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The Partner-Ship of Theseus

6 min read

In 1602, clever Amsterdam burghers invented the ancestor of today’s limited partnerships, the Dutch East India Company. Under statutory rules governed by contract, the world’s first joint-stock enterprise enabled Holland’s entrepreneurs to pool their capital, used it to outfit vessels and send crews a-voyaging in pursuit of globe-spanning profits. If some partners later wanted off, their fellow shareholders could buy out those wishing to go ashore, and the partner-ship would sail on, continuously amended and yet unchanged:

The ship wherein Theseus and the youth of Athens returned from Crete had thirty oars, and was preserved by the Athenians down even to the time of Demetrius Phalereus, for they took away the old planks as they decayed, putting in new and stronger timber in their places.  – Plutarch, Life of Theseus 23.1l

Four centuries later, our modern equivalent, the affordable housing limited partnership, has likewise evolved to a self-renewing and self-extending amendment. Each removal of an old plank in a partner-ship (exit of a limited partner) and the substitution of new and stronger timber (entry of a new investor) means not only an upgrade in capacity but also a shift in orientation and motivation. While old capital wants a gentle landing, new capital buying in pursues accelerated growth, and in the process, partnership governance is always amended, supplemented or otherwise modified. Let a partnership age several decades, and the same legal entity, owning the same property or portfolio, can go through multiple configurations of leadership and decision-making. But is it the same partnership?

This ship became a standing example among the philosophers, for the logical question of things that grow. One side held that the ship remained the same, and the other contended that it was not the same. – Plutarch

Although the interests of the sponsor general partner and investor limited partners align during a partnership’s early years, as tax credits are received and consumed, their interests diverge. The property ages steadily, and inflation steadily revalues assets and liabilities. This slow change, like warping planks, makes the partnership gradually creaky and vulnerable. 

Steady stress from divergent motivations often culminates in abrupt fractures caused by financial transactions either inside or outside the partnership. A partner’s parent entity changes (a bank buys another bank), a partner exits (selling its interest to another investor or back to the sponsor), or a partner’s child or grandchild inherits. A founding CEO leaves, a for-profit platform takes in a private-equity investor with an ambitious agenda, or a nonprofit’s board is reconstituted. Each such shift of people creates a personality transplant that the other partners treat as akin to demonic possession.

The decades have given us scores of affordable housing entities—funds, developers, syndicators, lenders—that, although legally and contractually the same vessels owning the same assets, abruptly experience dramatic changes in behavior. These have become even more prevalent as the entity’s partners or shareholders have themselves become entities, where subsidiary corporations, inter-executive partnerships at the platform level or trusts (often via estate or gift) are added later to facilitate further offstage interest swapping. The result has been partnerships that in name and property, if not in identity, can live in perpetuity, endlessly refinancing, recapitalizing and revolving their casts of characters. 

A Ship, which signifies Matter so figured, will be the same, as long as the Matter remains the same; but if part of the Matter remains, and part is changed, then the Ship will be partly the same, and partly not the same. – Thomas Hobbes, Of Identity and Difference, 1656

In modern partnerships, therefore, one should assume from the outset that however sterling the character of those with whom we are initially partnering, their future characters are unreliable. That being so, the solution lies in creating appropriate governance up front, right in the organizational documents themselves, and that begins with two principles.

1. Change in Control. All too often omitted from the founding partnership agreement or LLC operating agreement is a definition of Change in Control – and yet, it ought to be an essential negotiating point. Change in Control ought to be adjudicable (observable based on facts) and expansively defined, covering many cases that include:

  • Events both voluntary (retirement of a key executive, which should also be a defined term) and involuntary events (death or bankruptcy of same);
  • Not just the participant entity itself (for instance, a new general partner corporation replacing a retiring one) but also its derivative or controlling parties. For corporate general partners, this means shareholders, while for partnership, trust or LLC GPs it means managing members or managing general partners;
  • Contingent control transfers, such as entry of a new capital partner that has contingent or springing rights upon future events, including collateral assignment to a secured lender or incoming partner; and
  • Upward merger or similar sponsor-tier recapitalization. 

Even if well written, the definition may become lengthy using extra words and enumeration of cases to give the concept durable meaning.

“‘When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’

’The question is,’ said Alice, ‘whether you can make words mean so many different things.’

’The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all.’” – Lewis Carroll, Alice in Wonderland

2. Incumbent partners’ consent/blocking rights upon Change in Control. These come in five types, whose mnemonic is the five V’s:

  • Visibility. Real-time awareness of what is going on or could potentially happen, with reasonable notice;
  • Voice. The opportunity to ask questions and have responses or commitments documented, and to resolve any potential issues of fiduciary duty or rights of authority before an action becomes effective;
  • Vote. A written vote with a percentage consent requirement before the action can occur;
  • Veto. In effect, the requirement of unanimity before proceeding; and
  • Value. Potential consequences of increase or diminution of ownership or shares.

The hierarchy of consent/blocking rights should be tiered to motivate the parties to resolve any potential risks through pre-substitution negotiation rather than post-substitution litigation – because, in the affordable housing partner-ship of Theseus, everyone should always know whose hand is on the tiller.  

David A. Smith is founder and CEO of the Affordable Housing Institute, a Boston-based global nonprofit consultancy that works around the world (60 countries so far) accelerating affordable housing impact via program design, entity development and financial product innovations. Write him at dsmith@affordablehousinginstitute.org.