Private Money Loan Process with Investor
Investor · San Francisco, CA · Member since 2022 · 36 posts · 41 votes
I'm having trouble understanding the private money loan process with another investor.
So when another investor gets involved, that's because they also agree that you have a good deal. So they agree to give you money in exchange for either 1) a cut of the profits or 2) (perhaps) to pay the money back as a loan.
For 1)
- How do you decide how the profits should be split? Say it is 70/30 for example, is that profit only realized at the time of sale?
- What about when you are receiving rental income? Should the rental income be stored in an escrow account or a joint checking account?
- Also, what happens when you want to refinance? What does the split look like then?
For 2)
- I've heard the term "promissory note", so I'm assuming that's something I sign saying I agree to pay this money back?
- How is the investor keeping track of the interest versus principal payments? Are there banking platforms that support private lending and handle these calculations?
Also in both cases, do lawyers need to be involved to make sure the contract is legal and both parties are protected?
Thank you
@Account Closed regarding question 1. it is all negotiable. It depends on the needs, wishes, goals of each party. It also depends on the resources each brings to the deal.
Typically it would be structured as one of two choices. Someone can lend you the money and has a mortgage against the property as security for the loan (debt). Or, they become an owner of the property with you (equity). If they are a part owner of the property this is usually through an LLC. The LLC is the complete owner of the property and you and your investor are owners of the LLC.
There are many ways to do this and many ways to split the profits. Lots has been written here about some of the options.
Regarding question 2, Loans are documented via a "promissory note" sometimes just shortened to a "Note". Loans against properties are called a Mortgage (or sometimes Deed of trust. They are essentially the same thing I will use the term mortgage here) What most people call a mortgage is actually two separate documents. The first document is the promissory note with all the terms of the loan like interest rate and term of the loan. The second document is the mortgage itself. This is what makes the property collateral for the loan. The mortgage document is recorded in the land records so the public is on notice that there is a lien on the property.
An "amortization chart" is a spreadsheet with all the payments listed with the breakdown of interest vs principal.
@Account Closed
Determining the split is entirely negotiable. You hear a lot about a "50/50 split where one partner provides the cash and the other provides knowledge or sweat equity" really doesn't make sense.
The concept is that investors make money off their capital or credit servicability. This also means that we can lose money. Employees/contractors, on the other hand, get paid for their work either way. So, in your case if your friend has no money to contribute, where is his risk? If this deal goes bad, what does he stand to lose? It basically sounds like a you are the developer and he just owns the land. Buy the land off him and perhaps give him a consulting for his knowledge and contacts. Also, its not clear what are you bringing to the table? The money? Then perhaps structure this as a loan.
Basically, when somebody is doing a "traditional job function" its many times better to just be paid for that job. You can split the remaining equity profits (... profits are after the expenses...). I'm not sure what is your difficulty in going alone...
Certainly, you could do any sort of equity split. However, from a pure "investor point of view" the risk profile doesn't always make sense. However, as a business deal as long as both of you are happy with the terms it doesn't matter what I think :)
So, back to your specific question: really the person with the money needs to determine what they want to be since each has a different risk profile. If its #1, then I expect you'd need to figure out how and where you get paid. If the deal loses money, then do you get nothing? Or, are you being paid a "fee" as part of the hired help? If they act as the lender, then basically you have a private backer and you just pay him interest and probably points until you finish the job and can pay him back. Just be sure that you have enough to pay him back at the end of the deal... If the project goes bad and you can't pay him back.... hmmm...
Does that make sense?