Any tips re: aligning interests when partnering w/ builder?

Question

I've got a good long-standing relationship w/ a guy who owns a commercial construction company.   He's got a diverse and skilled staff on his payroll,  and I know they've got the ability to do any sort of work that might be required.

Without any particular deal in mind I'd like to approach him about partnering on future flips that require significant work.  My question is how do I align our interests?  Especially re: coming in @ or under budget and on schedule?

I've only flipped on my own in the past, never with any sort of partner, so would appreciate any more general partnership guidelines that might help.

And in the particular case would love to hear some ideas how I can prevent conflict and keep us both on the same team.  Thank you!

Aaron McGinnis · Answer

There is one, and only one, way for partners to align their interests... A very, very simple measure.

"If I hurt financially, you hurt in equal measure. Our investments are parallel."

Law firms often require new partners to 'buy-in' to the firm prior to becoming a partner. The buy-in hurts. It needs to - it keeps new partners vested. They implicitly, and immediately, understand that if they do something that causes the firm to go under... their money is gone like yesterday. Partners need reward, yes... but they also need to have pain in spades if pain needs to be doled out.

The key difference between an owner/partner and an employee, or a contractor? The owner/partner has no disconnect between action->financial result. The employee keeps getting a paycheck until the day that the business shutters.

DO NOT mistake one for the other. A person is not a partner unless they are equally vested as you - if your total buy in to the company is a million dollars, their buy in needs to be the same. If your investment is 100% at risk, their investment needs to be also.

In real estate, the words "Partner" and "Partnership" get bandied about too lightly. People call me up all the time saying, "We're looking for a construction company to partner with" and I tell them... "This word, I do not think it means what you think it means"

If what you want is a shareholder, then sell stock. If what you want is a CEO/Manager, then hire that person and compensate them accordingly. If you need a loan, find a lender.

But do not, for your own sake and for the sake of your money, hire an employee and call them a partner. Or a CEO and call them a partner. Or a Shareholder and call them a partner. It is a mistake and it will cost you most bigly.

And finally? Don't hire a construction company and try to call it a partnership. This is a disaster waiting to happen. A good construction company will tell you what they're worth in the open market - pay it and acknowledge that you are buying a service. Don't try and beat the market by making them a partner... you will lose.

I'd also go a step further and say, don't offer a construction company an incentive based on being under budget or schedule... and certainly don't offer them a split of the profits. You'll immediately twist your relationship into something you don't want. Instead, pay them fair and square for the work they do and reward them by paying on time and not dickering over every single dollar. In the long run, this is a much more healthy way to interact with a contractor.

Aaron McGinnis · Answer

@Mark Allen - I think you've answered your own question here. The guy you want to hire is too expensive for you to hire, and he doesn't really do what you want him to do (IE: Work with investors).

You're falling into a common management fallacy... you think you can make someone into something he isn't by manipulating his income and the terms of engagement. This is not a good plan psychologically as, even if you get him to do what you want him to do, you will pay the price (now or later) for him doing something he didn't really want to do in the first place.

Fiscally, it's also a bad idea. At the end of the day, you're trying to get this person to discount his fees. You think that if you can convince him to take his money later, you can eventually pay him less than what he wants to be paid. He will figure this out eventually and then he'll be enraged and feel like you are cheating him.

If someone does not have a passion for flipping, you should not try to instill it in them. People are who they are, do not try to change them. ESPECIALLY if that person is someone who you want to be a partner... but also if you want them to just be an employee. (1)

So, what should you do? This is easy -

* Find a contractor who wants to work with investors and is priced to do it.

* Don't try to force someone to do something they don't normally do, and take less money for doing it.

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(1) - One of the hardest lessons I've had to learn is that training people or changing people is expensive, time consuming, and rarely works out. Understand that there are a lot of different kinds of people out there. The best way to work with them is to find out what they already like and want to do, and if you need that thing? Pay them for it and you'll both be happy as clams.

Don't hire an artist and then make them be an accountant. Don't hire a carpenter and make them paint. Don't try to hire a GC who doesn't want to flip, doesn't want to work with investors, and doesn't want to cut his pricing expecting him to do those things because it's what you want him to do.

Aaron McGinnis · Answer

@Manolo D. - My design director makes coffee that approaches nuclear strength. I stole a cup and happened to read that right when the coffee kicked in...

Aaron McGinnis · Answer

@Manolo D. - If you're ever in my part of the world, or at IBS or something, we really need to grab a beer. The bitch session alone would be epic.

I believe the underlying problem here is that investors often want contractors to have very, very simple business models. They look at the useless and unreliable (and cheap) contractors and figure that it's a simple model... then they look at a very useful and reliable (and expensive) contractor and start trying to figure out how to get the expensive one to behave (AKA: Price) like the cheap one while remaining useful and reliable.

The problem is that the useful, reliable (expensive) contractor is never going to agree to work for the kind of terms an investor wants in a 'partner' ... the dark truth is that a useful, reliable contractor who has been in business long enough could probably flip houses if they wanted to (many do), and the investor isn't adding anything that the contractor couldn't get through a lending bank.

Also, the business model of even a mid-sized successful construction business is fairly complicated and involves cost models that look like never-ending rabbit holes of complexity... and most investors (most people period) absolutely cannot believe how much it truly costs to be in business, to say nothing of remaining profitable.

Manolo D. · Answer

@Aaron McGinnis Haha, it would be epic, I'll make sure to message you once I land in Atlanta. That is true, I tried to explore one or two but alas, they couldn't believe the cost of doing a real business. There is always a dilemma in a triangle, there's always scope, price, and time, you can only choose two, balancing the three is hard enough for us to do, how much more if we accommodate all 3. I started with a 25k contract and have grown to 150k single in less than 3 years, the cost to keep our lights on with 0 margin is mind boggling as you say it.  You are correct, on a mid sized construction business, a P&L by itself should get you a loan in most banks, I tried to poke around a week ago for Lines of Credit based solely on tax returns and interim P&L and I got a 25k hit on unsecured LOC with no personal guarantee and I am sure it was unverified (IRS takes weeks if they verify) by simply submitting that, P&L and tax returns -- no SSN/personal connection whatsoever; how much more if we submit full docs.

I do believe that there is money in flipping, but I don't believe it will pay enough to sustain the company, unless you are doing hundreds of thousands in renovations or if you do at least an REO and not a 5k renovation budget. Everyone wants to make money, but we also want to pick just the low hanging fruit, if we have to climb the tree, it better be worth it, in my neck of the woods, 100k in 6 months, that should translate to 50k in my pocket after double taxation and everything. Heck, we do a small 60k job with a 25k profit in a week or week half and still feel it's low, I couldn't imagine an investor paying that.

Aaron McGinnis · Answer

@Mark Allen - Not without seeing his books! I will say that legal, skilled, insured labor is extremely expensive though. (Like, mind-bogglingly so. WC Insurance premiums on construction work is confiscatory)

I think a better question is - do you know it to be true or not? If he presented you with a cost statement that said, "My cost for a carpenter is $100/hr. Profit is on top of that", would you believe him... or have any way to really verify what he says?

If not, how are you going to determine if his 'at cost' renovation is really 'at cost' ?

And what does 'At cost' mean to you? Is his management time part of cost? (IE: Does he get paid wages in your partner scenario?) ... or is his pay supposed to be part of the profit share? What about indirect overhead costs?

What if he is making a fat margin? What if his margin is better than your profit on the flip? (Maybe he isn't interested in a profit split because he makes more money than the split would be? ... and as a contractor, his pay is [mostly] assured. As a partner, nothing is assured)

Not being argumentative, think of all this as food for thought. I've been down this exact road that you're thinking about, and it was an absolute pandora's box of problems that blindsided me one after another.

Mark Allen · Answer

Aaron I believe his work is expensive primarily b/c his skilled labor costs are high, not because he's making a fat margin.  In fact I believe his margins are pretty lean.  Do you know this to be untrue?

Aaron McGinnis · Answer

One of these (Bolded) things can be a logical argument for hiring him, but not both.

If straight up hiring this person is so expensive that you're concerned about it, but you think he'll make more money taking a share of the profit (to his benefit), then you have a straightforward math problem that you need to sort out for yourself.

Any tips re: aligning interests when partnering w/ builder?

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