Partnerships and Profit Sharing...what are the rules?

Question

I am new to Real Estate investing and have an opportunity to work with someone I trust very much and want to go into a partnership with.

What are the accepted or typical profit sharing arrangements when one partner funds and does very little boots on the ground work and the other partner does most if not all of the "work" but puts in zero or a small amount of capital to a fix and flip?

And a slightly different scenario...What if one partner does all financial analysis, negotiates purchase price, handles any funding issues (or even self funds the purchase and rehab) and the other partner acts as the contractor with zero or small amount of capital?

In either scenario one partner may find a potential deal sometimes and other times it will be the other partner. Both partners are planning on looking for potential deals.

Thank you to anyone that has insight!

Lawrence Potts · Answer

I agree with @Darius Ogloza, if one partner is in need of immediate cashflow (as most contractors are), this can cause a lot of tension between the partnership. No matter how professional you two are to each other, that can always make a deal fall apart.I've done partnerships with 50/50 equity splits, I've done more creative ones, but the easiest ones are the ones that you can get in and out of the fastest. Time is the biggest killer of any deal when working with partners and that's something to consider. If your contractor is a business owner of his own contracting company, this deal may not be as high of a priority to his crew and he may wait to do the work until the weekend. And if you are liable for the holding costs, this may create tension for you and you may put unwarranted pressure on him that can cause the partnership to fall apart. There are so many things to consider.The best advice I could give is pay for a long consultation time with an attorney and create an operating agreement between you two (since I'm assuming this is a partnership that you want to carry into future deals). A good attorney will ask you two a lot of questions that should cover any and all potential situations that could happen in this deal that you two need to communicate between each other of how you'll act and perform and what to expect from the other. Highly recommend this!!! Hope that helps.

Darius Ogloza · Answer

The chief obstacle to equity split deals is (granted, in my limited experience) that folks who are used to getting paid for their time often jump at the chance but have a hard time deferring financial benefits until closing. That said, a well-resourced contractor might just bite for a hybrid arrangement including bonus paid in equity.Key questions: who will be responsible for making down-payment + closing costs? For paying carrying costs as these costs come due? For materials?For permits/licenses? For subcontractor labor (and materials)?Whose credit will be used in case there is a shortfall prior to project completion?What consequences to equity split if project fails to complete on time? What consequence to equity split if contractor fails to timely complete milestones?What happens if the contractor walks off the job mid-stream? Who is responsible for compensating contractor for stolen tools?These are but a few of the issues you need to work out in a written agreement.

Darius Ogloza · Answer

We have been involved in similar situations on a dozen or more deals. In our experience, paying market rate for contractor-type services (perhaps with a small discount and a smidgen of equity) has proven to be the most effective arrangement. Providing equity for work alone too frequently resembles the situation where a tenant offers to perform work in lieu of paying rent. The work is seldom timely performed, is often shoddy and left uncompleted. Equity for cash is, in our experience, the way to go, especially if the equity partner is responsible for financial analysis, maintaining the books, identifying target properties and negotiating the buying and selling.

Jessica M. Leak · Answer

Yes, thank you so much for the feedback!

Jessica M. Leak · Answer

That is all incredibly helpful. Thank you.

Jessica M. Leak · Answer

Thank you for responding Darius, really appreciate it. I'm in the Bay Area btw. A key side note, my interest in creating some equity opportunity with just this one particular contractor is because I do not live in the area where they work and live, but the area is ripe for fix and flip if you can close without having to secure funding first. We have very high levels of trust, etc With all taken into account does this sound like a reasonable strategy:Find a deal: If I find the deal, great, if my contractor partner finds the deal I'm thinking I'd like to pay a finders fee bonus of $5k maybe up to $10k upon sale of the property. Manage the Business: Deal Analysis, Submit packet for financing when applicable, Maintain Financials, Secure Insurance/Legal advice as needed, Negotiate both purchase and sale and so on.Partner with Contractor for Rehab: Pay the contractor market/negotiated rates for labor and if Contractor wants to put Cash then allocate that % of profits plus an additional --% for completing work in agreed time frame and generally supporting the deal with initial inspection, meeting with the realtor at the property face to face as needed, etc.It's really difficult to put a number on the value of having someone engaged "boots on the ground". I want both of us to really have an upside on this partnership but I'll be doing the heavy lifting on the Finance/Business side and they'll be doing it on the Rehab side. Right now, it feels rather arbitrary. So, ultimately, I have to probably do some analysis on my opportunity cost. If I focus my attention elsewhere, maybe I could turn a larger ROI, but the value of having a trusted partner may be worth a lower overall return because it will be repeatable. Sorry, thinking out loud now, any input is super appreciated.