Road to Partnership or Road to Disaster?

Question

I posted this to another PRO forum area that may have been too old for one to be interested in so I am sharing here as well in effort to reach someone who has ran into this situation or to guide me in the right direction.

I've sifted through a handful of other posts and could not find a direct response similar to my concern. Let me enlighten you on the situation, as I will be seeking professional help from my attorney to doctor up the proper legal documentation to get started.

I have just finished another renovation (flip) if you will and am starting to pull more people into this mix. I have successfully completed 4 properties with gains on each, and am looking to gear this structure into a business entity so that the tax burden is less cumbersome and liability is lifted off my shoulders a bit as an individual. Here is my situation:

My Contractor offered the idea of possibly joining teams and continuing to turn homes in a structure that he and I split the costs for Materials and other burdens, while I absorb the cost for labor to continue to pay him of course to keep the team working and afloat. In the end, we handle this in terms of profit sharing. The percentages of profit hasn't been completely decided yet as we are just bringing this to the table. I have been working Time and Materials with this team, and I rather go the route of Bids for the project however If he is tied to a materials $$ amount, I would assume it would push him to complete the job faster and not take too much time to completion. At the moment, I am looking for the best route to approach this without being handled incorrectly.

Second approach to this- we may be completing 1 to 2 more of these fix and flips, and rolling into new build duplexes or quads. I would basically team with him to cover all costs for land and dwelling with possible help from a 3rd investor (Paying interest over time of loan) and eventually Cash out Refi once everything is completed.

We were discussing the different benefits in going this route, and he prefers to buy and hold until mortgage is paid down then sell. I had to explain the Capital gains would then be taxed from the sale unless otherwise 1031 exchanged into a new investment of similar or lesser value within 45 days of closure (new property lined up/under contract and custodial account finalized where exchange would go) If using the cash-flow to invest back into the business, it would and could be a very successful business venture and payout to ourselves if a business venture is the right route to go for this type of situation.

Where I am going with this is to pick your brains as i'm sure all of you at some point may have been in this situation before. Am I approaching this in the right order? Should I be focusing in only 1 niche? Separate entities for Rentals, and Fix and flips with separate Bank accounts I assume? Any suggestions and or guidance is welcome, as either way I will seek legal help to finalize this. Just wanted to put feelers out on what others have experienced. I rather learn from the failures of others rather than fear of failure and falling back into analysis paralysis. However if that is what it takes, I will fail on my own to succeed.

Again thank you all for your time and consideration, and looking forward to your responses. Your time means everything!

Rick Turman · Answer

So I called a meeting together and we jotted down some ideas from each side so we could obtain each view and long term goals. It seems as if one of his subs wants to break away and start his own flipping/investing venture and has come to me on the sidelines for assistance. Instead of losing two great contractors, I started a discussion that would trigger motivation to stay and work as separate entities while providing deal flow and monthly funnel overviews of how business can keep moving if they stay with me. This seemed to spark interest, and we began brainstorming. I came up with the idea that on average with our team, we turn a flip with a total of 800 man hours or roughly 6-8 weeks to complete. This equates to 6 flips each year and they are not to take on another project on the side but allowing time off for vacation with family. This will be contractual once we iron out the incentives. If we can complete a flip in less than 8 weeks, I will kick back or profit share with the team. This will motivate them to drive to completion faster and stay on site. If each contractor picks up another employee which is in the works, we have the advantage to turning these faster at a rate of 10 per year increasing their potential profit/year salary 10K. The only caveat to this is that 1 contractor wants Bids, the other is stuck in the Time and Materials mindset. If I can get past this hurdle, I think I will be on track to having an unstoppable team, with a bright future ahead of us. Well thanks for tuning in and if you have any suggestions on how to solve the bid/labor materials hurdle, it would be amazing!

Rick Turman · Answer

@Jim GoebelThanks for the reply. You are absolutely right in the fact that I had left something out. I forgot to mention that I do not want to lose this contractor/team but want to keep them busy without buying them out. I'm essence, keep them for myself and not on other projects. I'm not yet in that position to be able to do such transaction but I have the system in place that will streamline our workload just need to pull the trigger. Thanks again.

Jim Goebel · Answer

@Rick TurmanHi Rick I don't have a ton to add here other than the observation that any time I've ever explored the possibility of sharing equity with a contractor, AND paying them for their work (time) - there's an inherent conflict here that cannot really be resolved - my experience here is that it's a bad idea to try to accomplish both these things.I don't have much to add on your entity structure, etc. I'd be inclined to simply pay your contractor as long as your financing situation allows you to do that. Why not pay for materials yourself, as well. If what you're doing is working, focus on the long term and keep the ownership/equity yourself, right? Maybe I'm missing something. Perhaps you need the capital sharing with your contractor from a cash flow perspective or you like the idea of sharing risk.