As you set up your partnership, you and your new partners will all have to decide how to contribute capital for the business. For some partnerships, this might be an easy decision while it gets more complex for others. What are your options to make a contribution of value and to establish your working interest in the new business venture? Here is a short guide to partnership contributions and their effects.
1. Cash Contributions
Cash is by far the most simple way to contribute to a partnership and identify your stake in the business. It also gives the partnership the most flexibility in deciding how to use the contribution to begin operations. The downside of contributing straight funds is that your investment is tied up in the business and your return on that investment may be limited for a number of years.
Cash contributions are simply recorded on the company books at face value. This becomes your partners' capital account and is used to determine tax treatments of future payouts.
2. Property Contributions
Contributing property can be a more economical way to buy a stake in the business. If you are already in the industry or have personal assets that could be useful, you can avoid a large outpouring of money. Contributed property could come in the form of a vehicle for business use, heavy equipment or specialized tools, a building or land on which to conduct the business, or assets that the company can sell.
Contributions of property are not as clear-cut on the books. You'll need the help of an accountant to determine if you must recognize a gain — such as if you are relieved of a loan against the property or get cash in the exchange — and how to find out the fair market value as well as the asset basis for the company's records.
3. Services Contributions
The least expensive way to earn a capital interest in any partnership is to contribute your own services. If you have a specific skill needed for the business, such as accounting, or you are able to work on a day-to-day basis, you could receive a stake in the company in return for these services.
The challenge for those who contribute services is to appropriately value the services. You may use salary comparisons to find the right dollar amount or partners might simply agree on a reasonable payment. However, keep in mind that you will need to declare as income the dollar amount placed into your capital account as a result of your efforts.
There is no right or wrong answer as to how to create your capital account as a partner/owner. Whether you use a simple method like cash contributions or earn your stake through hard work, the result will be the same: a business that allows you to truly be your own boss and the profit that it brings.