Preferred rate of return question?

[Charlotte Dunford]

If you were to pay your investors $8,000 in preferred rate of return of 8% on their $100k capital investment, the second year the capital account amount would be brought down to $92,000 right? The second's preferred return would be $92,000*8%=$7306, right?

What would happen if your investors choose to leave their money in, would the capital amount just go up?

[Brian Burke]

It depends on how the waterfall rules are written in the operating agreement.  Most often the terms specify that distributions are first paid to satisfy the preferred return and second they are paid to return capital, so the capital account would look like this:

• $100,000 starting balance
• $8,000 preferred return accrual
• ($8,000) preferred return distribution
• $100,000 ending balance

In year two, there is another $8,000 due, etc.

But partnership agreements can be written however the parties agree, so the rules could be different and that would result in entirely different calculations and results.