Guidance needed for forming partnership (or JV)

[Gary Parilis]

I'm looking for some guidance on partnership or JV. I've been communicating a lot with a potential partner, and we're very compatible (dispositionally and in our objectives), and we've built up a good deal of mutual trust over a couple of months, discussing deals in detail, etc. We're very confident we'll work well together, and that's a big deal. I have capital and he has intimate knowledge of specific neighborhoods in his local market, and can find deals, manage rehab, and the manage the rentals. We know what we want our commercial arrangement to be (pretty simple). Now the next step is to formalize it. Any advice on this? Should we form an LLC? Or just JV on individual deals? We plan to do a BRRRRs, which makes this more of a "marriage" than the "dating" we'd be doing if just flipping. Do we each need legal representation to negotiate/document an agreement? Or is there some boilerplate contract for this kind of arrangement we could use? We'll be doing business outside of my state. Would I need an attorney in the state in which we'd be doing business? I assume it would make sense to form an LLC there (if anywhere).

[Lance Lvovsky]

@Gary Parilis

There are different ways to allocate income, losses, etc in a partnership. Be sure to speak to a CPA to make sure Partnership is structured correctly. Legal counsel needs to be hired to draft documents.

[Darius Ogloza]

Being the "money guy," you have more skin in the game and hence are assuming a lot more risk than your putative partner. Note that all of his his promises involve future performances whereas you will be asked to perform at the point at which you find an appropriate property. I tend to discount promises of future performance. I would strongly encourage you to try one initial deal wherein you provide convertible debt into the deal. In short, make a loan at a stated interest rate that you can convert into equity if the BRRR turns out to be a fruitful investment. If it does not, the putative partner will be on the hook to repay you. If that person has real skills in identifying, rehabbing and managing property , he or she will go for it. If not, you are likely to lose money on any deal you do with him/her.

[Gary Parilis]

Originally posted by @Darius Ogloza:

Being the "money guy," you have more skin in the game and hence are assuming a lot more risk than your putative partner. Note that all of his his promises involve future performances whereas you will be asked to perform at the point at which you find an appropriate property. I tend to discount promises of future performance. I would strongly encourage you to try one initial deal wherein you provide convertible debt into the deal. In short, make a loan at a stated interest rate that you can convert into equity if the BRRR turns out to be a fruitful investment. If it does not, the putative partner will be on the hook to repay you. If that person has real skills in identifying, rehabbing and managing property , he or she will go for it. If not, you are likely to lose money on any deal you do with him/her.

Thank you, Darius. That's good advice. A test case where my risk is low (and so is his if his confidence is justified) is a great place to start. So it sounds as though we wouldn't form a joint entity at this point. What happens at the time that we convert the interest to equity (assuming the deal performs as expected)? Would we then form an LLC?

[Darius Ogloza]

A lot of this is going to depend on the state you live in, so specific legal advice is clearly warranted. As a rule of thumb, LLC formation and compliance costs are quite high (as it seems you know). People who sell this solution often ignore these. Also, the degree of asset protection you get from an LLC varies by state. (See case law on "piercing the corporate veil"). Still, this is one possible solution. A lot can also be accomplished through simply adding you to the deed as a tenant in common and adding you as an additional insured on the property's insurance policy. Another alternative (especially if there id an underlying loan with a due on sale clause) is entering into a joint venture agreement where you can receive a contractual right to any distributions or share in sale proceeds as a matter of contract rather than through property rights. Again, worth consulting a lawyer to ensure the method complies with state law requirements and makes sense from a tax perspective.

[Daniel Dietz]

It sounds like you are planning on accumulating and holding these for the long run if all goes well.

What we do is not BRRRR, as most of them are already in good condition when we but them.

We ran out of our own capital, both cash, SDIRAs and SOLO401Ks when we hit around 25 units. At that point we brought on a Private Money Partner, who also had been a Private Money Lender on previous deals. We knew each other for decades, and they were very familiar with our success for far in buy-n-holds. We did/do all out own PM on them also.

The way we set up our partnership is to do an LLC (about $800). I think it is well worth it to cover all the basis, make things simpler for buys outs, deaths, surviving beneficiaries, etc..... We (2 main partners & I) had already done 3 LLCs for various properties and essentially just tweaked if for the new one.

The way we did the deal was that the Private Money Partner put all of the down payment and a bit of reserves in, about 23% on a 260K property or 60K. We find, manage what updates are needed, do all ongoing PM and financial management etc..... We are 50-50 partners on all decisions, although they prefer to leave 99% of that up to us. We split all cash flow 50-50, and when time comes all equity growth 50-50. When we choose to sell some day, or do a large refi with 'cash out', they will get their down payment equity back FIRST, and THEN all the rest is split 50-50. Also, if we are ever NOT able to perform PM duties, the cost for that will come out of OUR half of the 50-50, since that is one of our main ongoing functions that we are responsible for.

One of the main things that the 'money person' gets with a good 'on the ground' partner who does a GOOD job like us is less than 2% vacancy, very low maintenance cost as we do many of the simple little 30 minute type of things, great loan rates as we have the connections and experience, and finding deals that are 'off market' that they would never find otherwise (20 of our 29 units were off market and found by networking and cold calls - there is virtually NO inventory in our rural area that hits the MLS)

The PMP gets a great steady return and sleeps at night, we get to 'make money with our time and knowledge' - it is a win-win in my book :-)

[Basit Siddiqi]

@Gary Parilis

You should sit down with an attorney in the state where you will do business(the state with the properties).

You want to hash out and agree to several items with the attorney and your partner - 

What is the profit / loss ratio for each investor
what is the exit plan?
What happens if partner A or B dies?
etc

[Gary Parilis]

@Daniel Dietz, thank you. The arrangement you're describing is very much like what we're discussing (except I'm the PMP). Did you have contracts drawn up by lawyers to formalize the arrangement? Was there some negotiation that occurred between parties? I'm trying to figure out the quickest (responsible) path to getting moving on actually doing business.

[Dani Beit-Or]

I'd say first sit/meet and outline the "What Ifs" situations you can come up with. This will also serve you should you decide to seek legal work - you'll be able to provide an att. listy o things you have talked through. 

This is your opp. to discuss the uncomfortable staff . . . you most likely will never have this opp. unless you decide to sit/meet and discuss it. 

Don't seek perfection - it will not happen. What you will have is the spirit of an agreement + many pre-discussed situations.  

If you agree and in good standing w/ each other maybe it does not need to seek legal work BUT must do an agreement to be If signed that spells everything you discussed.  

If you cannot agree and still want to work together than seek legal consult. 

It is also possible that the conversation will generate tension which may end up not working together.

Such meet is: smaller inconvenience saves a bigger inconvenience kind of a mindset.  

If you plan to agree on everything - it won't happen. At some point a leap of faith is needed - the big Q is how big is the gap. 

Good luck!

[Gary Parilis]

Originally posted by @Dani Beit-Or:

I'd say first sit/meet and outline the "What Ifs" situations you can come up with. This will also serve you should you decide to seek legal work - you'll be able to provide an att. listy o things you have talked through. 

This is your opp. to discuss the uncomfortable staff . . . you most likely will never have this opp. unless you decide to sit/meet and discuss it. 

Don't seek perfection - it will not happen. What you will have is the spirit of an agreement + many pre-discussed situations.  

If you agree and in good standing w/ each other maybe it does not need to seek legal work BUT must do an agreement to be If signed that spells everything you discussed.  

If you cannot agree and still want to work together than seek legal consult. 

It is also possible that the conversation will generate tension which may end up not working together.

Such meet is: smaller inconvenience saves a bigger inconvenience kind of a mindset.  

If you plan to agree on everything - it won't happen. At some point a leap of faith is needed - the big Q is how big is the gap. 

Good luck!

 Thanks. We are in agreement on everything we've discussed, and don't doubt we can come to an agreement on anything we haven't. My concern is about things we haven't thought to discuss. I want to avoid a disagreement two years from now about a situation we hadn't considered. We've developed a very good relationship, and I think we'll work well together. I understand we can't cover every eventuality -- at some point good faith will be required. But I don't know what things we can and ought to anticipate. 

[Dani Beit-Or]

@Gary Parilis if this is the situation I'd seek legal consult not to draw an agreement but to help make sure you covered things you both did not anticipate. 

[Daniel Dietz]

@Gary Parilis

We, my two existing partners (brother and uncle) and I already had 3 LLCs set up by the time we started working with a PMP. One for 'cash' purchases, one for SDIRAs, and one for SOLO401Ks, so we had a pretty good 'outline' of what we wanted to do.

We prefer LLCs over JV deals since we are looking at at least 10 years to hold, and a lot can happen in that time.

On the original 3 LLCs we spent a LOT of time go over details. The more simple ones are how we would each get compensated for our time contributions. Financially we all contributed the same capital, so that was simple. The more time consuming was the 'buy out' details if a partner wants out, and the 'what ifs' if a partner were to pass on. 

The answers to those two are; the valuation at buyout if the other partners wanted to stay in is valued at the same price/rent ratio at time of purchase. Meaning if we bought a 150K place that rents for $1500 a month, and say 8 years later it rents for $2000, it is now valued at 200K. If a partner were to pass on, the surviving heirs  would have the option of staying in (which would be all 3 of their preference at this time) or they can be 'cashed out' using the same formula.

I guess a summary would be to think of all of the 'what ifs', especially the 'bad ones' like death etc.....

Once we brought the PMP partners on, who was a family friend and watched our success over time, we let him read over out existing LLC documents and he was very content with what we had, with the exception of covering how him or his heirs would get their capital contribution back, since they were the only one putting capital in.