007 is a non-recurring event? How can you assume that distributions are recurring but not contributions?
A: As noted in Note 4 in the Sequoia Properties financial statements, during 2007, Mr. Schumacher converted $4.1 million of personal loans to Sequoia Properties from long term debt to equity. The cash from those loans was injected into the company prior to 2007, and therefore those transactions are being treated as non-recurring events.
Q: Would you approve this $3.1 million loan request from Fresno Properties?
A: This would be a very difficult loan to approve for the following reasons:
Using the reported distributions from a K-1 would not necessarily reflect what is available for debt service. It would be possible to "distribute" more than the company's income thereby depleting owner's equity. Conversely, no distributions could be made from a company with substantial cash flow. With that thought in mind shouldn't we be looking beyond the K-1 to the company's financial statements?
A: Totally agree. We should and we do look beyond the Schedules K-1 and distributions to the financial statements of the companies. The various global cash flow tables did so, providing a proxy for company cash flow that, of necessity, include the cash outflows associated with distributions and loans to owners.
Q: We did not discuss legal implications. If a separate legal entity (S-Corporation or Partnership for example) does not sign the note or a guarantee, even though our borrower is the sole owner of one of these companies and is personally obligated to pay I doubt we can force the separate legal entity to pay the borrower's debt. With that thought in mind we should probably not include such companies in a global cash flow analysis. Would you agree?
A: Agree with the legal implications and issues. But it makes sense to include all related parties in our analysis to determine the possible positive impact from their inclusion. That analytical process should show us whether there is value in requiring a related party to guarantee or co-sign the note. In addition, that inclusion in the analytical process may certainly show the potential dangers and pressures on the borrower’s cash flow and debt repayment prospects by virtue of related party cash flow problems. The relative positions of Fresno Properties and Sequoia Properties make this point. Both are owned and controlled by Fritz Schumacher. If we failed to include Sequoia Properties in our analysis, we would miss the threat to the Fresno Property 2008 cash flow and debt repayment prospects, regardless of whether Sequoia Properties were legally associated with Fresno Properties in any fashion.
Q: Why are you assuming that the $4MM capital contribution made to Sequoia Properties in 2007 is a non-recurring event? How can you assume that distributions are recurring but not contributions?
A: As noted in Note 4 in the Sequoia Properties financial statements, during 2007, Mr. Schumacher converted $4.1 million of personal loans to Sequoia Properties from long term debt to equity. The cash from those loans was injected into the company prior to 2007, and therefore those transactions are being treated as non-recurring events.
Q: Would you approve this $3.1 million loan request from Fresno Properties?
A: This would be a very difficult loan to approve for the following reasons:
- There is insufficient projected 2008 cash flow (DSC of 1.11) from Fresno Properties to service this debt.
- We would need to fully analyze the acquisition NOI calculated in the appraisal to ensure that it is an actual number and not a projection. If that calculation determines a lower NOI for the acquired property, the DSC may, in fact, be lower than 1.0.
- There is no likely cash support from either related parties or the owner.
- The related entities have tremendous cash flow obligations in 2008 in the form of significant increases in CMLTD, accounts payable, and accrued expenses.
Using the reported distributions from a K-1 would not necessarily reflect what is available for debt service. It would be possible to "distribute" more than the company's income thereby depleting owner's equity. Conversely, no distributions could be made from a company with substantial cash flow. With that thought in mind shouldn't we be looking beyond the K-1 to the company's financial statements?
A: Totally agree. We should and we do look beyond the Schedules K-1 and distributions to the financial statements of the companies. The various global cash flow tables did so, providing a proxy for company cash flow that, of necessity, include the cash outflows associated with distributions and loans to owners.
Q: We did not discuss legal implications. If a separate legal entity (S-Corporation or Partnership for example) does not sign the note or a guarantee, even though our borrower is the sole owner of one of these companies and is personally obligated to pay I doubt we can force the separate legal entity to pay the borrower's debt. With that thought in mind we should probably not include such companies in a global cash flow analysis. Would you agree?
A: Agree with the legal implications and issues. But it makes sense to include all related parties in our analysis to determine the possible positive impact from their inclusion. That analytical process should show us whether there is value in requiring a related party to guarantee or co-sign the note. In addition, that inclusion in the analytical process may certainly show the potential dangers and pressures on the borrower’s cash flow and debt repayment prospects by virtue of related party cash flow problems. The relative positions of Fresno Properties and Sequoia Properties make this point. Both are owned and controlled by Fritz Schumacher. If we failed to include Sequoia Properties in our analysis, we would miss the threat to the Fresno Property 2008 cash flow and debt repayment prospects, regardless of whether Sequoia Properties were legally associated with Fresno Properties in any fashion.