Exit strategies for partnership dissolution

[Thomas Combs]

Hey BP,

I am a new investor entering into a 3-person partnership & we are currently developing an exit strategy before approaching an attorney. We are having a hard time deciding how to approach dissolution as one of the partners wants the ability to liquidate the property at any time if he decides he needs to for any reason (emergency or not).

We also want to work in a statute that gives the other 2 of us the ability to buy a partner out before they liquidate the property.

I am curious to hear any dissolution strategies you have outlined before buying real estate with a partner & members' thoughts on freedom to liquidate. For more context, we are looking to live in a single family property for 365+ days then keep it as a rental.

[David Gotsill]

Hey @Thomas Combs - welcome to BP.

I'm a big fan of partnerships/joint ventures in real estate, and am involved in a few myself.  I'd like to clarify a couple of aspects of your plan, and share a few thoughts for your consideration.  Some of it's pretty technical, so feel free to ask follow up questions.  Also, I sound like a wet blanket.  Ask my other real estate partners, I'm good at that...

Why? Why are you partnering? Just in general, I would typically expect to see partnerships when going after bigger fish, rather than one SFH. Can one guy just buy it and let the others lease?

Financing.  Are you intending to obtain financing?  In my experience, the lender will have to rely on your personal accounts (of one or more of you), and that person or persons will be signing on the loan.  Probably not feasible (or worth it for any of you) for you each to be on the loan.  If, ultimately, one of you is on the loan, then is that partner entitled to an "extra" piece to compensate him for the extra risk?  If you're not using financing and instead are coming out of pocket for the full purchase price...THEN I'd strongly encourage you to reconsider and instead strategically use a loan to get other property.

Exit.  

(1) You've picked up on one of the key issues for any partnership. As to the Two to buy out the One, that's easy enough in principle. You have a ROFO/ROFR provision of your governing agreement (we're referring here to "partners", but I presume that you would actually be forming an LLC, and therefore would all technically be "members", and in such case your governing agreement would be the LLC Agreement/Operating Agreement (same thing, different name used by different folks)). With a ROFO - Mr. One would have to offer his interest for sale to the Mssrs. Two and Three prior to being able to sell to a third party. The fun starts when you try to value the purchase price for Mr. One's portion. Could be agreed in advance, could be FMV, could be something else. You'll also want to set out the process, including how long Mssrs. Two and Three have to exercise after receiving notice, what happens if both Two and Three want to exercise, and what happens if Two and Three don't exercise. Meaning, can One sell to anyone? Or are there limitations, such as a buyer reasonably approved by Two and Three. In a partnership of this size, I would personally never permit unrestricted transfer. There is too much risk. IMHO, a lot of work for one SFH.

(2) As to allowing Mr. One to sell whenever he wants (subject to the ROFO above), you'll have to confirm it's permitted under any loan that he is signing under.  Lender would typically restrict any transfers that alter "control".  So if One is deemed to control the borrower, he might not be able to sell without Lender approval.  Also, I would be sure to build in certain protections - such as a sale "in the ordinary course" or "in a customary, orderly manner" or some such.  You want to avoid allowing him to cause a fire sale, particularly if he has less to lose than the other partners.  Again, in general, I would never allow "sale at any time" without some protection.

Eventually, you want to consider what each partner is contributing, and how much it's worth of the whole.  You'll also want to decide how decision making works.  2/3 votes for any action?  Certain action requires unanimous consent?  Set out the business plan in detail in the beginning, and any variation requires unanimous consent?  

Again, this is not meant to discourage you.  Just get you thinking.  

Good luck!

David