Funding Flip with Family loan

[Carlton B.]

Securing hard money loans for flips has become more and more expensive. So I'm exploring the option of involving family members as investors in my next flip, borrowing funds from them at a 10% interest rate, resulting in approximately $1,000 monthly payments.

To simplify this arrangement, we are contemplating the creation of an LLC that includes the lenders. Should we establish a dedicated LLC bank account for managing funds and property matters? Additionally, what's the best approach for disbursing funds and handling tax-related matters? Do I have this approach wrong is there a better way? A step-by-step guide would be immensely helpful. Thank you in advance for advise.

[Jeff S.]

Keep it simple, @Carlton B. Either your family members are your lenders with recourse to the property, or they are your partners with an equity interest.

Also, keep it fair. If they are going to lend you money, they should be protected like any other lender. That means a set of professionally prepared loan documents from a lending lawyer. These would include a note, a recorded mortgage or deed of trust, a personal guarantee from you and your LLC members, and the many, many, other documents associated with a business-purpose loan. Your LLC would own the property with you the manager. Your family members would be the lenders to this LLC (in first position only, but that's another topic).

Your family members should also meet with this lawyer, so they know what they are getting into. You should be part of that conversation.

A professionally prepared loan will enable your family members to foreclose and even enforce a personal guarantee, if necessary. Deals go bad, and behaviors change, even though that would never happen to you. Plus, what if they wanted to, or had to, sell their loan? Professionally prepared and originated loans are more valuable than something arranged haphazardly. You have an obligation to the people who trust you.

Alternatively, you could partner or JV. Again, a lawyer, not your accountant, should prepare the agreements. In this case, you could pay your family members a percentage of the profits or any other creative sky's-the-limit arrangement you could think of. Of course, as members of the LLC, your family members would be exposed to all legal issues associated with property ownership that a lender would not be exposed to. Plus, do you really want them as partners? An LP could prevent some of this, but do you really want to get into that?

Once you start mixing loans and LLCs, as you wrote, your family members will likely get the worst of all worlds.