BI > DECEMBER 1998

Admitting a new partner into the club isn't really that difficult, math wise anyway. One of the main advantages of the Unit Valuation System recommended by NAIC is the ease in which it accounts for changes in partner's percentages of ownership. As mentioned in last month's article, every month the club Treasurer prepares a Valuation Statement. The resulting figure, the Value of Each Unit This Date, is calculated by dividing the club's net assets at fair market value by the total number of units issued and outstanding. This figure sets the price for the incoming contributions at the next club meeting. A new partner joining a club would simply make a contribution at the meeting like any other partner. The Treasurer would set up an Individual Valuation Units Ledger for the new partner, and contributions and units would be entered accordingly.

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If we continue with last month's illustration, at the March 15, 1998 club meeting the partners of the Anytime Investment Club voted unanimously to admit a new partner into the club, Mattie Hat. The Valuation Statement prepared by the Treasurer just prior to the third meeting set the current unit value at $10.7533. Since there are now four partners, each contributing $100, the Treasurer will issue to each partner, including the new partner, 9.2995 units ($100 / $10.7533). The original three partners, Nick, Jane and George, now own in total 68.6862 units while the newly admitted partner owns 9.2995 units. The Value of Each Unit This Date is always based on the fair market prices of the club's assets. Thus the new partner will always be purchasing units at the most current price which takes appreciation, or depreciation, of the club's holdings into account.

Mathematically, admitting a new partner into the club isn't a difficult process. In reality, however, there is much more to consider when admittting a new partner. For one, will the new partner be a good fit? Not to be facetious, but an investment club should be viewed as long-term endeavor. It should represent a group of like-minded individuals who meet monthly to share ideas, enhance their investment knowledge, pool their funds and hopefully make a profit. It is important that any prospective partner is made fully aware of the club's investment objectives and goals. And, in turn, the existing partners should feel comfortable that the new partner will enhance the success of the investment club. many clubs will have a prospective partner attend at least two if not more club meetings. This time period gives everyone a chance to get to know each other before making any final decisions.

This waiting period will also allow the prospective partner time to review the partnership agreement. Remember, all partners have a fiduciary responsibility to act in good faith for the benefit of the partnership. As a co-owner in the business, the new partner's name must appear on the agreement. They should be made fully aware of all of the provisions of the agreement and understand them completely. Once signed, the new partner should receive a copy of the signed partnership agreement. As mentioned in a previous article, conflicts and hard feelings that may occur in an investment club can easily be avoided if all the partners are fully aware of the provisions of your partnership agreement and they are applied uniformly and consistently.

Another concept brought up by many club members, especially newer ones, deals with equality. It is not uncommon for new clubs to form and provide in their agreement that all partners share everything equally. If the club starts with three partners, they will each own one third of the club and receive one third of the club's annual profits or losses. On the surface, this seems reasonable. It would certainly reduce the amount of bookkeeping involved in accounting for the club. However, for many clubs, it eventually becomes apparent that equality can very well threaten the long-term success of the club. With each passing year, the size of the partners' capital accounts will grow larger and larger. Say, five years down the road, one of the original partners wishes to retire from the club. They hold a 33 1/3 percent interest in the partnership which represents $10,000. To maintain equality, the club must now find a new partner willing to invest $10,000 into the club. With the passage of time, it will become more and more difficult to find new partners willing to invest larger and larger amounts of cash. In time, the club may well have to dissolve.

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For those clubs using the Unit Valuation System, the equality concept becomes even more complicated. Every partner in an investment club has a cost basis and a fair market value in the club. The question then becomes how do we admit the new partner with the exact same dollar amounts and units as the retiring partner? The new partner can not be exactly equal with the original partners. Again refer to the Individual Valuation Units Ledgers for the partners of the Anytime Investment Club. Since the Unit Value This Date was $10.7533 and each partner owned 68.6862 units, they has a fair market value of $738.60 in the club. We can also see that each partner had a cost basis in the club of $700. How do we admit Mattie Hat into the club as a equal partner? If she were to purchase 68.6862 units, she would have to contribute $738.60, the current fair market value of a unit. If she contributes $700, the amount of the original partners' cost basis, she would only be able to purchase 65.0963 units based on the current unit value of $10.7533. As you can see, the new partner may come close to either the units owned or the cost basis of the original partners' capital accounts, but she will never be exactly the same as the original partners. Some clubs require a larger, good faith, dollar amount contribution while others may try to come close to the original partners. And, some just require the new partner to simply make a normal monthly contribution as we did in our beginning example. This is, of course, a consensus decision of the partners. The fact still remains, at some point in the future, equality can not be maintained.

The above example is not the only situation that could throw a wrench into the equality concept. Also consider partners who pay their monthly contributions late. Should they receive the same number of units as those partners who make their contributions on time? How about partners wishing to vary the dollar amount of their monthly contributions. If a partner wishes to make larger contributions and purchase more units, there would be additional funds to invest each month. What happens in the case of a financial emergency or you just wish to take some of your capital out of the club? You could force a good partner to fully withdraw from the club. Do you also close the door on the possibility of admitting additional partners to the club? Again, possibly losing out on a very viable method of growing and strengthening the club. The point is that even as desirous as equality may sound in the beginning, there are definite drawbacks that eventually come to light.

Next month we will take accounting concepts one step further and begin our discussion on partner withdrawals. If any of you have additional ideas or suggestions for future articles, please let us know.

Martha A. Moore is a guest columnist for BetterInvesting Magazine.