Saturday, November 6, 2010

communal equity accounting - large open partnerships

Egalitarian enterprise ownership provides a function similar to Natural Finance Comptrollership in that it controls hierarchical management power concentration.  A circle of equal partners has to be managed for the equal benefit of all the partners, and equality membership is the only effective way to enforce it.

In my last post, I discussed various ways to structure an equal partnership.    The most interesting of these options was one (3rd option) offering an equal partnership with equal low financial commitments amongst partners. This is a more formal analysis of that option where I will try to keep the more complex parts near the end.

The exciting aspect of allowing low buy-in egalitarian open membership/equity in a project is making projects accessible to both rich and poor members.  It can replace financing and ownership structure for most projects, but is specifically tailored for real estate projects/municipalities, multi-level marketing organizations, and volunteer charities or semi-volunteer organizations. 

Natural Finance provides a more flexible and cheaper financing alternative than the loan syndicate described in the original scenario.  Natural Finance uses queued priority open soft loans for financing where each investor is guaranteed to never be diluted by future obligations.  Queues exist (in order of payment priority) for unsecured loans, secured loans, deferred compensation, and purposeholder/"shareholder" dividend-equivalents.  An impartial comptroller is assigned to the organization to ensure funds flow through accounts as agreed, and to enforce all other agreements entered by the organization, and so facilitates partnerships in the organization by ensuring trust in it by its partners.

Another function Natural Finance Comptrollership provides is more flexible accounting options than standard GAAP.  GAAP procedures aim to portray an organization to outsiders as an estimate of its liquidation value.  While useful, a partnership with an open buy in price must use the principle of setting a buy in price which doesn't disadvantage anyone based on time of buy in.  So internal information must also be accounted.

Minimal investment partnerships within a natural financed organization may as well be labeled Natural Partnerships.  A natural partnership share has many similarities to standard corporate shares.  It is a share of paid up equity, a right to vote. a right to share in future profits, and is freely transferable.  Unlike a standard corporate share, it also has an obligation to pay its share of unfinanced obligations.  Because of this last feature, the shareholder has the right to abandon his share most likely to avoid paying such obligations.  There are thus 2 financial components to a natural partnership share.  A membership fee and a paid up capital amount.  The membership fee is the small buy in fee that can start an egalitarian organization.  The membership fee is forfeited if the share is abandoned.  Paid up capital is not forfeited however when abandoned, though share of future gains is forfeited.  Natural finance queues enable a distinction between returning past dues, and shares of future streams.

For almost all natural financed organizations, paid up capital of natural partners would be accumulated exclusively through paying back of lender principal.  Basically through accumulated profits.  In natural financed organizations any capital contributions made by partners are lent under the same terms available to general investors.  If, in the future of an organization, contributions from its partners must be raised as a last resort, then its likely the partners agree to make those contributions in the form of interest bearing loans rather than as capital contributions.

Deferring discussion on calculation of open partnership share value (called communal equity) for a moment, a new partner joining the organization, if he is the n-th partner,  owes 1/n-th of the partnership value to the other partners on top of the membership fee.  If the prospective partner is interested in joining mostly for employment income opportunities he can derive from the organization, then it is likely the organization is willing to negotiate with him to pay that amount with no interest, at a speed commensurate with his responsibilities.  If the prospective partner only has a financial interest in the partnership, then he is likely expected to pay the partnership's full entry price without any organizational concessions.  The motivation for a financial partner to invest in the partnership rather than through natural finance loans to the organization is usually in addition to natural finance loans.  Individuals may only purchase a single partnership share.  It grants them a vote and access to collaboration opportunities, and so can be supplementary to other financial stakeholdership in the organization.

Communal Accounting is a supplementary measure to GAAP accounting.  It does not prevent standard GAAP income statements and balance sheets.  An additional accumulated communal equity account is tracked which "capitalizes" most expenses of the organization that are permanent reflections of past member contributions to the firm.  The principle of communal equity is to record those expenses incurred by the first members in the buildup of the organization, so as to equalize contributions made by the first and last members.  Members joining now or 10 years from now should be indifferent to the joining dues.  Expenses that are not a personal benefit to communal members nor are part of the costs of goods produced for sale are presumed to build up communal equity (value).  For organizations that don't provide direct benefits to their members (such as housing, food etc...) then supplementary communal equity will be accumulated losses (with minor timing adjustments).

As analysis, consider an open communal owership of an art piece (soup can drawing) that is bought with a 100% vendor loan.  The only costs in maintaining it are insurance and interest on the loan.  Initial communal membership of one.    The vendor gets no cash, but will collect rent equivalent interest and avoided insurance costs, and holds the art as collateral.  The buyer hopes that the art will appreciate in value more than the interest and insurance costs.  The commune sets its risk to (almost) zero in allowing new members to join at the value of accumulated interest and insurance costs.  A partnership set at the time of purchase would always be set at this value.  Partners joining in the future, however, have the advantage of waiting to see if the art appreciates in value more than the buy-in costs.  Therefore, a markup percentage is appropriate on the buy in set price.  It can be set monthly or quarterly, and can be negative if market conditions demand so.  5% or 10% markup is considered naturally acceptable capital returns, and 5% will attract more partners than 10%.  Expressing it as a percentage markup is important for disclosure purposes, communal voting on setting the markup, and mathematical simplicity in rewarding each existing communal partner.  The value of soup can drawings, as any project venture, is highly subjective, and categorically impossible to predict.  A 5% markup will attract more members than a 10% markup.  At 5% annual interest and insurance costs, the open communal buy in price would increase by 1/n-th of 5.5% (with 10% markup) of the original asset value.

The above venture excludes valuing either the advantage of having possession and enjoyment of soup can drawings, and the revenue potential of charging a few cents to soup can drawing aficionado visitors.  Any revenues earned by visitation fees reduce the cost of partnership buy in provided they don't exceed the expenses.  Retained profit also increases buy-in price by increasing equity.  Ironically, both losses and undistributed profits increase share value by the same amount, while breaking even does not (to be contradicted later). An aside, but interesting alternative to the vendor selling to the buyer, is the for the vendor to form a communal partnership with the buyer.  The vendor gets to insure that insurance is up to date on the asset, and may continue to enjoy the possession privilege, and the buyer gets half the speculative ownership but half the risk (obligations to pay interest and insurance).  The buyer's ability to abandon the project returning the collateral is unaffected.  If the communal partnership grows to 1000 members, then the vendor will have succeeded in divesting 999/1000 of his interests while continuing to participate in the potential increase in market value, its insurance security, and potentially its viewing pleasure.

The paradox of an organization losing 100k per year being valued the same as one earning 100k is indeed nonsensical.  Net Present Value principles apply.  For presumably perpetual projects with aggressive market value based depreciation schedules for assets (as natural finance secured QCSLs demand), then an earnings multiple of 5-10 times over and above tangible equity is a fairer open buy-in price than accumulated communal equity.  Open buy-in price is the greater of the 2 values.  Tangible equity is essentially the liquidation value of an organization, and excludes intangible assets such as goodwill and brand image.  If intangible assets are a substantial value of the organization, then the multiple of earnings can be justified higher.  The importance is a formulaic buy-in price based on earnings and tangible equity.  Terminal value projects such as an oil well, gold mine, or drug patents have different valuation formulas.  They are also NPV based, but not discussed further at this time.

When the right to abandonment is invoked by a partner, the membership fee portion of his partnership share is forfeited to the organization.  Their share of communal equity is segregated into passive communal equity.  Passive communal equity is only returned to investors as distributions are made.  No profit is available on their shares.  If the organization requires future partner contributions, they are drawn proportionally from passive communal equity and active partners/communal equity.  Any distributions made to partners whether profit shares or results of the sale of the organization, are made to passive communal equity holders as well, but reduce the passive shareholder balance.  New partners buying into the communal partnership have their contributions distributed with passive communal equity counting as half of its proportion.  The rationale for reduced participation of passive equity members is that recruiting new members is an active action by the existing active partnership.

One major advantage of a communal partnership over standard corporate shareholding is that management abuse of shareholders by diluting equity is prevented.  The price of admission to the partnership through either markup of communal equity or earnings multiple above tangible equity can be set through a democratic average of partner desired amounts.  The structure makes it impossible to bribe one manager for preferential stock distribution, because each person is limited to one share, and a price is set for all buyers.  yes/no decisions by potential buyers of a fixed or formulaic price are still market based pricing of stock issues.

For most projects, the membership fee is expected to be $1000.  Membership fees become organization equity.  Each share would have a book value of at least $1000 because of this.  Consider an organization like General Motors with 1-10 million people affected by its operations including customers.  If such an organization formed as a communal partnership with 1m members, there is $1B in equity from membership fees alone.

A communal egalitarian partnership can have senior and junior partner divisions.  Junior partners are those who haven't fully paid up their partnership share yet, but are current with their negotiated payment schedule.  A partnership share can be split among a group, though no one can own more than a share.  Those partners with more financial resources than other partners can contribute additional funds through (natural finance) loans.

A communal egalitarian partnership can replace many natural finance comptrollership duties other than account control if the partnership is large enough (5+), as peer review/monitoring enforcing partner commitments to the partnership is likely serves investors as well.  A communal egalitarian partnership is more trustworthy to outsiders also because it allows outsiders to join it.

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