A new business client comes to your office. There arethree owners of the business. The three individuals, Alan, Bob, andCarol, are thinking about forming a partnership. Alan is onlyinvesting $1 million in cash. He will not have anything to do withthe daily activities of the business. Bob has had some experiencein the business and will be responsible for the day-to-dayoperations of the business. Carol has a great deal of experienceand many contacts within the business. She will be responsible forattracting new clients. Neither Bob nor Carol are investing cashinto the partnership. During the first year of operation, thepartnership generated a profit of $150,000. None of the partnersreceived distributions during the year.
Specifically, the following critical elements must beaddressed:
I. Allocation of Profits
A. Explain how allocating theprofits evenly between the partners would work. Consider thefairness to each of the partners in your response.
B. What would be the value of eachpartner's capital account at the end of the year, given that theprofits were allocated evenly among the three? Support your answerwith quantitative data and an explanation of how you came to thisconclusion.
C. Explain an alternative method ofallocating the profits if 80% of the profits was given to the cashinvestor and the remaining amount was split evenly between theother two partners.
D. What would be the value of eachpartner's capital account at the end of the year, given thisalternative allocation method? Support your answer withquantitative data and an explanation of how you came to thisconclusion.
II. Payment of Salary
A. Should the two partnerswho are working in the business receive a salary? Why or why not?Be sure to support your decision with research and quantitativedata.
B. If the two non-investors did receive asalary, how would their capital account be affected? How would thisimpact a potential future liquidation or buyout? Be sure tothoroughly explain and support your answer.
C. Should the cash investor receive ahigher share of the profits or other sharing options? Why or whynot? Support your opinions with research and quantitativedata.
D. If the cash investor did receive asalary, how would his capital account be affected? How would thisimpact a potential future liquidation or buyout? Be sure tothoroughly explain and support your answer.
E. How do the payment of salary and theallocation of profit affect entries and the financial bottom line?Be sure to support your explanation with concrete examples.
F. How could the payment of salary andallocation of profit be a more effective method of splitting thecompany's profits for the three partners? Explain a scenario inwhich the three partners would all be compensated fairly, andsupport your answer with logical reasoning.
G. What would be the value of eachpartner's capital account at the end of the year, given yourproposed fair allocation method? Support your answer withquantitative data and an explanation of how you came to thisconclusion.
