Help or Ideas Needed - How to bring others into deals

[Karl James]

Bottom line: I am looking for ways to bring others, who want to invest with me, into single deals. Will likely be different ‘partners’ for each successive deal and/or have multiple deals going at one time.

Background: I've been blessed to have had some decent success recently buying and flipping vacant parcels of land. Through the process of doing seven deals in the last 5 months, a few folks I know have noticed and expressed serious interest getting in on deals; i.e. invest money with me rather than try to figure how to compete in the same space.

Previously I've passed on some attractive larger opportunities as I was not willing to commit the cash to get into the deal. Ideally, I’d be wholesaling and not need to bring much more than earnest money into the deal. But for now. I am finding the deals, getting them under contract, marketing the properties while waiting to close, closing them by funding them with my own cash, and then selling and taking the cash and profits and lather, rinse, repeat.

Thus far the deals I am doing are such that my cash out of pocket from buy close to sell close has been in the $10k to $60k range each deal. I am finding opportunity to do more of the $40k to $80k deals but couldn't concurrently have more than one of those going at a time.

What I would like to do is figure out a way by which I can find and get a deal under contract in my name or the name of  a legal entity (i.e. Buyer = Karl James and/or assigns) and then bring in one to three additional participants so they bring cash to the table before the purchase closes and have them take their share of the cash out at sell closing.

Typically, I need to close the purchase-side within two to three weeks of getting it under contract. Then, I have been able to close the subsequent sell side within two to five weeks. My associates who have interest investing have real estate experience and can bring something to the table. One is a realtor, one has typically been a buy and hold (rent) SFR guy, another a SFR buy, fix, flip person. So, they may occasionally be able to bring a target purchase but more often be able to help find buyers – or even take the parcel themselves at at a reasonable discount to FMV and build a house on the land.

It feels a bit like setting up an entity per deal might be the right way to go – albeit might be inefficient; maybe take too much time and has more costs involved. I've thought about constructing one entity and selling ownership in it proportional to the percentage / amount any one or each ‘partner’ desires to participate in the deal. I.e. if for deal #1 I need $80k to close the buy, sell Partner A 25% of the entity for a nominal cost (e.g. $1,000) and partner B 25% and I hold 50%. Assign the contract to the entity. Require partners to infuse the cash required to buy on the same ratio as their ownership. Close the purchase, close the sale, for example for $160k, and distribute cash in the same ratio. Buy back the ownership interest for $10 each. I keep the $990 difference on the sell / buy back of the partnership shares as compensation for finding the deal. I.e. at the time I sell the shares, the partnership has more interest because it has a contract / deal to do. At the time I buy it back, it’s basically worthless because it has no assets and no potential deals in the works.

What I would rather do is figure out how to paper something up on a deal by deal basis that didn’t involve complicated in / out of entities each time if I have different participants at different levels for each deal. I thought about something along the lines of loans. But in the example above, having two different folks loan me $20k and then repay them $40k ($20k principle + $20k ‘interest’) feels a bit like usury at best and pay-day-loan shark at worst.  I'd rather stay clear of anything that smells like crowd funding and takes me down a how to deal with the SEC, etc. road.

I recognize this is a long post but I am looking for real ideas or real-life examples of how others have tackled such a situation and want the BP community to have good insight into the need.

@Seth Williams , Jay Hinrichs, Mark Podolsky, Douglas Larson, Michaela G., Steven Butala and other season land investors on BP - any thoughts?  Others who may not do land but ran across this doing other types of RE, I'd love your insight.

Thanks

[Brian Burke]

There are a few different ways to accomplish your objective, @Karl James.  To find out all of the details of how to do it, you need to see an experienced business attorney and a securities attorney if you choose to go the securities route.  I'm not an attorney and can't give you legal advice, but I can give you some practical pointers to set you in the right direction.  I'll work from the simple to the complex:

Borrowing

The easiest way is to borrow the money. Finding a bank to loan on vacant land is tough, and they are probably too slow for you to be able to close quickly. The better solution is a private money lender or hard money lender. There are lenders out there who will loan on vacant land up to 50% to 65% of the value or cost (this varies widely). Costs for private/hard money range from 7% and no points to 15% and 5 or even 10 points. You have to shop around to find the best match, but this leverage might be all you need to do more than one deal at a time or do larger deals. Not to mention that even an exorbitant 10 points might be cheaper than giving up half of the profits etc. Use caution, however, because vacant land doesn't produce income and you'll be on the hook for the interest payments regardless of the success of your venture. Borrowing from private lenders played a very large role in my start in the REI business. For those who are newer to the business and don't have a very large track record, this might be the only option.

Partnership

In this case, you and the two other guys in your example decide to go into business together to do this land idea.  Each of you put some money in (or maybe some do and some don't) and each of you are assigned a specific role in the business.  Let's say you source the land, the realtor is in charge of selling it, and the third partner is in charge of the finances.  Each of you have 1/3 of the vote and it takes a majority of the three of you to make important decisions.  What is important here is that everyone is involved and has some level of control over the outcome of the venture.  You can decide to carve up the profits using whatever formula you all agree to.  It doesn't have to be tied to capital contributions.  If someone puts in money and doesn't have control over the outcome, you've bridged into the paragraph below.

Securities

You say that you don't want to go "down the SEC road", and I get that.  However, just because you structure a securities transaction doesn't mean that you are dealing with the SEC.  Don't skip this paragraph, however, because you might be surprised by what is considered a securities transaction and it's important that you know what it is if you want to do it and just as important if you want to avoid it.

Any time you accept money to invest from another person, and the successful outcome of that investment is tied to the performance of another person (YOU), the transaction is the sale of a security.  Before you say, "hey wait, if someone loans me the money the repayment is tied to my performance"...not necessarily true.  While it is possible to cross over from loan to security if not structured properly (hence, get an attorney), case law generally recognizes the validity of a loan transaction in commerce.  In a loan, the lender has recourse to the borrower and can attach your wages, sue you and lien your house, etc if you don't pay.  In an equity investment, those remedies aren't as available if you follow the regulations, thus the distinction.  One sure-fire way to make a loan into a security is to have multiple lenders contribute to the loan, called fractionalizing the note.  Don't do that.

This means that if you have your two other friends give you the money for the deal and the arrangement is that you will use the money to buy the property, then sell the property and give them their money back plus a percentage of the profits, and they are not active participants in the business with voting rights, you have sold them a security.  It does not mean that you have to go through the process of taking your company public, but you do have to comply with the securities laws in place that allow you to qualify for an exemption to taking your company public.  Namely, Regulation D of the Securities Act.  Forget about the legalese of it, go see a securities attorney if you want to do this and they will keep you out of trouble and in compliance.  Don't try to short-cut it by doing it yourself.  If you screw up you can not only get sued, you can go to jail.

All of that said, going the securities route isn't all that difficult if you have the right counsel.  It is, however, expensive.  For low-dollar land transactions it would be prohibitively expensive to set up a securities offering for every deal.  You'll pay at least $10K and as much as $40K (complex offerings can be over $100K but you wouldn't need anything that complicated) to get this done and your deal size is too small for that.  The solution would be to do a blind pool offering where you take your money from the investors and invest it in properties over and over.  One entity.  One securities offering.  You could literally do hundreds of transactions in sequence by recycling the same dollars and pay the set-up costs only once.

The securities option is a bit cumbersome in the beginning and requires some annual upkeep, but it is this option combined with the borrowing option that allowed me to grow my business from zero to over $30 million in assets under management.  If you want to scale, this is the way.  If you want to do a few deals per year, pick one of the first two options in this post.  You can always grow into a securities offering when the time is right.  Good luck!