Partnering with a friend

[Dan Smith]

Hey BP, I have a friend who I have been speaking with about partnering together with and I was hoping for some advice on the matter. We are looking at contributing 50% each to fund a new deal and we wanted to make sure we did it all the best way. We are thinking about starting an LLC and buying the property through that entity.

I would take on the property management side of the business and he would take on more the year end closings/book keeping/taxes/financial breakdown side.

We are trying to figure out a fair way of distributing out money and compensation for different up keeping procedures.

So far we have thought of two main fees - Property Management (I am hands on with my current property, so he would pay me to continue doing so with our joint houses), and Tax Prep (He is a CPA, so I would pay him that).

I am curious to know what other partnerships look like in a similar situation and if anyone can provide further insight.

I.E. what's a reasonable fee to charge for property management? We are in Eastern MA, I am happy to do research on my own too, but I'm also hoping to get some guidance or learn from someone in which direction to start.

Any and all insights are greatly appreciated!

I'm especially excited to hear what did and didn't work for people who have been through this situation and what some after thoughts are on the entire idea of partnering.

[Todd Heitner]

Hi Dan,

I can't help too much with the specific numbers to use, but I do have a couple things for you to consider.

First off, make sure whatever you agree upon gets put in writing and you both sign it.  You may already be planning to, but I just thought it was worth mentioning.  Sometimes friends tend to not put things in writing because they think it means they don't trust each other or something.  But there's nothing that can kill a friendship quicker than a bad business deal.

It's easy to forget some of the details you had agreed to verbally a year or more down the road, or to think that you agreed to something when you really hadn't.  Putting it in writing will help to avoid any misunderstandings down the road.

Second, if I understand correctly, you're each putting 50% in, and I assume sharing the income 50/50.  You'll be handling certain tasks related to management yourselves, with you managing the property itself and your friend handling the accounting.  Then it sounds like you're going to be paying each other for the services.

What you're doing is starting a business, so I would think you'd have a bank account where funds related to the property (and any future properties) are coming and going - income and expenses.  Money coming in from either rent or selling the property are income, and things like managing the property and paying an accountant are expenses.  I would think that, rather than coming out of either of your personal profits, those are expenses the business itself has, so they would be paid from the business account, not from either of you personally.  Whatever is left over after expenses are paid is profit, and you'd divide that 50/50.

I'm not sure if what I'm describing is different from what you had in mind or not, but I think it's different, from what I was understanding.

If so, imagine that, rather than the two of you doing those tasks, you're paying other people to do them.  You're paying someone to manage the property and to handle your taxes at the end of the year.  Those are just expenses the business has, so the business would pay them, not any of the partners.  In this case, the two of you will be doing certain things and getting paid to do them.  If you're paid out of pocket rather than from the business, one of you will get the shorter end of the stick because the fees aren't going to be equal.  And what if one of you gets too busy with other things and doesn't have time to do those items, or doesn't want to do them anymore?  It wouldn't be fair for the other friend to be stuck paying those fees.

Let me give you an example with some made-up numbers.

Let's say your property produces 10,000 in rental income for the year.  Going the route you proposed, you'd each get half of that, or 5,000 each.  Let's say you decide property management fees are worth $1,500/year, and the tax filing duties are worth $500/year.  Let's see how this breaks down:

Dan gets 5,000, plus 1,500 for managing the property, minus 500 for CPA = $6,000 income

Friend gets 5,000, plus 500 as CPA, minus 1,500 for property manager = $4,000 income

Obviously in this scenario you'd get more money, but it's fair that you get more because you did more work.  But it's where the money is coming from and the amount that's the problem.  It's that it's coming out of your friend's share rather than the business' expense account.

Think about it this way.  You're doing $1,500 worth of work and your friend is doing $500 worth of work, so that's a difference of $1,000.  But the difference between your income and his income is $2,000.  Clearly, it's not balanced.

Let's look at the same scenario, but we'll let the business pay the expenses rather than you individually.

10,000 rental income, minus $2,000 expenses ($1,500 to property manager, $500 to CPA) = $8,000

That means $4,000 each.

Dan gets $4,000 + 1,500 for property management = $5,500 income

Friend gets $4,000 + $500 as CPA = $4,500 income

As you can see, even though you're each getting paid the same amount in both scenarios for your services, the second scenario is more fair.  The bigger the gap between the cost of the two services, the more unfair it will become.  The only way it would be fair is if the services had exactly the same value, which is unlikely.

I hope this helps.

Todd