How to structure an equity partnership??

Question

Hey, guys!I’m getting close to closing on a deal with an equity partner. This will be my first partnership so have no frame of reference. What’s the best way to split our equity if he’s providing the down payment and I’m managing the asset on my own? I want to be fair to the both of us.

Thanks for your time.

Riaz Gillani · Answer

A 50/50 split is most typical for a flip with a capital and day to day partner. A hold can be a little more creative. If this is your first deal with this partner and it went relatively well (aka you'd like there to be a second, third, so on ...) then try to reimburse the cap partner with as much of his initial investment as possible...After that you can pay split the cash flows 50 / 50.

If there's a very healthy amount of equity in the deal - consider paying him a return on his initial investment in exchange for a greater percentage of the asset.

For ex) a $100k initial investment. Gets paid $110k on the refinance. Equity split is 60 / 40.

Mohammed Rahman · Answer

Hey @Oladimeji Sonibare - excited to see you getting closer man!

I've run into similar scenarios and have observed my clients typically doing 50/50 - however, this is usually with a partner they've already been working with for a while and have done a few deals. You may want to consider taking less with the perspective of building a long term relationship since it sounds like you're putting in $0 into this, if so -- you're taking no risk.

If I were you, I would try to structure it in a way that the financing partner gets the lion share of the returns up until they hit their required return.

For example, if you ask them what % return they're aiming for and they say 10%, you can recommend taking only 5% (just an example, can be higher) of all cashflows/profits/etc. until the deal hits the 10% return. Anything above a 10% return, you get 30% (or higher) of the profits/etc.

It's more complicated than a simple 50/50 split, but based on our conversations and voice notes, this may help your financing partner feel more comfortable since your payout is now tied directly to how well you run the property/deal.

Good luck!

Ned Carey · Answer

@Oladimeji Sonibare       He’s taking all of the financial risk, as the silent partner, so I think it’d be equitable if I took care of emergencies without involving him again. After we’ve saved.

If you are in a financial position to do so that is one way to do it.  However it may not be the most "Fair". Fixing a busted pipe is an insignificant cost. Fixing a flooded property can be an enormous cost.  However this may be something you can get insurance for.

In addition to insurance another way to consider, is whoever puts in for a major expense, gets his or her share of the profits or equity increased.

Ned Carey · Answer

@Oladimeji Sonibare Ideally you should set aside money for cap ex from the beginning, and every month an amount taken out of cash flow and put aside for future capital expenses. Theoretically no one should come "out of pocket" for sudden expenses. It should be funded from capital reserves. The more money you keep in reserve the safer your investment is. The less money you have for reserves the riskier the investment.

This is one thing that can kill new or careless investors. They have no money put aside for very predictable but random costs. You know you will eventually have to replace a water heater for example, you just don't know when. Many investors bleed their investments dry and have no resources when the unexpected comes up.

Oladimeji Sonibare · Answer

Thanks, Ned. I’ll take all of that into consideration. The biggest headache though, is figuring out how to jointly save for cap-ex and determining who pays for what as far as emergency expenses. I think we just need to talk it out.

Ned Carey · Answer

@Oladimeji Sonibare It is a negotiation. It is more about meeting the expectations of each partner than is is meeting some idea of what is "fair".

50/50 is common but there are other considerations as mentioned before. Who gets paid first if there is a shortage. Is there a preferred return (minimum return for one investor) Does the other party want to get part of the potential profits as well as potential losses, or  does the other party want  a safer but secured position?

A good starting point is a discussion of does the other party want to maximize potential return or to minimize risk.

Chris Seveney · Answer

as others mentioned, I have done similar where we would do a 50/50 split and if there are no profits they would get any money back first since the are the ones with skin in the game. Also make sure your operating agreement would settle if there are any losses.

Chris Winslow · Answer

Hi @Oladimeji Sonibare, people structure these all kinds of ways so it's really up to you at the end of the day but a common structure is one partner funds the deal and one partner manages the deal and then all profits are split 50/50, good luck!

How to structure an equity partnership??

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