In a recent case study on partnership deal structuring, Dennis Moritz, principal at financial structuring and analysis software firm Advantage for Analysts, explored the impact of gross and net reallocation methods on financial returns and deficit restoration obligation (DRO) risk. According to the study, the gross reallocation method for limiting capital account deficits, although more complex to model, created significantly greater benefits to all parties.
‘A Case for Partnership Reallocation Methods’ demonstrated that extending DRO balances can increase returns while increasing risks. The gross reallocation method, however, helps mitigate this risk by remedying DRO balances quicker than the net reallocation method.
‘Although both methods comply with the U.S. Tax Code, modelers may be unaware of the limitations of the net reallocation method; or they may want to avoid the greater effort associated with modeling the gross reallocation method,’ says Moritz. ‘Our study demonstrates that the net reallocation method can hinder the development of a viable structure or limit yield and/or risk objectives. The gross reallocation method, however, increases the likelihood of developing feasible deal structures.’
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