How do we have a fair split of a partnership

Question

My partner and I are interested in entering into a partnership finding below market real estate, improve, and then rent out or flip for a profit. Assuming that we each split the up front cash needed 50/50, my partner has recently retired from his full time job and able to act as a general contractor role dealing with all aspects of on the ground work, however, I am the one who is still employed with a decent income from W-2 (my partner also has maxed out his credit due to his other real estate endeavors) and therefore, the plan is for me to obtain finance if the deal is financeable or, if not financeable, we will each contribute equal amount of cash, and then cash out refi using only my credit.

My question is - how to fairly partner up considering our situation? I would think 50/50 make sense but on the flip side I am a bit concerned that only myself is on the hook for the loan, assuming LTV of 70%, I am thinking I would have 85% of skin in the game as my partner would only risk his 15%. Anyone can chime in to shed some light to help me come up with a fair split?

My question is - how to fairly partner up considering our situation?  I would think 50/50 make sense but on the flip side I am a bit concerned that only myself is on the hook for the loan, assuming LTV of 70%, I am thinking I would have 85% of skin in the game as my partner would only risk his 15%.  Anyone can chime in to shed some light to help me come up with a fair split?

Dave Van Horn · Answer

@Tony Wu

You're right, you would be taking a lot more of the risk than your potential partner in this scenario so my question is: Why give up any ownership when it sounds like  all you need is a general contractor and maybe some capital (i.e. private or hard money)?

Speaking from experience, partnerships are tough. The roles, responsibilities, and compensation need to be clearly defined right from the outset.

Best,

Dave

Tony Wu · Answer

Great advice, thank you Norm, John, and Dave!

Norm Park · Answer

Tony,

Both of above sound like sage advice and from the podcasts, Dave Van Horn is a RE "savage".

I am not nearly as experienced, however, I entered into a partnership with someone that I met on BP. I essentially am the financier and my partner and his wife (RE agent) know the area that we bought very well and is the GC for the project. Since he has experience doing flips, he contributes market knowledge, experience and has the relationships (the contractors to do work, the type of work that will yield top return, etc).  We will split the profits 50/50. Some may say that I have a lot more skin in the game, but the way I look at it, I am paying for his experience and knowledge. He could easily do this with hard money, but this way he gets a better return. I see it as win/win with limited risk.

I had to find an attorney in the area of the project that helped me draw up the terms of contract. This is where most of the work will be required. You have to really analyze where the project could go bad and have contingencies in place in case you run up against them - i.e. the house doesn't sell, you have unexpected costs during projects, what the SOW of the project will entail, what your marketing costs are (his wife as an agent will help minimize these costs), what if something unforeseen happens and you cant finish project, whos name the house will be under, and that might determine who will be able to pull permits if needed, etc.

Anyway, you should spend A LOT of time going over "what ifs" and sit down with your attorney and pound out these details. Then I gave the agreement to my partner and his attorney approved it and then we started from there. It seems easy until you sit down and start hashing out all the details. Remember that the devil is in the details.

The good thing is, that once you formalize your working agreement, you can essentially keep using same agreement with minor modifications.

I am going to see the finished property in a few weeks. I am very excited. Trust me, it wasn't as smooth as I am making it seem, however, once the house is sold, it will be worth it. And hopefully we will be able to do it all over again.

I hope this helps.Aloha

John Jacobus · Answer

@Tony Wu You have many options here and there are no set rules regarding the treatment of situations such as yours.  You are making the financing possible by utilizing your personal credit and balance sheet.  Your partner would most likely argue that he is allowing you to achieve significant cost savings on your deals by acting as the general contractor as opposed to hiring an outsider.  Both of you are making critical contributions to the partnership, though it is fair to expect an additional boost to your ownership stake relative to his given your role as the loan guarantor.  Ultimately, it's critical that you reach an agreement that you and your partner think is fair.  Additionally, before you move forward with the conversation, be cognizant of the risks to the partnership that you face by attempting to negotiate for a few additional percentage points.

In multifamily deals, I've seen a flat "guarantor's fee" paid to a partner who is brought in for the sole purpose of signing on the loan and bringing their personal balance sheet to the deal to satisfy the lender's underwriting requirements.  This fee can be 1-2% of the purchase price of the property.  Pursuing this approach would mean that you would receive 1-2% of the purchase price of the property at a time determined by you and your partner, though typically at the time of sale.  The remaining profit from the deal would be distributed 50/50 between you and your partner.

Alternatively, if you wanted to keep things simple, I think it would be fair to push for an additional 5-15% split as a result of your role as a loan guarantor.  This would result in a 55/45 to 65/35 split of all proceeds from your deals.

In my opinion, I would not jeopardize your partnership over a few percentage points, which is what your role as a loan guarantor is worth.  While it is completely fair for you to attempt to negotiate a larger relative stake in the partnership due to your role as a loan guarantor, I'd argue that your focus should be on getting started and building momentum with your partner.  When you gain more experience and/or your needs change, you may be in a better bargaining position, in which case you could negotiate a more favorable split for yourself.

How do we have a fair split of a partnership

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