The Optimal Size, Financing and Personal Liability of Professional Partnerships

Abstract

Capital constrained partners determine the partnership's optimal size and financing by trading off the cost of dilution from recruiting equity partners that reduce average productivity against the expected liquidation and bankruptcy costs from issuing debt that is secured by the partnership's assets or partners' personal assets. The optimal partner mix equalizes marginal productivity per share between senior and junior partners. A two-tier partnership structure mitigates equity dilution and increases the value per share. Partnerships at risk of future insolvency register as a Limited Liability Partnership. Partnerships are not a suitable business structure for organizations that are both knowledge-intensive and capital-intensive.

Keywords: investment, debt, partnership, liability, personal guarantee, financing constraint