Allocation of Ownership Interest
Equal partners.
Example 1. Assume that a sole proprietor agreed to admit a single equal partner for a certain amount of money. The sole proprietor, Partner A, will give the new partner, Partner B, an equal share in the partnership. 100% interest of the sole proprietor will be divided in half, so that each of the two partners will have 50% interest in the partnership. In effect, Partner A sold 50% of his equity to Partner B.
Example 2. Assume that Partner A and Partner B have 50% interest each, and they agreed to admit Partner C and give him an equal share of ownership. Each of the three partners will have 33.3% interest in the partnership. Interests of Partner A and Partner B will be reduced from 50% each to 33.3% each. In effect, each of the two partners sold 16.7% of his equity to Partner C.
Example 3. Assume there are three equal partners, who have 33.3% interest each, and they agreed to admit a fourth equal partner. Each of the four partners will have 25% interest in the partnership. Interests of the three partners will be reduced from 33.3% each to 25% each. In effect, each of the three partners sold 8.3% of his equity to the new partner.
In either case, all partners must agree to the specific way to realign their partnership interests as a result of admitting a new partner.
Unequal partners.
Example 1. Assume there are two unequal partners in the partnership. Partner A owns 60% equity, Partner B owns 40% equity, and they agreed to admit a third partner. Partner C has several options to join the partnership.
- He can buy equity from Partner A.
- He can buy equity from Partner B.
- He can buy equity from Partner A and Partner B.
Partner A and Partner B may both agree to sell 50% of their equity to Partner C. In that case, Partner A will have 30% interest, Partner B will have 20%, and Partner C will own (30% + 20%) 50% interest in the partnership.
Partner A and Partner B may both agree to sell 25% of their equity to Partner C. In that case, Partner 3 will own (15% + 10%) 25% interest in the partnership.
Partner A may decide to sell 25% of his equity to partner C. Partner B may decide to sell 50% of his equity to partner C. Partner C will own (15% + 20%) 35% of the partnership equity.
Example 2. Assume now that there are three partners. Partner A owns 50% interest, Partner B owns 30% interest, and Partner C owns 20% interest. Collectively, they own 100% interest in the partnership.
They agreed to admit a fourth partner, Partner D. As in the previous case, Partner D has a number of options. He can buy shares of interest from one of the partners, or from more than one partner.
Assume that the three partners agreed to sell 20% of interest in the partnership to the new partner. There are more than one way to realign partnership interests.
Equal percentage reduction. The three partners may agree to reduce their equity by equal percentage. In order to sell 20% equity to new partner, each of the partners has to sell (20% : 3) 6.7% of his equity to the new partner.
Equal proportion reduction. The three partners may chose equal proportion reduction instead of equal percentage reduction.
Had there been only one partner, who owned 100% interest, selling 20% interest would reduce ownership interest of the original owner by 20%. The same approach can be used to buy equity from each of the partners.
Each of the existing partners may agree to sell 20% of his equity to the new partner. The result for the new partner will be the same as if a single owner sold him 20% interest.
This table illustrates realignment of ownership interests before and after admitting the new partner.
| Before | After | |
|---|---|---|
| Partner A | 50% | (50% * 80%) 40% |
| Partner B | 30% | (30% * 80%) 24% |
| Partner C | 20% | (20% * 80%) 16% |
| Partner D | 0% | 20% |
To summarize, there does not exist any standard way to admit a new partner. A new partner can be admitted only by agreement among the existing partners. When this happens, the old partnership is dissolved and a new partnership is created, with a new partnership agreement.
Read more about this topic: Partnership Accounting
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