The Arizona Beverage company makes Arizona Iced
Tea. It’s a big operation: Arizona had a 40% share of the ready-to-drink iced
tea market in 2013. The two founders of the company formed a partnership and
wrote a partnership agreement. The partners are now in a dispute over the value
of the company and the price one partner will pay the other for his interest.
The dispute is explained in the Wall Street Journal article: “Judge
Pores Over a Case of Tea” (9/4/2014). Here’s a link:
Like many partnership agreements, a
partner who wants to sell must get approval from the other partner. Now, that
seems reasonable. Say, for example, that Bob and I have a partnership. Bob
wants to sell his interest to Pete. I don’t want to be forced into business
with Pete. I set up the partnership with Bob. So, most partnership agreements
have this condition.
However, there is another important
condition that may be missing from the agreement. The Arizona Beverage’s
partners (apparently) did not decide on a formula for valuing the business for
a potential sale. A valuation is typically based on a multiple of sales or
earnings. The partnership agreement may dictate that the company should be
valued at three times sales, for example. If the company does $1,000,000 in
sales, the firm’s value is $3,000,000. If a partner wants to sell his 50%
interest, that interest is worth $1,500,000.
In Arizona’s case, the selling partner
believes the partnership is worth between $3 and $4 billion. The buyer argues
that the company is only worth $500 million. The decision is in the hands of a
judge. If the court values the company at the higher level, the buyer may have
to find other investors to obtain enough capital to buy the business. It seems
that a valuation formula in the agreement would have prevented this situation
from happening.
Changes
to a Capital Account
Capital represents the worth of a
partnership. It’s similar to the equity of a corporation. The basic balance
sheet formula for a partnership is (Assets – Liabilities = Capital).
·
Increases to a Capital Account: A partner’s
capital account is increased (credited) by capital contributions. Those
contributions can be cash of other assets. The account is also increased by the
partner’s share of profits.
·
Decreases to a Capital Account: A partner’s
capital account is decreased (debited) by capital withdrawals. Those
withdrawals can be cash of other assets. The account is also decreased by the
partner’s share of losses.
·
Income to the Partner: If a partner
withdraws more assets than his capital balance, the amount withdrawn may be
considered income to that partner. The partner will be taxed on the income.
Check out my podcast on this subject:
For blog and article writing, tutoring and
speaking on investments and finance, contact me here:
Ken Boyd
St. Louis Test Preparation
Author: Cost Accounting for Dummies, Accounting
All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies (2015)
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