Partnership Structure continued...

For those of you that read or responded to my previous post “How to structure the partnership”, I have come-up with a structure and would love your feedback.

Remember, Partner A has all the money into the deal and Partner B has all the time into the deal. In the original plan A would be reimbursed their out of pocket and then A and B would simply split profits 50/50.

B pointed out that if at the end of the deal the house only sold for cost + expense then A would be sitting at break even and B would be out all the hours they had put into the project.

So they are trying to restructure the deal so both share profit and loss more fairly.

Proposed new structure:

A contributes money and is “credited” for that $ as a portion of the total investment.

B contributes effort and is “credited” for that effort as a portion of the total investment.

A and B split profit (or loss) proportional to their contribution of investment.

Does this make sense? Any thoughts?

The hard part is putting a $ amount to B’s effort contribution. Should it simply be fair market value for the type of work they did? I’m having trouble with this piece of it.

Sorry this is so long…any feedback or previous experience of your own that you care to share would be very much appreciated.

Based on your initial posts I assume that the $60,000 Partner A has in the deal are closing costs and materials only? By that I mean that partnter B is the only ‘paid’ labor. If that is the case then Partner A should get all $60,000 back before B is paid at all because B has risked nothing more than time. While his time if valuable and he should be compensated, he’s taking on that risk of compensation by assuming the eventual payout on the sale of the property will be greater than had he spent that same amount of time working as a paid hourly employee. What you are proposing is that Partner B now enter into an agreement similar to an investor and a contractor. Where the investor is taking all the risks and the contractor is getting paid regardless. It’s no longer a partnership.

Look at these scenarios-

  1. House sells for Cost of aquisition, plus $60,000 plus $60,000k capital gain in value of house. Partner A gets his $60,000 back and is at break even. Partner B has no intial capital expendature and gets $30,000 along with partner B. Both sides profit equally.

  2. House sells for Cost of aquisition plus $60,000k and ZERO captial gain. Partner A gets his initial $60,000 back and partner B gets nothing. Net gain for both partners is zero but partner B risked no assets and Partner A risked $60,000.

  3. House sells for Cost of aquisition plus Zero money. Partner A is out $60,000 and Partner B again has zero gain. Does this appear equitable? Would Partner B then pay Partner A money in consideration of the loss he took on the venture? Not likely.

The most equitable arrangement is example 1 and that’s why almost all agreements that are with Worker and Investor require the intitial investment to be paid before the profits are considered.

If A prefers for this to be a partnership, it will be most advisable to have B bring some cash to the table. A, can simply transfer 10k to B as B’s contribution before structuring the business.
One great benefit that will accrue to A if B brings no cash and is made a partner will manifest if ever the business goes belly up. A and B will both be liable to repay debt with personal belongings where applicable.
Your new proposal will best work as an Investor/Contractor relationship.

  1. On the other hand, A can have B bring only labor to the table and split 50/50 profit with B if an LLC is formed. B will be listed as a shareholder with equal nominal value as A. A, will end up losing since A will solely bear the tax burden of 15.3% and split 84.7% 50/50 with B.

If they formed an LLC both would bear the tax burden of the self-employment tax as all income derived through the LLC is subject to the 15.3% tax.

As an S-Corp partner A could pay B a salary and then take all the profits after that as passive income and wouldn’t have to pay 15.3% on the passive income while B would have to.