Investigation on behalf of an incoming partner

Nature of investigation
An incoming partner of a firm/ Limited Liability Partnership (LLP) may approach a CA to investigate the books of the firm/LLP.

Purpose of investigation

The purpose of such investigation is that the  incoming partner would be interested to know:

• whether the terms offered to him are reasonable having regard to 
• the nature of the business, 
• profit records, 
• capital distribution, 
• personal capability of the existing partners, 
• socio-economic setting, etc., and
• whether he would be capable of deriving continuing benefit in the shape of return on capital to be contributed and remuneration for services to be rendered .
• whether the capital to be contributed by him would be safe and applied usefully. 

Understanding between incoming partner and firm/LLP 

In this investigation, the problem is that the CA would investigate the books and records of a firm/LLP. However, he is appointed not by the firm/LLP but by a third party(a person who has been offered partnership by the firm/LLP). Therefore, it would be very useful if the firm/LLP and the incoming partner have a clear understanding that the CA appointed by the latter would be extended full co-operation and assistance by the firm/LLP in terms of access to records, personnel etc.

Steps involved in the investigation

Broadly, the steps involved in the investigation are:

(a)Ascertain the history of the inception and growth of the firm/LLP

(b)Study the provisions of the deed of partnership/LLP agreement , particularly for composition of partners, their capital contribution, drawing rights, retirement benefits, job allocation, financial management, goodwill, etc

(c)Scrutinise the record of profitability of the firm’s business over a suitable number of years, with usual adjustments that are necessary in ascertaining the true record of business profits. 

Pay particular attention to the nature of partners’ remuneration, which may be excessive or inadequate in relation to the nature and profitability of the business, qualification and expertise of the partners and such other factors as may be relevant.

(d)Examine  the asset and liability position to determine the tangible asset backing for the partner’s investment, appraisal of the value of intangibles like goodwill, know how, patents, etc. impending liabilities including contingent liabilities and those for pending tax assessment. In case of firms rendering services, the question of tangible asset backing usually is not important, provided the firm’s profit record, business coverage and standing of the partners are of the acceptable order.

(e)Examine position of orders at hand and the range and quality of clientele which the firm is presently operating.

(f)Carefully scrutinise position and terms of loan finance to assess its usefulness and implication for the overall financial position; reason for its absence should be studied.

(g)Study the composition and quality of key personnel employed by the firm/LLP and any likelihood of their leaving the organisation in the near future by retirement etc.

(h)Ascertain various important contractual and legal obligations and study their nature.It may be the case that the firm/LLP has standing agreement with the employees as regards salary and wages, bonus, gratuity and other incidental benefits. Full import of such standing agreements would be gauged before a final decision is reached.

(i)Ascertain Reasons for the offer of admission to a new partner.Determine whether the same synchronises with the retirement of any senior partner whose association may have had considerable bearing on the firm’s/LLP’s success.

(j)Appraisal of the record of capital employed and the rate of return. It is necessary to have a comparison with alternative business avenues for investments and evaluation of possible results on a changed capital and organisation structure, if any, envisaged along with the admission of the partner.

(k)Manner of computation of goodwill on admission as also on retirement, if any, should be ascertained

(l)Whether any special clause exists in the deed of partnership/LLP agreement to allow admission in future of a new partner, who may be specified, on concessional terms

(m)Whether the incomplete contracts which will be transferred to the reconstituted firm will be a liability or a loss.