Equity Partnership With Out-Of-State Investor

5 Replies

Hello all. I'm working to purchase a few smaller multi-family apartments and in order to do so I'm looking to partner with an out-of-state investor. I've discussed this with a couple investors I've worked with and want to move forward. My partner is going to bring more of the upfront cash but I will have a significant amount in it as well. For the down-payment, the other investor would be bringing approximately four times as much capital as me but I found the deal, am the 'boots on the ground', I'm licensed, will be managing, doing maintenance, watching over them, etc. 

We've decided to start a LLC and we're planning on coming up with a very detailed operating agreement to outline all circumstances. I'm wondering what I should be most cautious about when drafting this agreement. I really need the capital in order to purchase all three of these buildings.

Any suggestions for the operating agreement when the out-of-state investor is bringing 75% of the down-payment, but you're going to be doing a majority of everything else? This will be my first partnership and I want to have everything covered. We've established a good working relationship and both want to hold these for the long haul. Since these are in my market, I want to be able to buy the investor out in the future. Any feedback/insight will be appreciated. 

If I was your out-of-town investor I would want to know the following

1. Do you have a track record of finding good deals of similar size?

2. Do you have a track record of being the boots on the ground? What is your role in this aspect?

3. How many other units do you currently manage?

4. How much do property management companies charge for similar sized units in your area?

5. What sort of maintenance are you doing and what will you have to contract out? Are you licensed in anything, like HVAC?

As for buying them out, likely at some point you will just have to come to an agreement on value and then you pay them out for their pro rata share.

I’m not 100% on tax consequences here, but from a strictly legal standpoint you’ll want to be sure you know who makes final decisions about things. I’ve seen that expressed as an Officer title with various duties assigned solely to the officer. There can also be a dollar threshold above which the officer has to ask for member permission. Distributions can also be structured in a way that allows your money person some or a majority of the first cash flows, and there are creative ways to structure his input (eg loan to company vs equity). Finally, money partners, in my experience, often want to control whether and how the company can call for capital if things hit a snag. Depending on ownership percentage, a minority owner could wind up unable to contribute and then be forced to sell to the other member (that’ll be state law specific of course).

@Bradley Sindt , you ask what you should be most cautious about when drafting the agreement?  Actually, nothing at all.

That’s because under no circumstances should you be drafting the operating agreement. Your lawyer should be doing that, and your partner should have his/her own lawyer reviewing it and commenting. Until the agreement is authored and signed, you two are not on the same side of the table. Get the negotiating out of the way, sign the agreement and then unite to conquer the world. Want to know what causes all kinds of problems in partnerships?  Ignoring that advice. 

Now let’s talk about structure. There are two components to this venture:  work (bringing the deal, managing it, etc) and money. Treat each separately and allocate the economics to each.  As to the work, you can designate profits, fees, or both. The rest goes to the money, and that’s divided pro-rata. 

So let’s say for the work you decide that you get X% of the purchase price for bringing the deal and X% of the income for managing it.  Maybe you also get X% of the sale price for managing the sale.  Those are your fees.  On top of that you also get, by way of example, 25% of the profits. 

The other 75% of the profits goes to the money. If you bring 25% of the money you get 25% of the 75%, and your partner gets the other 75% of the 75%. So it looks like this:

  • 25% to you for the work
  • 18.75% to you for bringing 25% of the money
  • Total to you 43.75%
  • 56.25% to your your partner for bringing 75% of the money

These are just examples, mix and match as the two of you agree. It’s all just a negotiation. For the work, I’ve seen everything from 20% to 60%, it all just depends on what you two agree to.

Your lawyers will handle all of the other details such as what happens if one or both of you die, how one buys out the other (usually by averaging two or three appraisals) any confidentiality or non-compete provisions, who is responsible for what and what happens if someone fails to perform those functions, who has authority to do what and what needs to be voted on, etc.

Trying to draft this yourself can lead to disaster if something happens that you didn’t think of, the agreement doesn’t cover it and you two can’t agree on how to proceed. It’s much better to have those discussions now, and if you can’t come to an agreement at least you don’t have real estate and money tied up in the discussion. 

@Bradley Sindt

Hi Bradley,

you need to ask yourself how badly you need the outside investor. If you can't do the deal without him, then I would take less equity on my first deal and prove myself. I would still take a management fee to run day-to-day, and possibly an acquisition fee to do all the work to put the deal together. You can roll fee into equity.

On the next deals, you can ask for more. If the investor is bringing 75%, then 75/25 appears reasonable for the first one.

Your first one is the most important.  Build your credibility and build your empire!

All the best

Gino

Thanks everyone! That was very helpful and gave me insight on what to expect and how to move forward. I have been in contact with my lawyer and they will be drafting the operating agreement if we get our purchase agreements accepted. I know we can structure this to be prosperous for both parties included. 

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