Contractor is equity partner, pay him hourly too?

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Contractor is equity partner, pay him hourly too?

Ken NyczajPro Member
Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes

Hey Everyone,

Settlement is next week for my first flip. I have some questions about how our profit/ payment structure is setup, here are the details:

--- 4 Owners in an LLC taxed as an S Corp

--- Myself and 2 other people have 30% equity ownership and the fourth has 10% equity ownership.

Currently we have agreed on that the GC/ my friend/ business partner who is a 30% owner, gets paid every two weeks an hourly wage but that payment is deducted out of his profit he receives at the end.

Should these hourly wages not be deducted from his profit and he makes profit plus hourly?

At first I thought no, because he brings the contracting to the table and has relationships with subs but, I've done the self prepared DM marketing campaigns, taking phone calls, building rapport with prospects to sellers, finding the deal, building our team (lenders, title, insurance) for the past 6 months, and did not get paid for any of that work. And, I will not be getting paid hourly for my continuous efforts in building a massive marketing campaign. Plus I will be helping him work on the house on the nights and weekends when I'm not at my full-time job.

That being said, this is now his full-time job where he could be putting in 40-60 hours a week, which certainly will eventually add up to more time than I've put in.

Is this a fair way to structure the deal? Should we be paying ourselves hourly for any work done in the business? Instead of hourly, should we set up an incentive program for him where he can make bonuses for money saved by using him opposed to subbing work out?

 Any advice would be appreciated.

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Bryan Devitt
Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
8y

In the end the GC will be working I'm sure 40, if not 50-60hrs a week on the deal and every deal after that. If it is a 2 month deal then he'll have 320hrs into it at least, if not 400+. How many hours will the lawyer have into it? How many will they have on each deal after this because most of the paperwork and knowledge will transfer over. Same with the other people doing similar work. Their job gets easier over time, the GC's stays the same. If you're putting in hours doing labor to help and it is just you and the GC doing the work that isn't being subbed out, that should be factored in, but really all of this should have been written into the deal before anything was even started. I assume the GC is at least a competent lead carpenter, so if the deal loses money or breaks even the other investors lose 10 - 20hrs of their time. The GC normally has that just looking at the properties before anything is purchased. Then he'd lose another 2 months of pay, while everyone else has a job. Even if the deal goes good, there is a good chance that splitting the money so many ways the GC will lose money compared to what he would make if he just worked for someone else doing the same thing. Either way, this is something that should be talked about with the GC and if he isn't smart enough to know his own value and do the math, that is on him, but if I were you, I would feel like I was taking advantage of him

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  • Edward B.
    Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    8y

    @Ken Nyczaj, you can honestly do it any way you want. There is no industry standard here. I would say that if it was a successful deal then I would do whatever it takes to maintain the relationship. 

    I like to keep things relatively equal, but if someone is bringing expertise to the table that adds value you otherwise wouldn't have realized then they should be compensated accordingly. For example, I am a licensed real estate agent so if my license makes the deal more profitable should I have to split that with everyone else? After all, if I wasn't there then we would have to pay a real estate agent the full amount for that expertise. However, that is always made exceedingly clear before the deal begins so there are no misunderstandings.

    So without knowing what was said, implied, or expected with your friend. I would have structured the deal so that any work he did that you all would have otherwise had to pay for would be paid to him as an expense subtracted from the divided profit. Seems fair to me, but your situation may be different.

    0Reply
  • Matthew Paul
    Severna Park, MD · Member since 2013 · 7k+ posts · 7k+ votes
    8y

    Look at it this way ,  if your friend didnt exist , you would be paying a contractor . True he has a stake in the outcome . But 30 days without income is hard to swallow

    0Reply
  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Edward B. Appreciate the response. All four of us agreed upon him only being paid 30% of whatever profit is received. Some of that is paid in two week pay-checks, the remainder is paid out when the property is sold.

    It makes sense how you would structure the deal, except for the fact that I'm also over there as a laborer (much less skilled laborer but I'm there nonetheless). And it starts becoming convoluted the more people that start getting paid out of the profit.

    Just an equal equity pay out at the end would be clean cut, but if we save a lot of money on the rehab then maybe paying him for his expertise would make sense. I honestly don't know at this point.

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  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Matthew Paul Yes, we would be paying a contractor no matter what, and that is what he brings to the table as his expertise. Another partner is a lawyer, and the fourth partner is doing our taxes and bookkeeping while I'm on the marketing/ deal analysis end. We all bring in our own expertise to the company, and I can't yet wrap my head around that he would be the only one getting paid for his time. We could all start charging for our time, but again that would further complicate the matter.

    He will be getting paid every two weeks which in the end will be deducted from his 30% share of the profits earned.

    1Reply
  • Edward B.
    Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    8y

    @Ken Nyczaj, totally understand. If that is what was agreed upon and he is cool with it, then no worries. Sounds like he is bringing  a lot to the table, though, so moving forward maybe consider a different arrangement. Otherwise, he may realize that you need him more than he needs you.

    It gets a little convoluted but it's fairly easy to distinguish what the deal would be worth if you farmed everything out vice relying on people who are bringing more to the table. I can very easily quantify what my license brings to the table as I am sure your contractor friend (or anyone for that matter) can. I can also probably pretty easily quantify what your unskilled labor is worth :) and tell you that you are probably better off finding the next deal.

    It costs money to maintain licenses and so our costs for bringing more to the table are more. Something to consider. So we are burdening all of the costs associated with all of the profit that is being split. 

    Literally, just pretend like you have to pay a third party for everything to determine your profit. If someone has expertise that saves on that expense then they should be paid for it accordingly. If you do this enough you all will probably find that your time is much better spent finding and working deals than actually doing the work on deals. 

    Sounds like this guy adds a lot of value. I only say that because dealing with contractors is a PITA so if you have one on your team he is worth his weight in gold in my opinion. Keep him happy if he is a good dude. If he is cool on this one then fine. But I would make sure that he is fairly compensated for his extra time, expertise, and expense going forward. Same with any of you that bring something special to the table. Any of you can be replaced for a cost. So what is that cost? Don't ignore the trust and bond factor, but understand that it may not be a total equal split and all you have to do to break it out is pay the guy what you would have had to pay a third party to do the same thing. Otherwise you are taking advantage of him and his expertise.

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  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Edward B.You're right, he's definitely worth his weight in gold. What you say makes sense and after this first deal we will see how it goes and figure out how to pay ourselves for each process we bring to the business. The eventual plan is to find a team that can take over these processes so we can step out of the business and work on it not in it. 

    I'll follow up next week after we close. Thanks for the guidance.

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  • Tammy Graham
    Winamac, IN · Member since 2018 · 8 posts · 2 votes
    8y

    How did you arive at his 30% share? Did everyone contribute capital in the beginning and this was his percentage of contribution? If so then I would say his labor is additional to that...as would be the other members..You mentioned you were set up as an LLC not disregarded...so are payroll taxes being withheld from his checks or will he be issued a 1099 for his payments?...if he is a member of the LLC I'm not sure a 1099 would work...just some other facets of your arrangement to think about.

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  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Tammy Graham Shares are based on capital contribution towards the property. We are using bank financing so each member is responsible to pay the down payment plus closing costs equivalent to their percentage of interest in the company.

    As far as the payroll taxes or 1099 that is something our CPA will be guiding us through. And, he has recommended us to be filed as an S-Corp for tax reasons.

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  • Tammy Graham
    Winamac, IN · Member since 2018 · 8 posts · 2 votes
    8y

    It seems with that arrangement that paying him wages on top of his ownership share is the fairest way to handle it then.  As an s corp you need to be paying payroll taxes and owners are considered employees for that purpose..just pointing it out because taxes should be withheld from the paychecks and remitted to the state/fed...check with your CPA right away so you don't miss filing deadlines...

    1Reply
  • Bryan Devitt
    Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
    8y

    IMO if he was just running the jobs and hiring subs for everything, then 30% is fine. If he is doing the work himself and hiring subs on top of it, he should be paid for his time he does the work and then his profit covers his GC work. If he just decided to sub everything out and not do the work himself, would he not get paid at all?

    1Reply
  • Matthew Paul
    Severna Park, MD · Member since 2013 · 7k+ posts · 7k+ votes
    8y

    @Ken Nyczaj  4 partners involved in a flip . Thats a lot of opinions to deal with .

    Where did you find a place ?

    0Reply
  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Tammy Graham I don't think our CPA would let us miss any type of deadlines. Our lawyer knows and works right next to him so we should be covered on all this. 

    @Bryan Devitt If he subbed everything out he would still share in 30% of the profits, as he put 30% of his own money into the deal and still has the experience/ relationships to the subs which is his expertise he brings to the company.

    @Tammy Graham @Bryan Devitt What about everyone else's time that was spent leading up to the point? Lawyer creating contracts/ operating agreement, tax strategies. Myself building a marketing list, marketing campaign, building relationships with sellers- taking calls, having coffee etc, finding the right network of lenders/ title companies/ insurance that are willing to cater to our needs. Some of these may be harder to quantify but any wholesaler knows building a campaign from scratch does take time and it took me 6 months to get one deal under contract. I expect better results in the future as more deals are coming through the pipeline but that momentum took many early mornings, late nights, and about every weekend.

    @Matthew Paul In the Annapolis , Maryland region. Modest calculations show more than 20% profit off of the ARV to be more than likely. With 4 people, risk is spread and there's enough meat on the bone if we buy deals right.

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  • Account Closed
    Lender · Pensacola, FL · Member since 2017 · 658 posts · 626 votes
    8y

    You might want to look into Department of Labor rules about the payment of wages. They might take precedence over the distribution of profits.

    I'm not a lawyer, but I remember back in the early 1990s when California issued IOUs to everyone, including its workers. Then I read where the DOL ruled that issuing IOUs to workers was against the law. Then in 2009, California again issued IOUs, but paid its workers in cash (paychecks).

    Coffers Empty, California Pays With I.O.U.’s

    https://www.nytimes.com/2009/07/03/us/03calif.html

    0Reply
  • Susan K.
    Real Estate Agent · Palm Beach Gardens, FL · Member since 2017 · 205 posts · 124 votes
    8y

    What is the estimated time to complete the flip?  Is the GC going to be tied up for 1 month, or 4 or 5?   If this is something basic and he is out in a month or two then he's probably going to be ok with it, and since he "agreed" he must be.

    We had partners on a flip before and as the GC we were paid an hourly in addition to our profit split.  Since I am directly involved in both sides of the business (Realtor and GC) my personal experience is the contracting side is more difficult and stressful.   

    0Reply
  • Keith Weigand
    Rental Property Investor · Cleveland, TN · Member since 2015 · 176 posts · 58 votes
    8y

    @Ken Nyczaj I also have a GC as a business partner in our new construction and rehab deals. I guess mind is simpler. We just put in 50/50 cash for the land or the house. He manages the GC work, hiring subs etc. We split all bill during the building or rehab phase. At the end, we simply split the profits 50/50. He recently became a licensed real estate agent so now he will list the properties and get his 2-3% (which we would have to pay anyways). So basically we split everything 50/50 (expenses and profits). We just pay for legal and accounting services, if neeeded.. We don’t include them as partners. If we needed more capital, maybe but we pay cash for our jobs between the 2 of us alone.

    1Reply
  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Susan K. estimated time is 2 months. The labor intensive part will be roof and tearing up carpet and installing new floors. I’m helping with roof 100% of the time and floor when I can. We are building a new deck as well, small deck that’s only four foot high.

    Painting, crawl space, sheet rock work, tile for kitchen and bath will all be subbed out. We will demo the two bathrooms and kitchen as well, but we are keeping kitchen cabinets and having Painter paint them.

    0Reply
  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    8y

    You didn't say what the specific deal is, how much work it will take, time frames, and what is required, so it's hard to give a good answer. Who is funding the deal? What will each partner contribute? 

    In most instances, a general contractor is going to put in far more hours and have a lot more responsibility than a real estate agent, attorney or bookkeeper would, unless he's just being asked to do minimal project management. 

    How much real time do you think each of the partners will have in on the deal. Time devoted specifically to the required work for the deal? A GC that works on the job, manages subs, gets permits, works with engineers, designers, etc. will have substantially more time into the project than the rest of you combined, easily. 

    Just try to come up with a realistic balance based on actual time and effort that will be put in. 

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  • Tammy Graham
    Winamac, IN · Member since 2018 · 8 posts · 2 votes
    8y

    Hi Ken..I agree with you everyone is putting great effort into the project...but you mentioned the GC was Her to g weekly or biweekly payouts so that's why I focused on that.. I am an enrolled agent which means I'm licensed by the IRS to represent people with tax problems. I was just pointing out that the regular payouts might be construed as wages by the IRS.  Good luck to you all...sounds like you have a great team put together!

    0Reply
  • Bryan Devitt
    Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
    8y

    In the end the GC will be working I'm sure 40, if not 50-60hrs a week on the deal and every deal after that. If it is a 2 month deal then he'll have 320hrs into it at least, if not 400+. How many hours will the lawyer have into it? How many will they have on each deal after this because most of the paperwork and knowledge will transfer over. Same with the other people doing similar work. Their job gets easier over time, the GC's stays the same. If you're putting in hours doing labor to help and it is just you and the GC doing the work that isn't being subbed out, that should be factored in, but really all of this should have been written into the deal before anything was even started. I assume the GC is at least a competent lead carpenter, so if the deal loses money or breaks even the other investors lose 10 - 20hrs of their time. The GC normally has that just looking at the properties before anything is purchased. Then he'd lose another 2 months of pay, while everyone else has a job. Even if the deal goes good, there is a good chance that splitting the money so many ways the GC will lose money compared to what he would make if he just worked for someone else doing the same thing. Either way, this is something that should be talked about with the GC and if he isn't smart enough to know his own value and do the math, that is on him, but if I were you, I would feel like I was taking advantage of him

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  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Karen Margrave I believe most of this was covered in follow-up posts. But here are the quick points:

    1-2 months and the most labor intensive part will be new roofing, demo of kitchen and 2 baths, new deck and tearing up carpet and putting in flooring. All of which I'll be helping with.

    Bank is funding the deal, partners are split 30/30/30/10 and we all put in 20% down plus closing costs.

    I'd agree that yes, on site he'll have more time, but it is our first deal which a lot of learning, thought and time was put into creating a marketing machine on the front end.

    0Reply
  • Ken NyczajPro Member
    OP
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    8y

    @Bryan Devitt We do have an operating agreement between the LLC, but for this specific deal we just hand shook on the terms. I'm close friends with the GC and word is bond.

    Remember we are paying him every two weeks but out of his profits, so he will not be w/o a paycheck and will be paid regardless if we profit or lose.

    He definitely didn't spend 10-20 hours looking at houses. Again, that's my position, marketing, speaking will sellers, setting up viewings, negotiating, tracking leads etc. Yes maybe it's not manual labor, but mentally it takes perseverance.

    As far as taking advantage, you are incorrect. It took us 6 months to get to this point and I slaved every weekend building, tweaking, licking f'ing envelopes to get to one deal. Plus, for all the labor intensive work- Roofing, Demo, Flooring, Scrubbing smoke off walls, building a deck, I am helping and not getting paid 1 cent nor did I get paid 1 cent for the countless hours I've had until this closing. And I'm fine with that.

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  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    8y

    @Ken Nyczaj I'm a licensed general contractor and real estate agent. I have put deals together (from locating land, worked on the design from concept through final, worked on finding tenants to lease, and buyers for the sale of end project, plus lined up the financing etc. I schedule subs, get bids, list properties, sit on open houses, do marketing, etc. (projects varied from SFR , office/retail condos, office buildings, and office parks). I will tell you that the GC portion, if he is working physically on the jobs, scheduling subs, and project management, is much more physically and mentally demanding than the business side of the deal (real estate/ marketing/legal). In all fairness he should not be required to take his profit for his labor. Is he a partner, or buying himself a job? Because from the sounds of it, he's buying a job, not being compensated as a partner.

    2Reply
  • Andrew S.
    Real Estate Agent · Baltimore, MD · Member since 2016 · 37 posts · 12 votes
    8y
    It seems like your getting upset that people are telling you the realities of being a general contractor vs doing the business side of things are more strenuous physically and mentally. Fact is it’s true, I am a contractor myself and I have a partner who strictly does the paperwork side of things, while this works for us the truth is I spend a lot more time and effort on my end. Every project has surprises, even in new construction. You came here looking for others opinions on your business dealings, they’ve giving you a honest answer. Nobody here will likely say that the time/hours put in are equal, but if it works for your partner and you then that’s all that matters. As I said my partner doesn’t do any labor while I do but it works for us..
    1Reply
  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    8y

    @Andrew S. but the question is about him being compensated for his labor with "his profit". Do you do that too? 

    0Reply
  • JC Biggs
    Member since 2018 · 6 posts · 0 votes
    8y

    You guys all know much more than me, but my philosophy has been "do the math."   Lay out the numbers, and when you get to the end, see if they make sense and are fair.

    Scenario,

    You bought 100k Home.  Put 20k into it (10k labor and 10k materials) and now its looking to sell for 220k.    If you payed a contractor, then you would each be sharing that  20k worth of cost and nothing changes other than everyone makes a little less.   However, because the partner-contractor is responsible for that 10k worth of labor, now he mathematically has his 30% skin in the game, plus 10k.  Thats 10k beyond what any of the other partners pay.    To be fair,  I personally would either A) pay him 70% of that 10k -thus ensuring all partners had equal stake in all cost, or B, adjust the amount he had to pay to the bank down by 7k to compensate him for his time, while still giving him 30% Share.   If he absolutely has to have a check every week, I would still separate  the labor and the equity.  Pay him 70%  for his labor, and when the labor is done, and you're waiting to sell pay him from his share of the equity.  (quite honestly, his value is worth more than the other partners and its a small sacrifice to keep that talent)

     That's just me though.  If he said "yeah Ill do all this work and just take my 30%"  then that's on him. Just make sure you have a  long pointed conversation about it when its time to settle up.  While you guys are getting your $40,000 checks, he might be getting $12,000. even though he already got paid, it doesnt feel like it when you see the check.     

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