Partnering up on a flip with two other investors. Best practices?

Question

We found this little gem through networking.

A single family house built in 1970, 4/3, 1671sf. It's all brick in a quiet neighborhood.

HVAC has been updated, the roof is older but still has many years of life. with a large back yard and a cause front yard.

The interior will need a total renovation. It has carpeting all throughout (even in the bathrooms).

It has lower quality paneling throughout the house.

The kitchen is avacado green.

It has a step-down living room (that we plan to raise).

The purchase price under 100k.

Rehab under 45k.

ARV around 195k.

I am partnering with two other investors.

We are setting up an LLC to control this project.

We have an operating agreement being reviewed by a lawyer.

We have the documents that contractors and subcontractors will be signing including

(#1- Independent Contractor Agreement

#2 - Final Scope of Work

#3 - Payment Schedule

#4 - Insurance Indemnification Agreement

#5 - W-9

#6 - Final & Unconditional Lien Waiver)

My question is, how would you guys handle the funds?

Would you open an account in a bank with all of the funds for the project deposited into it?

Would you open an account and deposit only what is needed for the next part of the project?

Would you set up no accounts and just operate through personal checks or cash?

Would you not do any of these things?

Thank you so much for your help!

Bob Woelfel · Answer

@Georgui Kasaev...I've only ever done buy and hold partnerships, but I would definitely set up a separate LLC bank account.  You should not be mingling 3 different peoples personal funds in deals like this.  Set up one account that way all 3 partners can see exactly where things are at and where money is going.  I'm not sure it matters when or how much you decide to deposit, but you need to make sure that all 3 partners are depositing the same amount or are on the same page with how this is going to work.

Have you discussed a scenario if everyone is putting in 15k and one of the partners only has 10k?  I'm sure you have but these things come up.  I've also seen a number of flip partnerships go south when all the partners don't agree on the rehab budget, scope or change orders.  I actually just heard a story today from an investor who partnered on a higher end flip in Kansas City.  They thought they were going to make about 60-70k total and around 30-35k each.  Well one of the investors thought that if they spent more on various items they could push the ARV a lot further.  They went over budget by about 80k and ended up breaking even on the deal....all because they didn't agree on the rehab and one of the investors got greedy thinking if they did more they would make more.  Three partners can be a lot of different opinions.  I wish you the best.

Bob Woelfel · Answer

@Georgui Kasaev I don't know if there is a right or wrong way it terms of when to fund and how much.

It's probably more of a paint to split the rehab costs and fund a certain amount for steps in the rehab.  For example, if you split the rehab into 3 different phases then in theory each of you would have to contribute 5k per phase.  The advantage to doing it this way is you will have very clear idea of where you are at financially and where you are in the rehab as it pertains to the finances.  If you just deposit 45k into the account and start drawing down on it as you pay that 45k looks great in the beginning but if you aren't careful you might get to the end and wonder where it all went if you aren't done.  If you aren't experienced it's a little tougher to keep track of it all.

I guess I would suggest doing it in steps and here is why.  Most private or hard money lenders do this to protect themselves.  When a portion of the rehab is done they will release funds to cover that portion.  Every piece of the job that gets done will increase the value of the property.  This way if the deal went south and they had to foreclose it shouldn't be that hard to either sell it as is or pick up the rehab where it left off and finish.  It's a protection mechanism.  How it might work for you guys is it might help draw a line in the sand on the rehab and money spent so far should the deal go south.  I hope that makes some sense.

Braden Klope · Answer

*I'd like to preface this with stating that I have not personally found my first investment deal yet, I am just actively searching/continually trying to learn.*

I am about to form my own LLC to protect assets and help organize financing for loan/tax reasons, and my thought process behind funding all business costs is this:

• I will open a business checking account with my local bank in the name of my LLC.
• All profits from any investment deal will be deposited there first before withdrawing my own "salary" or living expenses out. I feel like that would help a lot during tax season and also give me more organization with any business transactions that occur.

As far as funding the first deal with your partners' money, I would expect that it would work in the same way: to pool all money equally in the business account to fund the project (at the beginning of the deal). That way there is a record of everything and you don't have to worry about one of the guys refusing to pitch in his 1/3 three months down the road when the reno is going full-force.

P.S. If there is a serious flaw in my thinking, please feel free to point it out to me, as I am always open to constructive criticism in this area.

Georgui Kasaev · Answer

@Bob Woelfel Thank you so much for participating! Yes, that actually makes the perfect sense. Basically, the entire job should push off the detailed scope of work. Brake everything off into sections first purchase and the amount needed to do start the demo. Then as the demo starts, go ahead and deposit the next portion of rehab... so on and so forth that make sense. Thank you so much.

I think since we haven't signed the operating agreement yet I am a bit worried that someone might back out in the middle, but once that is signed we will all know what we will be doing if someone decides to back out.

Would love to hear more from you guys. This has really been educational! And I am sure I can just go read a bunch of posts about this but talk to people is way more fun!

Georgui Kasaev · Answer

@Braden Klope Thank you for participating. Congratulations on starting your investment carrier. Your plan for the formation of the LLC and the setting up of a bank account is a great one. I like that you are following the "pay your self first" train of thought. If I may suggest you should set up more then one account. If you ever read the book The millionaire real estate agent, not the millionaire real estate investor, then I'm sure you read the part where he brakes down how your accounts should be set up. I think he suggests 4 or 5 accounts. 1 to deposit the proceeds. 2 to dedicate for taxes. 3 business expenses other than marketing. 4 marketing. 5 your salary. I am paraphrasing but you get the gist.

I guess my worry is that because I am a licensed real estate agent if I want to set up a bank account to hold other peoples money then I have to report that account to the Georgia Association of Realtors. Which is not a big deal just a lot more paperwork. But I do not know if this rule is applicable for investments. Or just when you are dealing with earnest money and rental deposits.

Also, how do we disperse funds after the end if there are some left over? I am sure it's not as complicated as I am making it in my head but, knowledge is power. So I'm trying to get as powerful as I can before moving forward.

Georgui Kasaev · Answer

@Bob Woelfel Thank you so much for your response. We are actual flipping this property. The documents mentioned above are helping us to define the relationship and make sure we know what we will do in the event of the entire project going south. The operating agreement and the scope of work will be agreed upon with everyone.

My big question is, on how to handle the deposition of money and the accountability for the deposits. Do we all put the entire sum of our part of purchase and rehab or do we deposit sums big enough to cover the next part of the project? I can see positives and negatives to both. Thank you once again!

Partnering up on a flip with two other investors. Best practices?

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