Read Prospectuses Carefully to Avoid Pitfalls of Roll-Ups

It seems things couldn’t get worse for limited partnership investors. If you are one of those who invested hard-earned dollars in partnerships that bought apartment complexes and oil wells, among other things, you probably have been getting kicked in the teeth for the past half a dozen years.

First, the Tax Reform Act of 1986 killed tax writeoffs for many partnerships and caused thousands of investors to face IRS audits and whopping tax bills. Then, the real estate slump sent hundreds of partnerships into bankruptcy. And, there was a “chronic depression” in energy prices that battered oil and gas investors.

The bottom line: Thousands--possibly millions--of limited partners have been losing money.

And now along comes the “roll-up.” Some investors maintain this is the “Predator 2” of the limited partnership world: Not only is it deadly, it’s out to get you.

What is a roll-up? It is the term for an exchange of interests from one partnership into another partnership or corporation. Usually, several limited partnerships band together to trade in their partnership interests for shares in a new, publicly traded company.

In other words, investors in partnerships A, B and C might all decide to “roll” their shares into company D, which will be listed on the New York Stock Exchange. Typically, general partners promote the exchange as a way to turn an illiquid investment--the partnership interest--into a liquid one, a stock certificate in a publicly traded corporation.

That gives investors the ability to get out if they want to, but it also loosens their grip on the partnership’s assets. (Typically, limited partners were guaranteed a share of proceeds from the sale of partnership assets by a specific liquidation date. Roll-ups tend to do away with liquidation provisions and allow the new company to last into perpetuity.)

Many limited partnership experts maintain that these deals may also frequently cause partners to lose a substantial portion of their investment overnight.

Indeed, the American Assn. of Limited Partners (AALP) charges that the term roll-up is a misnomer. “Stick-up would be more like it,” the Washington-based group says in a booklet to limited partners.

In 13 large roll-ups conducted through 1990, investors lost 63% of their equity, the group says. About 44% of the loss came in the first day of public trading. Meanwhile, the general partners who instigated these deals are taking home about $275 million in management and disposition fees, according to the AALP.

And that may only be the beginning. Partnership experts believe that there will be more roll-ups this year than before. By the time they are through, about 8 million individuals could be affected and billions of dollars could be lost, experts say.

It is important to recognize, however, that not every roll-up is a bad deal. Some might actually enhance investor values.

Congress, state lawmakers, regulators and consumer groups are all trying to find ways to prevent abusive roll-ups. But change is slow in coming, so partners must act now to protect themselves.

Spend the time to read the prospectus. Pay particular attention to financial information that should spell out how the company will be financially healthier once the roll-up is complete.

Look for rule changes that give general partners higher fees and allow them to take their money before limited partners get their due.

And be particularly wary of “super-majority” provisions that require large percentages--sometimes 75% or more--of all the partners to agree on operational changes of the firm. In some cases, managers themselves own more than 25% of the new entity, which makes any change unpleasant to management impossible.

Cash bailouts for general partners should also serve as a red flag. If it’s such a good deal, why would managers want out?

Finally, don’t get pressured into anything. If the company or a broker is forcing an answer before you’ve had a chance to consider the deal, vote no. You shouldn’t be forced to walk over a precipice without some advance indication of when you’ll hit ground.

Let the Partners Beware If you’re a limited partner and a roll-up is proposed, here are a few tips to make sure that the action happens in your favor:

* Read the prospectus, where the risks of a proposed roll-up must be spelled out, and look for financial information that should explain how the company will be financially healthier once the roll-up is complete.

* Beware of rosy projections that anticipate lower costs and higher revenues without the facts to substantiate such assumptions.

* Look for rule changes that give general partners higher fees and allow them to take their money before limited partners get their due.

* Be particularly wary of “super-majority” provisions that require large percentages--sometimes 75% or more--of all the partners to agree if they want to oust management or change other operations of the firm.

* Don’t let yourself be pressured.