Capital, Profit, and Voting Interests

Unless otherwise noted in a business’s operating agreement, the default rule is that all partners in a business has an equal ownership interest in the company’s capital, profit, and voting interests.

 

Why is this important?  Imagine if a group of three partners come together to start a small donut business, each may have been included in the business for a different reason.  Jim may own the perfect building with a great location, John may have the connections to get the right donut making equipment and the knowledge to use it, and Jane may have the marketing and sales expertise to get business in the door.

Scenario #1: With no specific agreement otherwise, the three start the business, and its starts to get off the ground, but the market isn’t right, and they have to close down their doughnut shop.  If they were able pay their creditors and employees with the cash they had on hand, each partner would still have a one third ownership interest in the building and equipment.  This type of situation would turn out well for Jane and perhaps John, but most likely not well for Jim.  Jim would be getting a sour deal, if he put in the whole building in the beginning, but is left with only a third of it when the business has been fully wound down. Had there been any profit, they would have shared it equally, and the same goes for any losses they incur.

 

Scenario #2: Each of the three could agree at the outset that each will receive compensation for the capital, cash, equipment, or land that they put into the business, and will be noted in their own capital accounts.  These accounts would have to then be paid back when the business is wound up.  The partners could agree on the base salaries of each partner, based on their position, workload, and responsibilities.  For Jane, her salary could be offset by a commission based on the monthly sales.  John could also have the choice to receive the cash value of the original equipment he brought to the business, or could have the right to keep it, if ever the business wound up.  Any combination of the two would also be possible for John.  Jim could also lease the building to the partnership, or contribute it outright.  Another possible option would be to give Jim a larger percentage of voting rights if his building contribution warranted it. This could be done by assigning percentages of stock to each partner, or just giving each a certain number of votes. In any case, having capital accounts, which track the capital contributions of each partner, is the way to assure that each partner is justly compensated according to their original contribution and efforts along the way.

 

Photo By: Rob Brewer