The problem of whether the lateral recruiting costs versus the net production of the laterals present a “winning” financial proposition are not addressed with a heavy capital contribution program versus a debt financed program. The redirecting of cash internally from equity capital as contrasted with debt — much of which has been pushed down to individual partners rather than sourced from revolving lines at the firm level — is not a solution. Dewey used debt to do what it did to its partners, but it wasn’t restricted to only using debt — it could have used heavy capital contributions instead, or in a blend. The classic challenge of overdistribution as contrasted with undercapitalization is not protected against just because a firm uses all equity for its capital needs. With a large performing receivables base, not much capital is actually needed to operate the business, assuming distributions are reasonably restricted to net cash on hand less operating reserves.
If the firm that pursues a heavy rolling capital contribution commitment is well managed, and compared to a firm with balanced use of debt and equity, and thus responsibly uses capital at a 35 percent of targeted compensation ratio, isn’t the average PPP partner in this firm investing $300k more of their after tax savings, with no interest or capital appreciation in its growth, to “buy” their $1.2 million compensation package as compared to other firms? Compensation that is the same as the firm across the street would also offer in a competitive market for the same performance?
And if the equity heavy firm is not well managed and goes bankrupt anyway, the unfunded portion of a partner's capital contribution is going to be an estate claim that the creditors and trustee will demand her to satisfy with the unrelenting focus of The Terminator. The bank loans she may have taken out to make capital contributions will remain as personal liabilities to satisfy as well!
It is up to you to ask the questions you need to know the answers to. How much capital does a firm really need to have, whether debt or equity, and what is that capital being used for exactly.
(Reprinted with permission of the Daily Journal Corp. Copyright 2012)
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