Partnerships- What's the deal?

[Zachary H.]

Hello fine people of BiggerPockets. I currently work full time in logistics. My wife, Mav, is a stay at home (property manager) mom with our 5 month old son. 

We are fairly new to the business of buy and hold deals. We currently own 3 rental properties in central Arkansas, but are feeling like we are at a crossroads. We have had several people (friends and family mainly) ask to partner with us on our next deal. While it's flattering, we always decline because we have heard horror stories from other business people about partnering with family and friends. However, we do feel like we could use another set of eyes and opinions in our business planning and are not opposed to a partnership. 

My questions are:

What is the breaking point where you decide you would do better in a partnership?

How do you decide who is the best partner to have?

Do each of you get separate loans with the bank or do you have a joint loan? (Which is better?)

Thanks so much for the advice. We are always wanting to learn more and connect with more people interested in this field!

-Zac and Mav

[Austin Fruechting]

@Account Closed - I would say you should have an LLC for your properties even if it's just you and your wife. If you bring in silent partners, every new structure of people/equities/etc should be a new LLC. An LLC is even more important with partnerships (or LLP or some type of legal structure). You really want to make sure you're separating liability when bringing other people in. If some type of worst case happens to one of your partners, you don't want their creditors or judgements to come against your ventures.

(1A) If they are happy with just getting a certain return over time that's closer to a hard money loan and structure it like that with a promissory note.  They wouldn't be an actual partner in property, but just a lender for a certain return and you'd make payments back to them at the agreed upon interest rate and timeline. 

(1B) Let's say we're looking at a true partner in the LLC and the cash investor gets a certain percentage ownership. You can structure this in any way you want to make it beneficial for all parties. Often, but not always, the cash investor gets a preferred return of 3-8% on their investment off the top, and then the rest is split according to the equity stakes. EXAMPLE: In one of my partnerships, the cash needed was $120,000. The annual cash flow should average to about $34,600 per year. My investors get 7% preferred return on the $120k per year so $8,400. That comes off the top leaving $26,200 to be split according to ownership percentages, which we have set at 50/50. I get 50% of the 26,200, so $13,100 and they get $13,100 + their preferred return for a total of $21,500. They get a great return and I'm happy to make $13k a year for putting the deal together and doing monthly bookkeeping and oversight. We hire property managers so I don't have to do any of that work. If I did I would either charge a property management fee to the LLC or take a larger equity stake for doing that.

(2A)  If we sell (still using my partnership example) the way it works is mortgage gets paid back first, their investment second, and then whatever is left would be split 50/50.  If we refinance it's the same thing.  If we refinance and still hold the properties, they maintain their ownership percentage, but if they have all of their cash back there will no longer be the preferred return. 

(2B)  If they want bought out, but it's not majority to sell the properties, they can sell their ownership stake along with all benefits to any one at any time.  I have right of refusal though so if they do get a qualified offer from someone for their share, I can choose to match the terms.  If I don't their ownership and all interest will transfer to the new person.  I have it in the operating agreement though that if that happens, the new person does not have voting rights.  I didn't choose to go into business with the new person, so they have say in what happens. 

(3) Get a VERY solid operating agreement that clearly spells everything out. The LLC will get the loan, although many banks will still underwrite the members and want personal guarantees from all members that own a substantial percentage (with my bank any partner that has more than 25% has to do this).

(4) Include everything you can possibly think of!  It's better to have everything lined out before than to have any questions or disputes later. 

There are endless ways to set up splits.  It's all about finding the scenario that works for all parties given the investment you are looking at.  The preferred return is not always necessary and not only included.  Equity stakes can be whatever you want too... 50/50, 60/40. etc. 

On another partnership, I injected cash into as well.  The structure was similar.  The cash represented 50% ownership and my expertise represented 50%....  I injected enough 40% of the cash needed, so I ended up with 70% ownership: my 50% plus 20% of the cash equity (0.5*0.4).  The investor only gets the preferred return on the difference invested.  So if it was 200k, I put in 80k, he put in 120k, he only gets the 7% on the 40k additional.