How to decide lien position with two private lenders

Question

I have found a deal and it will be purchased with a partner as a JV. Now if we both bring in private money how do you decide who gets 1st or second position?  I currently have an LLC in which the house can go under. Also if we are unable to sell the home in say 6 months to a year, how do we go about refinancing to pay back our lenders?

Bill Gulley · Answer

John, if the property is held in an LLC you don't need liens filed. Your monies are contributions to capital in the business entity, you buy assets with combined capital, the share of ownership of assets is described in your operating agreement for LLCs. The accounting of capital assets and liabilities goes to owner's equity that is shared under your operating agreement. There is no mortgage. Need to see an accountant and your attorney as to the operating agreement terms and obligations. :)

Tim DeBellis · Answer

Thanks @Jeff S. I know your response was some time back but my partner and I are facing this same question now. We are looking for ways to make our initial projects attractive to private lenders, including components of the deal that we can offer to minimize their risk, and your response was exactly the guidance we were looking for.

Jeff S. · Answer

Some, but not all states, allow you to fractionalize a loan, @John Geldert.  In this case, all investors can be listed as the lender on one set of loan documents along with their percent ownership (e.g. John Doe 15%, Fred Smith 75%, Mary Jane 10%, etc.).

Here, the mortgage can be recorded in first position, providing all lenders one security agreement which allows them to enjoy equal seniority.

These can be a bit tricky since it's normally the majority that rules, as a percent of their collective investment, when it comes to such potential decisions as modifications, extensions, and foreclosure.

I'm not a fan since you give up some control as a lender, but I know rehabbers who use these as a way to legally pool relatively small amounts of money into larger deals without having to do a registration and provide the same secured position to all lenders.

If this doesn't work, traditionally the lender who provides the purchase money would be in first position and the lender providing the rehab funds would be in second, but there is no rule.  Ordering by amount loaned is equally valid, as Bill mentions.  To be fair, make sure the lender in second position truly understand their risks.

Also, no matter how you structure these loans, if I was a lender and the borrower was your LLC, I'd expect all members and managers to sign a personal guarantee. Don't forget lenders title and liability insurance as well.  These are the right thing to do to protect your investors.

John Geldert · Answer

Jeff S Na, thanks so much for the explanations and info.

John Geldert · Answer

Great info Bill, thanks again!

Bill Gulley · Answer

If they are going to be lenders and not in the LLC, They can fund a "participation loan", each having a lending agreement between them under one note.

A note can also be made with separate principal parts held by different parties at the same or different rates with the same or different amortizations and secured by one trust agreement. Have your attorney call me :)

If that isn't acceptable, the one who lends the most is usually in first position. The second can stipulate that any default of the first constitutes a default of the second and they can join together in a foreclosure action if that makes the warm a fuzzy. :)

John Geldert · Answer

@Bill Gulley

Thanks for the quick response. Both lenders are going to want some type of collateral and rightfully so. I also do other business out of my LLC, that being said how would I go about structuring this deal?

How to decide lien position with two private lenders

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