How do quantify intangibles in a deal?

Question

Hi folks! @Shane Pearlmanand I are working on structuring a partnership for a commercial investment (We aren't sure yet if we'll invest in California, Minnesota, or Washington).

I have a short sale on my record so I likely can't participate in the note. Shane's also a much more experienced investor. I will be brining capital and will play a support role in setting up the deal and engaging in the long term oversight. But Shane's definitely the lead on this.

How should we think about our partnership arrangement?

We did some soul searching and identified the following factors in a deal but we don't have a great handle on quantifying them:

• Cash - That’s a relatively easy thing to value. It is notable that it is also a highly risky thing to invest.
• Mortgage - I can NOT get a mortgage at a reasonable rate and probably not at all for a commercial property. And if I did, I’d be at risk because I couldn’t refinance or 1031 for another 5 years. So I have to weigh that in when I look at my real estate expectations.
• Experience - I am not super experienced with commercial real estate (or any real estate for that matter). If I was to enter into this myself, it would take a tremendous amount of time and would be a lot more risky. Shane would probably volunteer to help me review deals that I’m taking serious, but if I was rolling solo, I’d have a tremendous amount of work cut out for me. And honestly, there is a great benefit to me to be on the same team as Shane because he’s a hawk if he’s got skin in the game.
• Effort - Shane works really hard on this even when I try to get him to slow down and pace himself. He's really passionate about it.
• Team - Bringing the right team to the deal ensures that the deal has a high degree of success. Some of the opportunities we're looking at are in places where Shane's got an established team.
• Investor Network - We probably won't go this route, but if we don’t have enough capital to make a deal, and Shane can pull on his investor network to pull in the difference, it may be worth a bump in the deal.
• Deal Flow - Finding the deal itself is quite valuable.
• Project Management - Who’s managing the project (upfront and once the project is rolling)
• Work Support - This one is weird and I'm not even sure if it merits being called out. All the same, I'm throwing it in the mix. Shane and I are business partners. As Shane becomes busy handling phone calls for a deal, I attempt to take things off his plate.

Do we try and define a % value for each of these? Shane proposed that we just skip all this and he'll want some % and I can take it or leave it. How do you think about this when you set up a partnership?

Account Closed · Answer

@Peter Chesterand @Shane Pearlman,

So far, it has been 50/50 equal equity in all of my deals with my various partners. We don't really divide or assign tasks. Whoever has the time to do it, that person would take care of it.

When I was buying properties at the courthouse steps. We agreed on how much the partner would pay me on each deal for the work that I put in. All in all, it has to be the dollar amount or percentage that both of you guys believe it's fair.

To me it's very hard to put a dollar amount or percentage on a true friendship. We never know when we're on the other side of the coin. It's great that we have similar goal, and it's even better that we can invest together to achieve the same common goal. The final percentage has to be a number that both of you are happy with regardless of what I or others think.

Now, how do I structure it with my partners? 50/50 in equity on everything. I have a couple of partners with total assets over $3MM. We're grossing over $200k/year. I don't charge a nickel to manage these assets. At 5% property management fee, I'd be making an extra $5k+/year for myself. However, we have gained well over $1MM in equity from these investments, and one half of that is mine. $5k+/year is tiny in the scheme of things compared to our friendships. On the plus side, whenever I need a favor, I always get it. Do your trust your partner enough to give him an unsecured $200k check payable to him with no questions asked? How much does that worth to you?

I have another partner that we have over $5MM worth of assets together. He has another $6MM worth of real estate assets himself. Whenever he needs help with his personal assets. I'm more than happy to help. Again, no questions asked. TRUST goes a long way. That's how operate.

I take care of my own assets because I have my own contractor team. I have been sharing my team with my partners, and everyone has been happy. Although I don't get any referral fee, I'm happy that my partners are happy with my contractor's team and workmanship.

One last note, J. M.recently helped my partner and I obtained a $1.725MM bridge loan at 4.75% interest for our deal. Helping others with a common goal without expecting anything in return has worked wonder for me. Two of my partners were referred to me through contacts that I met on the Internet, and now we co-own over $8MM worth of real estate assets together. None of them was from BP though.

I guess my point is that you guys should look at a bigger picture. Come up with a partnership structure that both of you are happy with. Tweak them along the way if need to. As long as both of you are happy with it, that's the formula for success.

Best of luck.

Account Closed · Answer

Peter,

It was a flat fee of $5k for each deal that we won at the courthouse steps. Anything beyond that was a 50/50 split.

When it came to remodeling the place. We either subcontracted it out, or we did the work ourselves. We didn't distinguish who was putting in more time and sweat equity. Whoever has the time would do the work.

You can tell Shane that you would pay him X amount of dollar for what he does. Anything above that you guys split 50/50. As much as you guys want to resolve as many scenarios upfront as possible, don't let that hold you guys back from doing deals. More things will come up along the way that would need to be ironed out. Like Warren Buffett said "It's human nature to make easy things difficult."

If you guys want me to share my Operating Agreement between my partner and I, shoot me an email. Keep in mind that this is not legal advice.

Shane Pearlman · Answer

@Jeff Greenberg

Account Closed

I know you all have partners. Curious how you structured the value of sweat equity, network, experience, deal opportunity etc?

J. Martin · Answer

@Peter Chester

and @Shane Pearlman,

Like @Minh Le and @Jeff Greenberg, all my partnerships have been 50/50 equity ownership with a single other partner (Technically, my partner and their spouse - both male and female.) I've found the deals and arranged everything, we borrow money (or sometimes just partner borrows), then I borrow about half of my 50% equity contribution form my partner at a healthy rate. Property management sometimes.

I find a great deal, operate it, and produce above-market returns. My partner signs for the loan and loans me a bit of my equity contribution in exchange for a healthy equity and debt yield (both near 10%), and an essentially turn-key below-market deal w/ good cash flow and equity built in, without giving up any "free" equity. We also have trust and enjoy each other's company.

It sounds like Shane is bringing more to the deal in experience, finding the deal, network, etc. And you can't sign on the loan (but may be OK for commercial loan since they're looking more to the property - or can do non-recourse around 60% LTV and no one guarantees).

So if you're going to both come in to fund the deal and split if 50/50, what would be good for Shane? Lend him some of his equity contribution at a favorable rate? Give him the right to get his returns before you start taking yours? Pay for someone to clean his house and re-do his backyard because he can't do it while he's spending time on your deal? I know that last one sounds strange, but the point is.. How do you meet both your needs?

My recommendations would be:

1) Make sure your long-term goals are aligned

2) Try to structure 50/50 partnership that meets both of your over-arching long term needs/goals

And here's why..

If your long-term goals aren't aligned, you're probably doomed from the beginning.. Do you both want to hold for the very long term? Buy and sell advantageously or with economic cycles? Both comfortable with mixed responsibilities?

I like the 50/50 because everyone's incentives are aligned. Interests are the same. Both tend to care about it similarly. For example, you may have different feeling if it's a 10-15% ownership. Or if one person is getting more cash flow, and the other more equity, how do you decide on big rehabs and improvements? How to decide when to sell?  In that line, I would try to adjust the "inputs" to get to that equal partnership. Like Minh said, having someone you can trust and in an investment that you believe in is very valuable.

So that's why I like the 50/50 partnership. In my case, I had less capital than my partners, but could find and supervise deals. But they both had more capital, one is 100% passive, and the other is a real estate investor, but not very active on this property. I find a good deal, negotiate the terms, lock it up in contract, supervise rehab, and lease up the units. I borrow part of my equity contribution from them at a healthy yield.

We typically borrow bank funds, then fund the remaining 30% or so with equity. Of that, we should each contribute 15%. Of that 15% I contribute, I typically put about half of the 15% down out of my own cash, and borrow the other 15% from my partner at a healthy rate (8-12%), backed by my signature, with equity dilution in the partnership for non-payment of the note.

I get paid for property management with my 100% passive partner, because it's structured to farm that out over the long run, and they're in Oakland and Richmond, which take more time with the tenants. (really, we each pay 50% of this property management fee b/c we both get 50% of expense and income.)

To specifically address your question regarding attributing specific 12% to this, 36% to that, I wouldn't even try. Just find an overall package that meets both of your needs :)

Michael Worley · Answer

Peter, one thing to consider, if you're a 20% owner or greater in the LLC most recourse loans will REQUIRE you to guarantee the deal. If that's a problem from a credit stand point, perhaps 19% owner ship with a salary (to be budget into the deal structure just like a property management fee) would make sense.

Another way to do it if you want 'equity' instead of salary, is to loan the LLC money with an interest rate and a balloon payment such that you'll capture 'equity' when the property sells or refinances due to them paying off your note at that time.

Jeff Greenberg · Answer

My partner and I are 50/50 partners.  We do define what we expect of each other, but don't try to nit pic on who is putting more hours.  We know we are both hard working ethical people an put in the hours that are needed.  When my dad died, I couldn't think about RE for 3 weeks so my partner made sure that things were held together.

It is important that your both have the same work ethics and do what is needed to get the job done.

Shane Pearlman · Answer

Does that mean that your buddy and you just went halfsies and don't worry about who contributes what or that you use cash as the basis and invest equal dollars? cc Matt R.

Jeff Greenberg · Answer

Unless you want to put everyone on a time clock you are going to spend more time making sure they are carrying their load and less time doing the job.  If you are so concerned about everything being equal, maybe you are working with the wrong people.

It is more important to work with investors, lender, lawyer, title, insurance, broker, inspector, or SEC attorney?  What does it matter, each needs to be done.

Matt R. · Answer

For me Shane it is a tag team style ( high school buddy). No exchanges on sweat equity, no percentages. We remain flexible and open if there is cause for adjustment however.

Account Closed · Answer

Peter,

No doubt Shane is bringing more to the table so I wouldn't be surprised if he deserves a 40% in equity contribution and gets 50% of the ownership.  Can it be 42% or 38% equity contribution for a 50% ownership?  Sure, but I'm not sure if his effort would worth 20% equity contribution for 50% ownership.  You guys will have to work out a percentage that both of you are happy with.  :0)

How do quantify intangibles in a deal?

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