Forming partnership of 6-10 people

10 Replies

Forming partnership of 7-10 people...(closer to 6-7)

So a few colleagues of mine are interested in pooling money every month to form a buy-&-hold rental company that would buy rental properties every few months. Thoughts on formation, best way to split, responsibilities, resources for this topic, etc. Any tips would be great. If you know or have done a partnership like this, please give me your thoughts and ideas.

Questions I have:

  • How to split ownership?
  • If one or more people end up not wanting to contribute to buy more properties, how is share split up then?
  • Forming LLC: how to contribute money monthly to business account from each member? Allowed? (capital contributions? Shares?)
  • Decision making?
  • If we decide to have payout every month; process?
  • Or should keep in business account? (assuming we have savings for 6-12 months bills)

Many, many, other questions; I’ll start there.

We are in NC- we all make same salary (for now)- relatively same goals (for now)- Same age group

Any info would be helpful,

Thank you,

Chad 

Profits should be distributed based on shares invested in entire business regardless of whether they invest in a particular house or not.

The more troublesome issue is how to reimburse the member who inevitably will put more personal effort into the business.  There is either a division of labor or someone will need to receive some small salary as general manager.

With that many people involved you really need to work with a securities attorney to do a formal private placement memorandum, operating agreement and SEC and state filings.  There is a VERY good chance one of you will end up dissatisfied.   If you assume that won't happen, you will be in trouble when it does.  If you assume it will happen, and do your paperwork correctly you'll be protected when it does.  Unfortunately, its not cheap to do this right.  I've heard numbers ranging from $10K to $25K.

The issues you mention are just a few of the ones you want to address.  What if one of you dies?  Gets married?  Gets divorced?  Desperately needs cash?  What if the group needs cash and someone can't ante up?  What if one of you gets sued and loses?

I know NOTHING about this topic -BUT- there was a podcast I heard not too long ago about this exact topic by Matt on his Epic Real Estate Investing podcast. It was episode #140 and he spoke about partnerships with larger groups of people through the use of hedge funds. Check it out. I think it might help.

Thanks @Jon Holdman & @George Creel

Yea seems complicated. I didn't expect to hear > $10k just to form. I wonder if there is a sound way to do this without that amount of starting capitol.

Any other Ideas, answers, thoughts?

& @George Creel- so we were thinking contributing $x amount to the company /month. can this be a capitol contribution to the company? So, $x dollars X 7 people - 7 contributions /month? or should it just be one from like a trust account or something; dont want to co-mingle? 

If $100,000 is raised as a group, and an individual gave $7,000, then he has a 7% share of profits.  If another $100,000 is raised by the group, but the individual did not give additional funds, then his share falls to 3.5%. (ie 7,000/200,000).

You would only have to track total individual and total group contributions to calculate percentage ownership.

Profits are given out based on percentage ownership of group.

When you're forming a partnership like this you are "selling securities".  That's where the complexity comes into play.  Two people could probably do this OK, though I can tell you from personal experience even two people will have conflicts.  With six, its inevitable.  That's why you need formal documentation about how the business will work.

If someone thinks they've been treated unfairly and you end up in court, having the proper private placement memorandum will be important, too.  Someone could claim they were suckered into putting their money into a deal they didn't understand.  The private placement memorandum will say something very close to "This is a bad investment.  You will likely lose your money.  You will not be able to get your money out.  Only a fool would invest in this deal.  I acknowledge I am a fool."

As far as division by far the simplest thing is to have everyone contribute the same amount of money and receive equal shares of profits.

Even that is not as simple as it looks.  Each person will be taxed on their share of the profits.  Whether those profits are distributed or not.  If the company chooses to retain profits, say to do more and bigger deals, the members are still responsible for taxes.  The partnership will file a tax return and distribute K-1's to each member.  The members then use those on their taxes.  Your operating agreement should cover how this will be handled and when (or if) money will be distributed.

Over time, you may need more money.  Some may want to put it in, some may not.  Now the shares are unequal.  Now it gets messy because part of the year you had a certain amount of capital contributions with one set of percentages and part of the year there are different numbers.  If you do this repeatedly, it gets even messier.  That's OK, just adds complexity to your accounting.  At the end of the year when you do your taxes you'll report each member's share of the capital, profits and losses.  Those numbers can all be different.  And, if the investments change in the course of a year, they will be.

Consider two people who each put in $500 on Jan 1.  Each gets 50% of profits.  You make $50 in the first half of the year (that's a 10% return, by the way, which is pretty good for rentals).  So, each gets $25 of that.  On July 1, one person puts in another $500.   So now one person has 66.67% of the capital in the company and the other has 33.33%.  And profits starting on July 1 are split accordingly.  In the second half of the year you have profits of $75, of which $50 goes to one and $25 goes to the other.  In total for the year, one person earned $75 and the other earned $50.  So, at year end the capital split is 66.67%/33.33% but the profit split for this year is 60%/40%.  If you have six people putting money in and taking money out your accounting will be quite complex to keep that straight.

You have to get all that sort of thing discussed, agreed upon and documented in detail.  If you cannot do this up front, you're not going to be able to do it when the company is stressed. 

Utah Series LLC, regardless of which state the real estate is in. The member of the master LLC is the property/job management entity (another LLC), along with a deep-pocket investor who you know and trust and will participate in each deal. The operating agreement (which must be a custom agreement - no getting around that) for the master LLC states that the management entity of the master will also be the management entity of each series, unless otherwise noted in the individual series agreement (which must also be customized at least once).

The members of each series consist of one or more of the following:

  • The investor(s) funding this particular series, and
  • The person(s) providing rehab/remodel labor to this series, and
  • The person(s) providing administrative functions (management - already covered)

In addition, there are so many other provisions to be worked out that it isn't even funny, nor can someone attempt this on their own.  You'll likely need two (or more) classes of membership interests, and possibly more depending on how each element of the interest is being divided (voting rights, equity split, tax deductions, long vs. short term capital gains, etc).  Of course, you'll need a Separate Series Operating Agreement and an Agreement to Terminate Series for each such operating agreement.

The master operating agreement for Housing for Humanity, LLC (of which I'm essentially its manager via my management entity) is more than 50 pages, out of necessity. Expect to pay $15K for this if you know what you're doing, and $25K for it otherwise (if the attorney has to guess as to your every need).

Chad, it's important to note a distinction here: you only need to go the SEC filings route if you're soliciting people who aren't close friends or family or are soliciting more than one million dollars. 

The SEC filings quagmire is meant to protect you from preying on people who don't know any better than to throw their checkbook at you. Friends and family are ok, whereas soliciting strangers or people you meet at real estate functions isn't. Since it sounds like your partners all work with you and everyone knows each other, a 7-10 member LLC is a perfect vehicle for accomplishing your goals. You could likewise do it with a Series LLC, or a Corporation, it depends who sets it up, in which state. In Utah the going rate for a Series LLC is $800-1000, PM me if you want more info/specifics.

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