Back in early 1987, limited partnerships looked awfully promising as a way for growing companies to raise capital, thanks in part to the Tax Reform Act of 1986 and the changes in the rules on tax shelters. Since tax shelter losses could no longer be deducted from ordinary income, some observers predicted that wealthy individuals would soon begin combing the landscape for income-oriented deals. And where might they find such opportunities? Why, in growing companies, which could create income-producing limited partnerships around stores, trucks, new products, you name it.

From the companies' standpoint, limited partnerships looked just as appealing. They offered a means to acquire expensive assets or to finance expensive projects without selling off equity, and without using up borrowing power. Beyond that, they offered flexibility, since payments to limited partners (unlike lease payments or bank payments) can be scheduled to accommodate a company's cash flow.

So did everybody flock to limited partnerships? Not exactly. A year later, the technique still looks promising, and quite a few growing companies still use it to raise money. But it ain't easy.

Consider Hornblower Yachts Inc., a San Francisco-based company that operates a fleet of luxury dining yachts. Hornblower seemed to have everything going for it when its owners put together a prospectus for a limited partnership last May. The company had been in business for nearly seven years. It had a loyal customer following. It was solidly in the black, with profits of $650,000 on annual revenues of $8.4 million. Perhaps most important, it had raised capital through a successful limited partnership once before.

All in all, Hornblower could show investors an excellent track record and tell them a very good story. It should have been an easy sell. It wasn't. When the deal closed at the end of December 1987, the company had raised less than a third of the $2.65 million it was seeking. Oddly enough, the disappointing result had relatively little to do with the deal itself. Rather, Hornblower's experience illustrates the difficulty of selling a private limited partnership in the current environment, especially when you work through broker-dealers.

Those were lessons that Hornblower's co-owners, Terry MacRae and Mike Watson, had never had to learn with their first limited partnership, which has raised $1 million in 1984. For one thing, they had sold the deal themselves. Offering units of $50,000 in a seven-year partnership, they had needed just three months to sign up 14 local investors, and people they met through their accountant.

And a good deal it had been all around. With a $1.8 million loan from Wells Fargo Bank, the partnership had purchased a $2.8 million vessel, which gave Hornblower the flagship it needed for its San Francisco Bay operation. The limited partners, meanwhile, got the use of the tax-sheltered losses (including a 10% investment-tax credit and accelerated depreciation) and, in the third year, a cash distribution amounting to 30% of their initial investment. On top of that, they had each received "captain's passes" (one per $50,000 unit), giving them free access to public cruises. And they could also look forward to eventually owning the boat, whose value was likely to increase over time.

Given the success of the first deal, it was only natural that MacRae and Watson would think of doing another limited partnership in 1987, when they set out to raise the capital needed to acquire two boats for a new operation in Newport Beach. By then, however, the rules of the game had changed. With the passage of the Tax Reform Act, the tax shelter aspects of the first deal had pretty much disappeared, so MacRae and Watson looked for other ways to sweeten the offering. Whereas they had not committed themselves to any cash distributions in the first partnership, this time they promised investors a minimum payout of 8% after the second year. They also reduced the unit size from $50,000 to $10,000.

But the major difference the second time around was their decision to work through broker-dealers. In the spring of '87, they established relationships with two reputable regional firms -- Morgan Olmstead Kennedy & Gardner Inc. and Wedbush Securities Inc. -- to help them sell the offering within California. The arrangements were strictly "best efforts," meaning that the firms did not guarantee the offering's sale. Their incentive was their commission, a standard 8% for each unit they sold, plus 2% for due diligence. As for Hornblower, "The thing that sold us on the broker-dealers was their distribution capability," says MacRae. "Between them, the two firms had nearly 300 brokers."

Almost at once, however, a problem arose. In the course of preparing the prospectus, the two firms decided that they should clear the offering with the National Association of Securities Dealers (NASD) before sending brokers out to sell it. This was a judgment call. Since it was an intrastate offering for qualified investors only, NASD certification was not necessarily required. Nevertheless, the firms considered the move a prudent one, and besides -- they argued -- the process normally took only a few weeks.

But the weeks dragged into months, and MacRae and Watson got antsy. In July, they decided to start looking for investors on their own. They mailed notices to customers whom they considered good prospects, and they organized seminar cruises for potential investors. One by one, they began to line up a few limited partners.

Then, in August, NASD cleared the offering. MacRae and Watson were delighted. At last, all those brokers could get out and beat the bushes for investors.

Well, not all of them. It soon became apparent that a lot of the brokers didn't have clients who were real candidates for Hornblower's offering. Nor was the offering as important to any of the brokers as it was to MacRae and Watson. As a result, the brokers would get distracted when, say, municipal bond yields began to fall, threatening their very livelihood.

To complicate matters further, the brokers weren't used to selling limited partnerships in the new, post-tax reform evnironment. "They couldn't just tell people about tax losses anymore," notes Bill Hoop, then director of special products marketing for Wedbush Securities. "They had to educate clients about how the business worked." That wasn't easy. Clients were continually asking questions the brokers couldn't answer, and so they had to get on the phone to MacRae and Watson. The more labor-intensive the selling process became, the less the brokers were getting paid for their time, since they were operating on commission. Small wonder that some of them lost interest in the offering.

Others, however, began to get the hang of it, and sales of the units picked up in September and October. Then, just as MacRae and Watson were thinking that they might sell most of the offering after all, along came Black Monday. Although the stock-market crash had no direct effect on Hornblower, a private company, it had a major impact on the brokers and their clients. "A lot of brokers," says Hoop, "just didn't have the confidence to tell this kind of story" in the wake of the crash. Thereafter, broker sales of the partnership limped along, until the deal was closed at the end of December. When the final tally was taken, the offering had raised about $800,000, two-thirds of which came from investors brought in by Hornblower's co-owners.

Their disappointment notwithstanding, MacRae and Watson continue to have faith in limited partnerships as a capital-raising technique. They point out that it has allowed them to raise close to $2 million in the past four years without diluting their equity in Hornblower. At the same time, they have been able to minimize their dependence on banks. And they have also avoided the cash-flow problems that both bank loans and leasing would entail -- particularly during the winter months when charter activity slows.

Above all, the limited partnerships have allowed Hornblower to grow. "As a company, we're healthy enough that we could always go out and lease a few boats," says MacRae. "But it would really limit the rate at which we could grow. You can only lease so many boats at once. Limited partnerships let us stay on a pretty aggressive growth course without losing control of the business."

With that thought in mind, he and Watson are already gearing up for another limited partnership, this one to purchase boats for a Los Angeles operation. The partners do not plan to change much in the basic structure of the offering, which they still consider an attractive deal for investors. What is going to change is the way they sell it.

At the moment, they are examining a variety of options, including the possibility of targeting the offering to travel-and-entertainment companies (hotel chains, for example), which might have a corporate interest in such an affiliation. They are also thinking about setting up their own licensed brokerage firm to handle the deal. But they would think twice before getting into another arm's length relationship with an investment banking firm.

"My sense is that there aren't many people out there who really know how to sell this kind of deal," says MacRae. "That's why you can't leave the selling up to broker-dealers, even if you decide to work through them. It's not enough for a brokerage organization to represent you. You have to make sure that the individual brokers understand your product -- and that they like it."