Where to form "Managing Member, LLC" which will be the "sponsor"?

Question

Hello all,

I'm just getting started in the syndication business and just finished Gene Trowbridge's "It's A Whole New Business: The how-to bible of syndicated investment real estate"... phew...

I plan to follow his suggestion and create a "Managing Member, LLC" with me (and possible future active-management partners) as the members.  I/We will then use this LLC as the "sponsor" and "managing member" in the "Operating, LLCs" that will be set up for each investment group.  I know it is best to set up the "Operating, LLCs" in the state where the investment property is located, but where is the best state to set up the "Managing Member, LLC"?  We live in New York City, but I expect to focus on Florida and Pennsylvania with our first syndications.

Looking forward to some healthy responses to my first post!

Thanks in advance,

Dan

Kim Lisa Taylor · Answer

Most states (or lenders) don't require that the Managing entity be formed or registered in the state where the property is located, so the determining factor is more about where you live and will be doing business, rather than where you will be investing.

Since all of you live in NY, you will likely be "doing business" there  (as defined in the state's LLC act). As such, NY will likely require  that your Managing LLC either be formed in NY or registered in NY as a  foreign entity. Another option (and perhaps better) would be to form it  in DE (so that your LLC is subject to more favorable DE law) and then register it in NY as a foreign entity.

Chris K. · Answer

@Daniel Crouse

I haven't read that particular book, so it's hard to comment on it. But my first question is whether you plan to do an actual syndication. If so, you will want to work with an attorney that specializes in this area so that he or she can provide necessary advice on corporate structure and complying with SEC requirements. During that process, he or she can answer this question for you after reviewing all the necessary details. It is unfortunately an expensive process.

I personally would open it in Pennsylvania, but that's just because I'm familiar with the laws here. In most situations, I don't see any strong reason for me to open an LLC in one of the Holy-Trinity states (Delaware, Nevada, or Wyoming). There are good reasons to open an LLC in those states, but they often don't apply to most people.

@Patrick Liska

Parent LLC could provide asset protection --- sometimes at a significant level if done correctly. But I think what you meant is where one person creates one single-member LLC and then creates another single-member LLC as a subsidiary of the first one. In those cases, you are probably right. Doing that probably won't help that much.

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.

Daniel Crouse · Answer

@Basit Siddiqi

All good points.  Will follow up in DM.

Daniel Crouse · Answer

@Steve Babiak

Very good point and duly updated!

In reality, I suppose this is a decision to be made based on one's own filing situation, but based on my desire to limit expenses for the Managing Member in a year without project-level expenses, I waited.  To date, in Q1 we've had significant project level expenses as we've ramped up our activities.

Daniel Crouse · Answer

@Travis Kramer

Thanks for following up! In a one (run-on) sentence Executive Summary: I already knew a few accredited investors to whom I wanted to prove my niche strategy so I am currently building what I refer to as a “case study portfolio” that is financed/backed by one investor and supported by an experienced, local partner (whom I met through BP!).

I'll provide some narrative and wrap with a summary of lessons learned to date:

Based on some advice from my CPA (who confirmed the advice above provided by @KimLisa Taylor ), I waited until January of 2018 to form my Managing Member LLC - Clear Run Capital, LLC (“CRC”) as I did not plan to close on my first investment until 2018. If I had formed at the end of 2017 I would have had to pay filing fees without any project-related expenses (or revenues). Because my primary residence is in NYC, I registered CRC in NYC - one of the most expensive places to file an LLC in the US. Regardless of where I filed (say, Delaware), I would still have had to register as a foreign LLC in NY as I am the sole member filing the passed-through taxes.

The costs to file included: $200 for NY filing fee; $175 for CPA consulting and filing of Articles of Org., IRS Tax ID (EIN #), and Operating Agreement review; $50 for Certificate of Good Standing (to be used when opening a bank account). As a “lovely added bonus” NY state requires all new LLCs to publish a public notice upon their creation in two newspapers that are distributed within the County in which your business’s principal office is located. For now, this is my home office in the Upper West Side of Manhattan. Total costs to publish were: $723.27 to publish daily for 6 weeks in the New York Law Journal and $399 to publish once a week in a Weekly newspaper, both designated by the County Clerk. See a Forbes article here for more details on requirements and ways to limit costs. In summary, total CRC filing fees were ~$1,550 in NYC. I set up a checking account and applied for a business credit card at a bank with whom I have a strong personal history (at first, you back your new company, personally) in order to a) clearly delineate the business from myself and b) start a credit history for the newly formed LLC. From these accounts, I paid most of the aforementioned expenses. If you do not have a CPA pay these fees and bill you afterward, you will need to pay them from your personal account in order to obtain the documents needed to set up the bank account (EIN #, Art. Of Org., etc.).

Once I had my Managing Member LLC (CRC) created, my experienced partner and I began looking for a property that would fit well with my long-term investment strategy. It needed to enable me to document a simplified version of the process through which each new investment would follow as well as the benefits of the strategy. My initial acquisition plan was: identify a property; get under contract; create an LLC to own that property; set up a bank account for the new LLC; and finally, close on the property with the new LLC. I learned that the process of setting up a new LLC with multiple investor owners is simple but setting up the bank account when those investors are not all in one place can be quite complicated. I went through multiple approval processes with big banks, but ultimately, I needed the flexibility of a small, local, entrepreneur focused bank that was willing to work within the limitations of our unique structure (our project LLC has two Managing Member LLCs and one individual as the "Owners"). After doing backflips to get the account opened and funded, we closed on our first property 1/31/2018 and it is in the renovation process right now. We are documenting and providing weekly updates to the investor while building a long-term relationship with our contractor that will reduce CapEx and improve returns.

During the contracting process for the renovations, one of the biggest points on which you and your contractor need to align is on project milestones. Aligning payment on milestones rather than dates is commonplace in large construction projects but may require some massaging for smaller projects and with residential contractors. This becomes even more important if you are making draws from a lender in order to ensure you are never short on funds.

As you can see, I am still very early in the process and have not “officially syndicated”, but the lessons learned during this initial credibility-building phase have been incredibly valuable. That said, we are on track to pull in some much larger investors on more complex syndications in 2018. I’ll provide another update in Q2. Until then, please feel free to DM me for more details or to meet up for a chat!

Lessons Learned:

1)  Build some experience before the “hard pitch” to accredited investors, but don’t hesitate to “soft pitch” and feel out some potential investors before you are officially up and running. The start of this process is an iterative cart-before-the-horse, chicken-and-egg, “insert idiom”, and keeping potential investors in the loop on your process will give you a reason to stay in touch while proving your abilities and defining your value-add with investor input.

2)  Partnering with experienced Bigger Pockets members is an exponential multiplier when you need to build your credentials, augment your skillset, and validate your platform with investors.

3)  Your investors don’t always need to provide 100% of the purchase plus renovation cash. This is particularly true for value-add properties. They can back a short-term loan or a long-term mortgage, as well as other financial products that combine the two.

4)  Form LLCs in a year when you will actually have expenses (and revenues if possible).

5)  Form Managing Member LLCs in the state in which members will pay taxes, otherwise you will likely be required to also file in that state as a foreign LLC. Ideally, this is a single member LLC.

6)  Pay your CPA or Attorney to complete the LLC filing process. You will want them to review your Operating Agreement at a minimum, and the filing process takes them very little additional time and has minimal (if any) impact on their fee.

7)  Setup your property LLC before putting in your offer and make sure to plan for all investors/owners of the new LLC to visit the bank and open the account in person, together. This should be something you are messaging to investors as part of your process in advance.

8)  Document, document, document… the more info to share with investors in a clear and reproducible way, the better.

9)  Align payment with project completion milestones regardless of the size of your project. Make sure to include an “invoice and payment” process in your contract so there is no ambiguity as to what a contractor needs to do in order to be paid including any requirements from any lenders that may be involved.

I hope this early experience has provided some helpful lessons learned and look forward to sharing more in the near future!

Best,

Dan

Steve Babiak · Answer

Item number 4 will always be "true" because LLC filing fees are an expense.  Perhaps you should consider re-stating that point.

Basit Siddiqi · Answer

@Daniel CrousePlease be wary that if you have a management company set up in NYC - you may be exposed to NYC's unincorporated business tax(UBT). The UBT is a tax of 4% on net income allocated within the city of NYC.Where you set up the management company will depend on the location that you ultimately make the decisions of the managed assets. If you set up an LLC in DE and you make the decision within NYC and you have an office in NYC - NY will require you to register the LLC as a foreign entity in NY.

Furthermore - if you have an LLC within NYC, the management fee earned is counted towards the "LLC Fee" on form IT204LL. The fee is on a sliding scale - the more receipts - the more the minimum tax is.Ideally you want to do business in a state that has no income tax and low fees.

Daniel Crouse · Answer

Agreed @Jesse Salazar

From this experience, I would suggest forming single-member or "Managing Member, LLCs" in the syndicator's home state.  Then form project/property level LLC/LPs in tax-friendly states and register in the property's state as an out-of-state entity (foreign) or register LLC/LPs in the state in which the properties themselves are located (domestic).  Our first portfolio is in Maryland, a state that makes domestic LLC/LP registration the easiest avenue for our property type and investment strategy.  Another factor to consider is your investors' locations.  One group of accredited investors we have been targeting is located in Florida and they are relatively well educated on that market (reducing our upfront education efforts/expenses), so we will likely syndicate in Florida with a domestic Florida LLC if we continue to pursue them.

As you mentioned, attorney and CPA consultation advised.

Jesse Salazar · Answer

It looks like you might have the LLC formed already, but in my experience the best setup has been forming the managing partner LLC in the state in which you're located. Then have the LLCs or LPs in that will actually holding the properties in a tax friendly state such as Delaware or Wyoming. Of course, you should always consult with an attorney first.

Good luck on your syndication!

Travis Kramer · Answer

Daniel,

How far have you got with your private placement?  Have you ran into any roadblocks thus far?  If so, what have been the biggest hurdles?  Where were you able to find the accredited investors that you would be using for the syndication?

Where to form "Managing Member, LLC" which will be the "sponsor"?

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