Equity Partner Splits

[Ryan Wilson]

I've never had an equity partner in all the deals I've done. I've only used my own money, private money and bank financing to fund my own deals. However, this has limited me to doing a fixed number of deals per year as I have not sought additional private money outside of a few people I know.

I have a very high net worth individual that wants to become an equity partner. She came along at the right time as I am motivated to build my business and add additional multi-family and other commercial assets to my portfolio.

If we partner together, we would be buying assets to hold long-term together as we share that common goal. Most of these projects will be value add and, at least in the beginning, I will be handling or overseeing everything (marketing, acquisition, rehab, property management, etc...). She will just be providing the capital as she lives 4 hours outside of my market.

I want to be very fair and I want to keep it simple. My thought is that a 50/50 equity partnership would be the best way to go but I have zero experience here. Additionally, I see these syndication deals where the syndicator/sponsor charges a 1-3 percent acquisition fee, a 1-2 percent management fee, a 1-3 percent disposition fee and then a 25-60 percent profit split after the investors make a preferred return. When I see those arrangements, I wonder if I should be charging some type of management fee (like 10% of rents or something along those lines) to compensate me for managing all the work that is required on a value add project.

Advice??? What is fair? What is standard practice? What is a standard equity split in this situation? Should I even bring up some type of management fee for handling the projects from A to Z?

Please let me know your thoughts. Any advice or experience is appreciated. Thank you so much.

Ryan Wilson

[Austin Fruechting]

- I just copied/pasted this from another thread a while back...

(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 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.