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partner until she’s ready to leave.If Mary views this as a short-term investment, she could lend to the business and earn interest instead. If she extends a loan, she’ll receive interest payments, not income distributions. The agreement will ensure that her capital
is returned after five years and that she’s earning a rate of return that she thinks is appropriate, based on the level of risk associ- ated with the business. If that’s the case, she may no longer be a limited partner and would need to create a proper loan agreement to ensure that her capital is returned after five years. She may get a lower return as a lender, but her risk is lower and she may get a higher return than she would by buying
a GIC.
As for taxes, the partnership itself is not
a taxable entity. It operates as a flow-through vehicle: the taxable income is computed at the partnership level and allocated to the partners. The agreement will spell out in what proportion that income would be allocated; then, Mary would report her share of the partnership income on her tax return. Since the candy shop is a start-up, it will likely incur losses in the first few years. Those losses will also be allocated to the partners, and Mary’s share could be reported on her tax return. She could deduct those losses against her other
WHAT YOU LEARN
Investing in a friend’s business involves business and relational risks. That’s why it’s important to have a partnership agreement to ensure both parties understand what’s expected of them. The agreement should spell out the terms, including mechanisms to review the company’s financial status, and include an exit clause, such as a shotgun clause outlining how a partner may exit the busi- ness prior to five years.
sources of income, which would result in tax sav- ings. Mary’s main risk is loss of capital (the upside is she could generate a positive rate of return). She may not get the same rate of return as a stable investment. If the business has to wind up, she would lose her capital and the general partner will be liable for any additional obligations.
JONATHAN KLEIMAN
As a silent partner, Mary wouldn’t have any input on how the company’s run, but she should have a mechanism to hold the company accountable for its expenses, revenues and business strategy. At least, the partners should come together periodic- ally to go over what’s happening in the business. It may not be reasonable to do that every month, so a quarterly review should be fine.
Also, Winston might want to raise more money in the future and issue shares to a third party. This could dilute Mary’s shareholder ownership. So she should encourage Winston to incorpor-
ate and offer shares to the investors, instead of maintaining this current partnership. This would give Mary more protection under a shareholders agreement, and generally more protection under the law. Mary should request that the partnership agreement include exit terms, including a shotgun clause. In such a clause, either party can force the other to accept a certain offer to buy their shares, or sell their shares at that same price.
If Mary wants to be a private lender instead of a silent partner to ensure the return of her capital, the amount of interest to charge can be negoti- ated. It depends on how badly the business needs the money, how many other options it has to raise funds, and the interest rates associated with the other options. Mary doesn’t need this investment, so she can push for the terms she wants. AE
26 AE 05 2015
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IRINA DRAZOWA-FISCHER /THINKSTOCK
NATASHA PHOTO/THINKSTOCK