Is GP taking the equity in the deal as a company or individual?

Question

Dear BP members, first of all, Happy new year!

This newbie is troubled to understand something. Let's say you have an investment company. (like Joe Fairless' Ashcroft Capital or Michael Blank's Nighthawk Equity) Through the company, you find the deal and take all necessary GP steps including doing due diligence and bringing investors, etc. Further, you decided to form an LLC to purchase the deal with GP:LP equity split of 30%:70% on top of the usual acquisition fees, etc. All LPs agreed to it.

Q#1: Now, would you (as an individual) get named as a member holding 30% along with other LP investors holding 70% in the operating agreement, or would your investment company be named as a member holding 30% equity? or would you have a 3rd separate master holding company to hold the 30% equity?

Q#2: And eventually, you will put your investment company as a manager of purchaser LLC of the deal, right?

Hope my question makes sense. Any comments will be greatly appreciated. Thank you and happy new year again!!

Yosef

Brian Burke · Answer

The sponsor doesn’t get any equity unless they contribute capital.  If they do contribute capital, they would hold title in whatever manner the capital was contributed. If a principal of the sponsor group committed personal funds they would hold the interests personally.  If it was company cash, they would hold the interests in the company name.

Having said that, I think that when you refer to “30% equity” what you are really referring to is a promote, which is not equity, it’s just a split of cash distributions.  Since this isn’t “equity” the promote isn’t “held.”  The investors own 100% of the equity but are only entitled to 79% of the cash flow, in your example.

Generally the sponsor is an entity (Corp or LLC) and is the managing member or general partner of the property ownership entity. The promote flows to the manager/GP so by default that means it flows up to the sponsor's entity.

Brian Burke · Answer

@Yosef Lee the sponsor would be the managing member of a manager-managed LLC or the general partner of a limited partnership.  No equity interest in the LLC or LP is required.

There is a common misconception that being a sponsor in a multifamily syndication is a cash flow business.  It is not. When you sell the property you will have a payDAY, but during the hold you don’t get a payCHECK.  This is a fee-based business where you get an acquisition fee up front for your efforts and a small asset management fee along the way.  You won’t be quitting your day job any time soon just because you did one large apartment syndication.

The reason is because of a preferred return to the investors, they get 100% of the cash flow until reaching the preferred return hurdle. Only then do you start participating in cash flow. Most properties take a couple to a few years to throw off enough cash flow to exceed the hurdle.

You might often hear a different take on all of this in the seminar and podcast circuit from sponsors that do this differently—such as no preferred return to investors and sharing in cash flow immediately.  What they don’t tell you is that they struggle to raise capital and only do one or two deals.  Then they go on the teaching circuit because it’s the only way to make money.  Take it from a 30-year vet who has raised well over a hundred million—it doesn’t work that way if you want to scale.  It works just as I’ve described here.

Joel Owens · Answer

This is a classic example of if as a syndicator you can keep things SIMPLE it can be golden.

Most passive investors want a complex subject dumbed down into easy to understand information. Personally I like vanilla set ups. The more complex it gets can confuse investors and also invite some syndicators that might not be completely above board in their dealings.

Example: The syndicator creates a process so complex that they try and tilt overall returns in their favor and take away from the passive investors over time through manipulation and complexity.

There are so called syndicators out there selling information and courses or not even being the syndicator but a figure head for the deal bringing in some capital. Some even will syndicate anything just to keep those upfront fees churning and coming in.

You really want the syndicator to have aligned interests with the passive investors where both win. If a syndicator is only taking a promote of 10 to 20% then they almost can make more churning smaller deals and taking their fee going in.

I take 50/50 split as a promoter on retail deals but those deals  tend to be smaller in size with shorter exit time under 3 years. I have to feel solid about the property because most of my return is aligned with the investors on the upside. If I was taking nominal promote on small deals I am becoming almost a glorified property manager looking over the management company if there is one. In that case I would rather keep transacting commercial deals as a broker.

It is important to know that a syndicator doesn't need the money right away and they aren't desperate to do a deal etc. Of course everyone has to start somewhere the passive investor just has to assess the risk much more closely with a new syndicator and what they are trying to syndicate. That syndicator might offer above market returns to try and entice passive investors into the deal. Usually when I see passive investors jump into deals like that it is with smaller amounts of money to curb risk versus their overall net worth and liquid cash positions ( They might invest 10k or 20k versus 100k or 300k and see what happens). That train doesn't last because as soon as that syndicator gets 1 to 2 deals under their belt and more established they IMMEDIATELY look for a cheaper source of capital because they do not want to work their butt off for paltry returns where the passive investor gets almost everything.

Think of for example someone doing their first flip. They go to hard money lenders and only the ones that charge the super highest points and rates will typically take them on unless they found a deal so amazing that it curbs risks substantially then they might deviate some from their standard practices. Once that flipper has some experience the flipper is then looking to the HML to change the rates charged to something better for the flipper on terms, looking for a new HML lender, or looking for private money at a cheaper cost.

I believe in the passive investor and the syndicator should both feel like they are winning. If they are both trying to negotiate terms that takes advantage of the other party then that's likely a relationship doomed in the long run. Basically you have to buy into the syndicators philosophy and how they set up deals. If you don't there are tons of other syndicators that might work for what you are searching for.

If you are wanting a bunch of free info for becoming a syndicator Value Hound Academy has tons of stuff.

Greg Dickerson · Answer

You are confusing equity with cashflow (profits). Michael Blank spoke incorrectly on that podcast. The GP will receive their share of the cashflow above the preferred return and according to the split. If it 80/20 like your example once the pref is met the GP would get 20% of the cashflow. This is profits not equity. Refer back to Brian's post as he explained it very well.

Ben Leybovich · Answer

I would add that the asset management fee should not be thought of as cash flow either. As you scale your business you will have to keep the lights on, hire personnel, etc. This asset management fee allows you the latitude to hire the help you need to do a good job overseeing your investor's investments.

This is not a cash flow business.

Greg Dickerson · Answer

You may have heard Michael incorrectly or he misspoke. Some people think profit splits are the same as equity but as Brian explained they are not the same. Where it gets confusing is the property will build equity as debt is paid back and the property appreciates which increases the equity in the property but that is not realized until the property sells or is refinance and that’s when profits are split and if all return hurdles have been meet the sponsor receives their share of the profits which is the promote.

The sponsor entity is the GP. This entity will be the managing member of the property LLC along with the LP members.

Yosef Lee · Answer

Brian, Your answer is absolutely golden to me. Thank you so much! Yosef

Scott Mac · Answer

@Yosef Lee

Hi Yosef,

There is also the (unintended) possibility of creating a Federal Tax liability for yourself without the offsetting cash flow to cover it.

Doing this isn't as straightforward as it may seem on the face. You need good council (tax, SEC and asset protection) to advise you on how to set things up for yourself and for the ownership group (getting that part of your team in place might be a good first step).

Because if you make a mistake, there are a lot of dogs that can reach up and bite you (the federal tax liability situation being only one of them).

Good Luck!

Tony Lin · Answer

Lot of great answers already. Just to add that there are indeed sponsors that take a equity percent in the asset as opposed to just a percent split of the profits.

Yosef Lee · Answer

@Alina Trigub

Alina thank you! I can totally relate to what you are telling me. So grateful for them who shared their experience here. Yes I will be looking into a meetup group.

Is GP taking the equity in the deal as a company or individual?

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