Here’s the simple formula for balancing contributions and returns:
a. If money for capital is put in, this should be rewarded by dividends.
b. If time to manage the enterprise is put in, this must be rewarded by a salary. This salary can be put in as money for capital as well.
c. If an idea is put in as capital, this must be valuated and accepted by all partners first. After valuation, the idea can share in the dividends. Alternatively, the idea can be also paid on a royalty basis. This happens when there is a problem in valuation. It is easier to just pay royalty on a per unit basis. In this case, the idea is not part of the capitalization of the enterprise.
d. If money is lent or advanced to the enterprise by a partner, it will be rewarded in the form of interest. Again, the money is not part of the capitalization. It is a liability of the enterprise.
Recently, a regular reader asked a question that was bothering him. Because of an unexpected increase in the volume of business, new money was needed for infusion into the business. After a series of questions and answers, the following ensued:
a. The option of a capital call (partners putting fresh capital into the business) was considered.
b. Capital call was not attractive since some of the partners did not have the liquidity position to put in new money.
c. Some other partners had the extra liquidity that would suffice to meet the total money requirements resulting from the increased volume, and they were willing to put up the money.
d. The consensus among the partners was not to disturb the current structure of ownership (percentage sharing).
e. The additional money needed by the enterprise was for a one-time importation. The unexpected demand was for a project and might not happen again.
f. Given the situation, it was suggested that the funding for the importation be sourced from a personal placement of the partners who had the extra liquidity.
Clearly, this action is consistent with the formulation stated earlier: If money is lent or advanced to the enterprise by a partner, it will be rewarded in the form of interest.
The money is not part of the capitalization. It is a liability of the enterprise. The additional money is not required permanently and, therefore, a permanent money infusion is not needed. The personal placement of a business partner will also not change the capital/ownership structure (percentage sharing). There will be no dilution or crowding out of ownerships.
The funds can also be secured from an external source. This can be in the form of a loan although this may take longer since bank processing takes time, not to mention the preparation of documents in support of the loan application. Therefore, if a partner has the funds anyway, securing the loan from him/her will definitely be faster.
However, the next issue is the interest rate. This represents the opportunity cost of the partner placing the money. If his/her money is parked in a savings account, then the interest rate must be at least higher than the savings rate. However, no matter what the opportunity cost is, the lending rate to the enterprise will be lower than a bank’s lending rate. The partner will get a better rate than what is being earned by the placement. Clearly, what is good for the enterprise is also good for the lending partner.
The last issue is security. How secure is the loan to the enterprise? Inasmuch as the creditor is also a partner, the operations of the business will be known to him/her. Since the purpose of the loan is to finance an unusual importation for a customer, the loan can be paid off as soon as the products are delivered and paid for. This is a condition that must come with the deal. In addition, the lending partner can easily monitor the importation and the status of the sale.
The bottom line is to keeping the friendships and partnerships intact. When the rules of partnerships are not clear, the friendships will not endure. Friendships and partnerships are kept because of the shared vision and values. These will be the arbiters of arguments. Friendships and partnerships last when the formulation on contributions and returns are not only clear but are also judiciously observed.
Now we know why friends who end up as partners do not always remain friends.
(Alejandrino Ferreria is the dean of the Asian Center for Entrepreneurship of the Asian Institute of Management. For further comments and inquiries, you may contact him at: ace@aim.edu.ph. Published "Entrepreneur’s Helpline" columns can be viewed on the AIM website at http//: www.aim.edu.ph).