Multiple Investors (take 2)?

[Michael G.]

So, a while back I posted a question about having multiple investors all making small investments to my LLC. That sounds like it's really hard to set up because of the SEC rules.

I have a different idea I wanted to see if anyone could help me with.....

I have 2 people that are willing to invest about $50k each and I would bring $50k to the table as well.

The goal of this partnership is to use that money to either directly purchase rehab properties or as money to bring to the table for lager property deals (to make up the 20% skin in the game that lenders need for a mortgage commitment).

My business partner and I already have an LLC that manages our existing properties. We want to keep using this LLC as the main entity.

We are thinking of creating a separate LLC or LP as the investor entity that would provide funding (and that would probably be a second position lean holder on the property).

The main entity would be the property owner and would pay the investor entity x% interest (probably like 11% or so). The main entity would pay off the monies used in 2 years and then the investors would be off the property (probably would require and closing).

1. Is this common?

2. Is this legal (I guess that is tied to #1 above)?

3. What is the best way to set this up? We are going to talk to our lawyer about this but, if this is common, what are some general things we should keep in mind?

Thanks

[Bryan Hancock]

Originally posted by Michael G.:

Hi Bryan
1. Do all the members of the funding LLC / JV need to put in the same amount? If not then I assume they get back a %, say, 11% on their amount of involvement. Is it legal to even stipulate a return on investment like that in the first place?

I would say no, but qualify it some. If "investors" are putting in money and getting less than their percentage back this is generally referred to as a promote in the industry. If one or more parties are signing for recourse for debt they should be compensated for this. If one or more parties are procuring the deal they should also be compensated for it. However, you need to be careful. If there is a large asymmetry then the setup becomes more security like and you would need to seek an exemption. These are questions for an attorney.

If you start to set up percentages they get back on their INVESTMENT then they aren't really fully partners. A setup like this where they have the right to vote you out needs to be vetted by an attorney.

Originally posted by Michael G.:

2. How do we firewall someone from taking 1/3 of the JV profits if they put in less than 1/3 into the JV? I assume this is possible and probably not something we are worried about but I am interested in hearing if it is possible.

I'm not really sure what you mean by firewall, but if someone puts in less than 1/3 then they should get less than 1/3 when the entity is drawn up. You could set up a new entity for each project to vary the percentages.

Originally posted by Michael G.:

3. Could a 4th member join at a later date? They would have to have equal voting rights as well I assume but would the original 3 partners have to sell shares or something?

Probably, but I would avoid this because you will have to specify how the dilution will happen. If you have unequal shares for value other than cash added then this will be tricky. Just set up a new entity for each deal. It is much easier unless you want to set up a private placement up front.

Originally posted by Michael G.:

4. If one of the original 3 members decided to leave the JV could they do that without risk to themselves? Or without risk to the JV as a whole?

What risk are you talking about? If they are full JV or entity partners then they share the liability of the partnership. Bailing when there are issues probably won't indemnify them, but this is an attorney question. If some partners are worried about liability then they should probably be limited.

Originally posted by Michael G.:

4. How do the partners get their money back out? Is there a limit to the length of time on the partnership or do the members have to vote to dissolve the JV?

If you set up a new entity for each deal they could just get their money back when the deal is monetized and the bills are all paid. Note that you need to address a partner wanting to exit early in your partnership documents. The procedure for this is important. This is especially true if these investments will be long term.

Originally posted by Michael G.:

5. If we were to do multiple deals would one JV work or would there be a separate JV for each project?

I would strongly suggest you set up separate entities for each project. If each of the intended partners has their own entity that they want to use you could draft a new entity or JV among those existing entities for each project. That is how I do things with folks in Austin when they are active partners. If the partners will be passive and want to limit their liability where you control the project you'll want to look into a private placement with a securities attorney.