Have interest from private money...Now What?

Question

I have one 2 family under my belt.  Currently holding it successfully with cash flow.  A relative watched me do this and now wants to do the next one with me.  He may have some buddies who also want in.  Not exactly sure how.

Would we form an LLC put money in and then I'd be the "Managing Partner" spearheading most of the search, buy, renovate, and hold?

or, similar to that but after I find the right deal we put together the LLC right before we buy?

How to handle Returns, %'s, my time managing the renovation, then my time managing the property, etc......

Keep in mind I am interested in buy and hold, not fix and sell.

Slightly complicating this is that though I am a buy and hold guy I'm not thrilled about the idea of holding a property for several years with a relative knowing the property management issues that might arise.  Perhaps I would need a way for them to be a silent partner.

John Blackman · Answer

I have the same problem and after a few of these do not include partners in LLC deals unless I know and trust them and they bring partner level value to the transaction.  Partners will take on the risks and associated management duties of the business.  If you want your family to participate in these deals in a passive way, I suggest a simple unsecured promissory note with a fixed rate of return that is less than the performance of the asset you are going to use the money in.  The difference is yours for sourcing and managing the deals.

This way you have simple fixed debt on your books and your assets cover it.  Send them a 1098 at the end of the year.  Simple as that.

They don't have any recourse if something goes wrong as the note will not be attached to the asset.  This will only work for friends and family who trust that you aren't going to bail on them.

For non friends and family investors you can go through the LLC route, although after trying this a few times, I will never do it again.

The other route is to offer a private placement.  That is a lot of work and expensive, but the right vehicle for raising a substantial amount of capital.

The above is just my experience and certainly not a hard fast rule.  There are a lot of ways to do this.

George Paiva · Answer

Ankit Duggal and John Blackman great insight. I am working on my next deal with partners on a larger property and you guys bring up some very good points.

Ankit Duggal · Answer

Larry K. Congrats on getting the 2 family under your belt. Now you are starting to step into the world of raising capital so tread carefully.

Here is the way I have done it:
1) Setup an LLC that will solely hold this new investment
2) Draft the asset specific investment plan with your target strategy, timeline and projected return profile 
3) Get an operating agreement together wherein you would define what would be your duties as the Managing Member and what would be the duties of the Members. Request potential capital members to sign an accreditied investor statement. As Jeff stated you should have a securities attorney who you can reach out to. 
4) You can put together the LLC before you buy or make a transfer after you buy; if you have the capital to take it down and if the seller will not allow an assignment of purchaser name/information
5) Managing Returns: This is the tricky part as it can be setup anyway that you and your capital partners can agree upon. The typical ways I have done it is as follows:
A. Acquisition Fee- this will help compensate you for your time associated with deal sourcing and even managing the renovation. Typically 2-3% of the total capital raise. 
B. Property Management Fee- this is will be an expense within the income and expense statement. Typically 8-10% of collected gross rental cash flow
C. Rental Cash Flow Splits: the net cash flow after all expenses I typically give capital partners 90-95% of cash flow and 5% to Managing Member after hitting a certain hurdle rate of return. 
D. Resale Proceeds: the net profit from the sale proceeds would be split 50-50% between Managing Member and Capital Members.

I hope this helps

Ankit

Jeff S. · Answer

I’m not a lawyer, Larry, and I don’t know NJ law, but I’m pretty certain you cannot form an LLC and take on silent investment partners unless they all have an active management position.  In this case, you’re likely pooling money and forming a security.

You really ought to talk to a securities attorney about the proper approach.

Jeff

Have interest from private money...Now What?

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