How to structure partnership arrangement

Rehabbing, Fix and Flip, Rental Properties
1

I am planning to partner with another person to buy and rehab a property in PA.
I am putting a whole amount (150k) and he is putting his time. It will take about 6-9months to complete and sell. We will then split PROFITS between us at 50/50.

My question is: Since I am putting 150k UPFRONT, how do I make sure that I have it secured by the property that we buy. Another words, since we are doing this as 50/50 → I want to make sure that he does not have any claim to the actual EQUITY that I am putting in. Just the profits.

Please advise.

2

Call your atty, have him/her draw up the paperwork. You want everything to be 100% perfect should you have a falling out with your partner. It will be the best money you spend.

3

Hello,

Can you advise how it is USUALLY DONE from your experience…

I just want to have some ideas on common ways of structuring this… before I go to the Attorney.

Thank you

4

Well you want to outline who is in charge of what, who puts in what, what each party gets out of the deal in the end (how profits are split), who gets the tax benefits, etc. You have most of that already outlined above, you just need to get an attorney to properly document what you’ve laid out.

5

NEVER, EVER, EVER do a 50/50 split. Make it 51/49 because at 50/50 no one can make a decision that counts.

If you’re putting up all the money in my book your the 51%. That’s it, end of story.

You will be glad in the end believe me. 50/50 sounds great, but this is business and decisions need to be made. Your partner will understand if he’s in it for the right reasons.

6

saplead,

In my opinion, this a reciipe for disaster! If you are putting up all the money, simply hire workers to do the labor and keep a LOT more of the profit. It is clear from your post that you already don’t trust this person. That’s why you’re worried about him having a claim on your money. Unless you absolutely can’t do it without a labor partner, I would forget the partner.

What typically happens is that the partner gets disillusioned working for 11 months without payment. They start to demand some of their money upfront and pretty soon you’re in a lawsuit or they simply quit working. Now, you’ve got an unfinished house and a partner that expects payment. Thanks anyway!!!

Mike

7

I think hired help would also get you a faster turn around and lower costs.

8

First, let me say, “been there, done that”.

Having said that, I agree with most of the others that this is not a good idea. I have done a 50/50 deal where I was the “money partner”, and I was a bit further ahead of you thinking ahead on what can go wrong.

In my deal, the other guy finds a way below value property, we tie it up (yes, he’s on the P&S contract), he supervises the work to have the place fixed up, we sell it, and split the profits 50/50. I put the money in (he has none) and he does all the work (I got no time). Almost like your deal except it’s a “quicker” turnover.

We also had a four page partnership agreement, detailing things reviewed by our attornies. I wrote it, because both our attornies were too busy to bother with it.

Whenever two guys do these things, the guy putting all the money in feels he should get more. On the other hand, the guy “doing all the work” also feels he should also get more because the guy putting all the money in “sits around and does nothing”.

But I went in thinking that the profit may not be as big as it may appear up front as “unexpected” expenses and holding costs may just eat up the profits. So, I insisted on, and the other guy grudgingly agreed to, that I get the profits out first, after we agree on a projected profit. For example. if I put 150K in, I want at least 25K out. So we structured it that it we made less than 50K, such as if we only made 35K, I take my 25K first, and he only 10K. If it’s over 50K, then it’s 50/50.

If both of you make 100K on it nine months from now, them none of you would squawk. But if the market goes bad, interest rates goes up, some code inspector shows up and wants permits for this and that, you’ll get mad because you’re seeing so little for your investment, and he’ll get mad because he spent so much time on it because he got so little to show for his work.

I also put it a provision where “I can buy him out” for a fixed sum if things go wrong, and we can’t exit as we hoped. THIS HAPPENED.

We were going to “quick flip” this baby, but things just dragged on and on, over a year if you can believe it, with deals falling through with several buyers, when I finally said “OK, I’ll hold on to it as a rental”. Fortunately, we were in an up market, but unexpected expenses, and holding costs ate up the profits. It would’ve been a disaster if the market went down, which it did a year or two later.

I paid him $5,000 to walk away from it. He was hoping to make 25K from the deal, and was very disappointed. Let me put it this way “he was MAAAAD, yelled, and screamed, and slammed the phone down”.

I was hoping for a quick profit, but was also disappointed that I got my money tied up instead. This was back in 1983, I still got the SFH that was purchased for 70K. The FMV is currently 375K. I put down 10K, another 10K to fix it up, another 5K to buy hin out. I didn’t do that bad.

He overestimated the “profit potential”, we both missed the difficulties of the time frame need to sell, and holding costs.

The “projected profit” was 50K, and I insisted that I get my 25K out first. Had the deal with the last buyer didn’t fall through, the profit would only had been less than 35K.

One last thing. Define “what costs are”. When the deal dragged on and on, I insisted interest expense is part of the holding costs, and he says it’s not. He says he’s due some “bird dog fee” as part of the expenses if I’m due interest, and I said he’s not.

OK, you still want to do a 50/50 deal??

9

In my opinion the guy putting in money is taking a far bigger risk and deserves to be rewarded greater. If it all goes wrong only he has something to truly lose. A little bit of time lost is not hundreds of thousands of dollars. I would maybe do 70/30 with a bonus if he really performs and makes you over X amount.

10

Rich:

I tried some deals, and what I found is:

  • The “money guy” should focus on his return first, rather than percentage of the deal. Even if it’s a 70/30 deal, as a boss of mine reminds me every day, “70% of zero is still zero”

  • Few people would do it for 30% and a bonus. They feel at 50/50, they’re more an equal partner, and their contribution is equally important. Going in 50/50 but with a projected profit would:

– Make the "money partner aware of his returns early on.
– Make the “working” partner aware of the financial objectives.

  • I actually allowed my “working” partner 60% of the profits above the projected, in return of my “taking my profits out first”. If you look at it this way, it’s a “bonus”.

  • In the deal I did, I wanted to make at least 25K, and I don’t really care how much my partner made if I made at least 25K in 90 days, as he said we would. I don’t care if I only made 25K in 90 days, putting in 25K, and he made 40K on the deal, even putting nothing in. My thinking is, he’ll be so happy with it, he’ll want to do another deal.

  • I rather say “look, make me my 25K in 90 days”, than to say “I want 70% of a deal that we don’t know if we’ll ever make any money on, or when??”. In the first case, there’s an objective, in the second case there is none.

  • The “money” guy should concentrate on protecting his downside, make the rules, count all the cost as expenes, before going in. Making the deal 70/30, and then have the deal lose money is not going to help.

As it turned out in negotiating my deal, the he was so interested in getting his 50%, and I was willing to give him the 50% for concessisns protecting my downside, that when things went down, I got more than 70%, and he got less than 30%.

Had we started as a 70/30 deal only, regardless of how the deal went down, he would’ve made much more. I got “equity of 35K when I close on the property as a rental, and he got a walkaway fee of $5,000”. Isn’t 35/5 better than 70/30??

Had he gotten 30% of whatever, it doesn’t matter to him how much the profit is because his return is “infinite” as he put nothing in.

I was way ahead of the game because I gave him his 50%, which he CAN earn IF, we made 50K, IF sold in 90 days, and IF IF IF.

In other words, he gets 50% if everything went right, OR MORE, if things went EVEN BETTER than expected. But as I figured, things more often go wrong than right.

11

I agree with propertymanager if you have enough money to do the deal do the deal and hire out the help. If you don’t know what to do, don’t do the deal get more education. In my opinion there is NEVER a good reason top partner on any deal.

If I can do deal number and make $100k but I can partner on deal number 2 and get $200k, then after I split the profits I still only made $100k but I added infinite amount of risk to that deal. It just doesn’t make sense.

12

just to echo what other have said. I’ve been the money guy on this kind of deal and it did NOT work out smoothly. If you must do this deal, Frank’s idea of investor get first cut on profit is a very good one.

13

wag’s rule #23: quickest way to lose a friend is to go into business with them.

wag’s rule #7: if it’s not in writing, it doesn’t exist.

14

I can’t speak to any of the “people” issues that come up with partnerships, but let me give you a quick rundown on how large commercial investors usually structure their partnerships. Frank’s methodology actually closely mirrors the way the big guys do it.

Partner (A): Puts in all the money but does none of the work
Partner (B): Puts in no money but does all of the work

Tier 1:
(A) receives 100% return of capital, plus a 10% annual preferred return
(B) receives nothing (except possibly fees – see comments on fees)

Tier 2:
With any money left over after Tier 1 is paid out, (A) receives 70%; and (B) receives 30% until (A) has an annual return of 20%

Tier 3:
With any money left over after Tier 2 is paid out, (A) receives 50%; and (B) receives 50%

Fees
Additionally, (B) will often times charge fees that get added to the deal expenses (acquisition fees, management fees, etc.) This may not be appropriate for this type of deal, but like I said – this is how the big guys do it. Although, (B) charging a birddog fee could be similar to an acquisition fee. Either way, EVERYTHING should be spelled out in the contract.

(A) should also have final authority on Major Decisions, which should be clearly defined (Sale, Refinancing, Etc.). You, as the money partner, can absolutely own 100% of the deal, but contract how (B) should be paid for his time. He does not need to be given any “ownership” or equity in the deal from day 1.

All numbers above are all examples and by no means standard. They are also all based on NET CASH FLOW. Each deal uses different terms, but this should give you a little bit of guidance if you liked Frank’s way of thinking. You can choose to use only two tiers and go 50/50 after (A) has received only 8%, or any other combination you choose.

I would also suggest a predetermined buyout option if you guys decide to kill the partnership prior to selling the house. This could be a set dollar amount or based on a 3rd party’s “As-Is” appraisal in case the project is in the middle of the rehab at the time (make sure you both agree on who will be doing the appraisal when you put together the contract).

This guarantees that the money partner will receive all his capital back, plus an adequate return on his money before (B) gets anything. However, if (B) performs well, he will be compensated well. That’s the main benefit of the tiered approach.

Negotiations with your partner should be taken as seriously as negotiations with a buyer or seller

I know this was a long post, but hopefully it was somewhat helpful to someone. If anything didn’t make sense, I can put together some example numbers to show how each parter would be compensated in Downside, Base and Upside scenarios