Why does 1% of the ownership need to consolidate 99% ownership in its book.

[Ballscientist]

A General Partnership who owns 1% of the ownership and Limited Partnership who owns 99% of the ownership.

Why GP needs to consolidate LP all of the asset, liability, revenue and expense to its book. That means it needs to report a lot of income taxes?

What is the rationale?

[Ballscientist]

One more question:

How can GP borrow the money from bank if it only owns 1% of the ownership? Without a doubt the bank will NOT process the loan.

GP is liable for the business liability? LP is liable for the debt liability?

[Snaggletooth]

Capital Structure

Earthquake, not sure I understand these questions, but if I can get through to your mindset, I might try to answer both of them with one fell swoop.

In order for the general partner to operate and make a profit, he has to have a source of money (Capital, if you will). The result of arranging these sources of capital is called the "Capital Structure." These can become quite complex, but to simplify things let's just try to classify all such sources into two broad categories: Lending investors and shares investors. These two types of investors comprise the entire "Liabilities/Capital" side of the balance sheet, for all practical purposes, at least until operations begin.

To raise money, the general partner has to thus either 1)Borrow money from a lending institution who will require the money to be paid back plus interest, or 2) SELL shares of his company by committing to shares of future profits and/or increased share value.

An illustration helps. A real estate developer plans to buy $10MM in land and another $100MM in construction costs, and ultimate sell $200MM in real estate over a 7 year period. There will be another $15MM in operating expenses over the course of the 7 years. Over this period of time, there will thus be $75MM in profits. But between $10MM and $110MM will immediately be needed to acquire the necessary elements for this profit. For purposes of discussion, let's assume $80MM is needed.

If the general partner already has the money himself, or chooses to borrow from a bank to fulfill his capital structure, then he would never form a limited partnership. He doesn't need limited partners.

However, let's say that a bank is willing to loan $10MM and take the land as collateral. The bank's investment is solid, as the land will stand for itself. However, the general partner needs another $70MM. He has various contacts and reputation for making tremendous profits on his developments, so he sells 99% of his company to investors, and raises the remaining $70MM. After 7 years, his development/sales are complete, and these "limited" partners receive checks totalling $75MM X 99% ($74,250,000) PLUS redeems their original $70MM investment. And pays off the bank. During this time, he avoids having to pay interest payments or debt service on the $70MM in limited partner shares.

He chooses this capital structure because 1) having to pay interest on the entire $80MM may significantly hurt profits of the partnership, or 2) the bank may not wish to finance the entire $80MM for one reason or another. Typical reasons are lack of collateral, bank policies, or too much concentration of risk in a single loan.

You have to look at this from these angles, and not think of why a 1% general partner would be beholden to the other 99% limited partners, or why a bank would be stretched to loan money when 99% of the partners are not obligated. In fact, from the bank's perspective, the more limited partners the better, as the limited partners ARE at risk for the value of their investments. In the above example, the limited partners could conceivably lose ALL of the $70MM of their collective shares and would have hardly any recourse.

Also typically the 1% "general" partner owns the construction company that the $100MM is paid too. Don't lose sleep over him.

If it helps any, I don't know much about seismology either, but I find it incredibly fascinating on the Discovery Channel.

Regards, Ron Jordan, Manchester, TN

[Ballscientist]

Thanks a lot, Ron.

Assume that there are 3 GPs and 1 LP, all GPs have control over LP, therefore all 3 GPs need to consolidate that LP. Then all of them need to report the income tax. As a result, IRS makes a lot of money.

This is not rationale, right?

[Snaggletooth]

Your example

is not realistic because there are nearly always more "limited" partners than general partners. But I will take your example and follow the money.

IRS is not "multiplying" the taxable profits by virtue of having limited partners. If there is $400,000 in profit, and four equal partners (limited or not) they will each pay tax on $100,000. And they will also RECEIVE (either during the taxable year or at some other point in time) $100,000 apiece.

I will not defend the IRS as being a bastion of fairness. But if we are to find something unfair, we're going to have find something other than this.