Sharing Equity With Contractor?

Question

Hello BP!

If I want to use a friend who is a contractor, and rather than pay him offer him an equity stake in our flip... what is a typical fair share for him for his work? This is based also on the notion that I will be paying for materials. It's just his handy-work and use of subs that we be footed on his end. Is there language in the contract that addresses penalties for not meeting deadlines? How should we word that and what is fair per the industry standard?

What if we want to have a friend give us money to contribute for a flip, and instead of paying him like a lender, we give him an equity stake; Assuming we each put in the same start-up capital, but I manage and oversee the entire flip start to finish... what would be a fair split?

What if we put in 0 money, friend puts in all the money, and we do 100% of the work. What's fair then?

Thanks!

Matthew G. · Answer

I've seen this arrangement many times. Your contractor has to be a partner with you. If the project loses money, then you split the losses just as you would split the profits. You should be picking someone you trust.

If you still have some concern then you can handle all the finances, so that any subcontractor bids go through you and your general contractor/friend only makes sure the scope of work is equal for all the bids. He won't be able to "skim" off the top when he has no control of the payments. If he's taking kickbacks from contractors, then you failed to pick someone you trust.

To keep him honest and working hard, the financial gain definitely has to be greater than if he were to just contract the job normally. If you try to take too much of the pie, he will have less incentive. Make sure he understands the profits and losses based off of different scheduled completions.

That being said, I usually see it where one person finances the deal and handles payments and the other manages the rehab/construction and they split everything 50/50.

Jim Goebel · Answer

@Trevor Deeter

Hm  ---- I see some real conflicts of interest here Trevor, if your sub/equity partner is getting paid for their work.  Here are some pitfalls:

• Let's say your equity partner realizes that they can 'skim' or take a chunk of what they negotiate with a sub contractor...  This means that you've got an issue where they own a chunk of the property AND they can basically 'pay themselves' - there's no amount of equity that you can offer that will offset the ability to make money in the present if they are inclined this way...  Huge conflict of interest
• Let's say your equity partner just sits on his thumbs and does't do crap...  Someone still is on the hook to get the stuff done.  If they get equity without hitting milestones you've just exposed yourself big time

I'd recommend reading up on 'Earned Value' methodology.  It's a concept used within project management.  I'd recommend tying your equity stake to BOTH a component of schedule completion, (actual vs projected) and cost completion (actual vs projected).  Good luck.  This is tough to do - not impossible but you have to have a crazy good tactical mind and anticipate human nature in its entirety here.