3.10.4. Economic and Financial Soundness
The risks discussed above address many of the outside forces that can affect the profitability of a DPP. Here we discuss some of the factors more particular to the inner workings of the business.
Quality of Assets. If the assets are already in the DPP’s possession, it should be possible to evaluate their potential to earn a profit. An income-producing oil and gas program will have a track record for its oil-producing wells. With a developmental program, the success of the neighboring wells can be analyzed. For a real estate DPP, the economics and demographics of the area where the properties are located are important to know. An investor in an orchard DPP may want to know the condition of its trees and the appropriateness of the climate for growing fruit.
Value of Assets. If it is possible to get an independent appraisal of an asset or property, this should be measured against its purchase costs.
Source of Proceeds. Capital contributions may be made in cash or property. They may be made by letter of credit, which is an irrevocable commitment made by a commercial bank to honor the payment obligations of the investor.
Contributions may be made in one lump sum or periodic payments. Investors may make a single commitment of capital, or they may be obligated to make additional assessments. An assessment is a payment mandated by the manager to pay for unexpected costs when they crop up for which funds are not otherwise available.
Investor contributions may also be leveraged with recourse or non-recourse loans. It is important to know how much borrowing the DPP management expects to do. Management may have a certain leverage ratio in mind, or it may wish to maximize its borrowing, depending on what the credit facilities will allow. Interest rates will be important to know, and how much interest payments may be expected to cut into distributions.
Use of Proceeds. Most of the proceeds acquired from a progr