Advice on Partnerships and sweat equity

9 Replies

I posted this in a different section but didn't get many responses. Need some advice on partnerships.

I've had some success in SFD re investing ($2 million portfolio). Now I've got family and peers that want in on the game, but want me to do all the work. Find the deal, close, manage, etc etc. Everything. Which is fine.

How much equity share is a reasonable amount in sweat equity if I have a silent partner? How is that typically structured? Can you give me some examples?

Example 1: Say we buy a 500k house, 100k down payment. How much can I ask them to put down if we are going to maintain a 50/50 ownership structure? 70/30? Or what if they are putting up 100% of the financing. What sweat equity is appropriate? 20%?

Example 2: I've thought about doing a large sweat equity share on the back end, or exit. So, we do a 70/30 split on down payment, and we maintain a 70/30 split on cash flow. But once the investor has been made whole (got his 70k back), then it shifts to a 50/50 profit slip. I realize that's probably not till we sell the place, but you get the idea. Would that be reasonable or attractive for an investor? I'm totally self funded so far so not sure whats appropriate, and I want to have a structure that will be attractive to other investors. 

I am interested in this as well.

I have 3 good friends whom all want to hop into a few Real Estate investments with me next year but I am the one doing all of the learning and will undoubtedly be the one to find, negotiate, close...etc.

Thanks for starting this thread Stewart!

There are 100s of options.  All start with hiring an attorney who understands real estate, partnership and tax law.  1. You can obtain a loan from them at a set rate with a right to convert the note into a share of the property 2. They can purchase the property and you can get a share of the profits upon the sale or rental.   3. You can enter into a limited partnership.  As the general partner you are entitled to a payment for services (market price). The limited partners receive the next payments (usually 8-12%) and any remaining profits go to you or are split 50/50 etc.  The option chosen and how the amounts are split will depend on the end goals--property flip, rental and the partners' finances (who gets the capital gains, depreciation, etc).  

@John Akolt Thanks for the suggestions. I know there's 1000's of way to do it. What I'm struggling with is the rates. You mention "market price". That's what I'm trying to determine. I'm in Atlanta, but I imagine there's a common rate. 8-12% return on their cash, then 50/50 sounds fair to me. That's more of a pay for performance model. If I can't get a client 10% return on his money, I shouldn't get paid either.  I want to model it in a way that would attract other investors I don't know. Not just friends or peers.

Would most investors not like me not having skin in the game? 

You can structure it in any way you want and in any way the investors would want. 

Lets assume the investor puts up all the cash. On large scale deals (syndication sized) the investors get a preferred return of 5-9% off the top and then 70-80%. The syndicator gets 20-30% plus asset management fees and other fees for closing.  

On small deals 50/50 with no preferred and no asset management fees or other fees can be done.

Mid sized deals I would say the investor would get 50-70% for putting up all the cash depending on how you structure it. If you do a preferred return and no asset management fees or other fees, you can go closer to the 50/50. Say you do a 6% preferred to the cash with a 50/50 split after. If it's $100k cash, they get the first $6k and any remainder is split 50/50. If it makes $20k they get $6k plus 50% of the remaining $14k. So they'd get $13k and you'd get $7k. That's the same cash split as 65/35 split. 

You could do a higher preferred return, then a matching amount to you, and then split the remainder according to a split. So say it's $100k cash in. They get 10% for $10k, then you get the next $10k, and split the rest 50/50. That gives them a higher guaranteed but ends up 50/50 overall if it's really profitable. 

Or you could do 75/25 split on the cash for a straight 50/50 split of the deal. 

There are endless options. What's acceptable for the investor and you will be very deal dependent. I think if you target a 15-20%+ IRR for the investor based on a 5-year exit that's a good deal for them. It can be structured in any way to make it happen. On your side you'll have to figure out what makes it worth to you for your time for the deal as well as the time of dealing with investors.

You can split the cash flow and the equity different as well. Say you need 50% of the cash flow with no preferred return for the cash to make it worth your time. But maybe that doesn't satisfy a high enough IRR for the cash investor. You could split the cash flow 50/50 and the equity 75/25 so they have more at the sale. Or if your goals are equity and net worth maybe the cash flow is 75/25 but the equity is 50/50.

Again, there are endless possibilities of how to split it and it's all dependent on the deal and everyones goals.

@Austin Fruechting VERY helpful. Thanks for those. I guess I could just structure it the way I want, and then see if there are interested parties. If not, I must be too aggressive. 

I think my preferred approach is they are putting up the money, and I'll provide a 10% preferred return, then 5% for me after that, and 50/50 after that on CF and equity exit. I'd be OK with that. I just wasn't sure if Investors would find that attractive. 

@Stewart Wyne

What investors find attractive is a successful track record. If you show you can perform overtime (which sounds like you did in the past!), then you have more leverage in your hands (your successes) than the investors. As you said, "family and peers" coming to YOU! Not the other way around. So you make them an offer that you believe is fair and then let the negotiations begin. 

If I can be of more help, please reach out via PM at any time.

Best of luck!

@Stewart Wyne are you flipping or holding or both? Do you use a management co or are you the pm?

google: value hound academy. good content on syndication.

off the cuff it sounds like you're undervaluing your role. the sooner you learn that $ chases great deals the better. Capital is rarely the problem. Having an actual D-E-A-L is...

Best of luck!

My suggestion would be to start your calculation with what you want to get out of the deal to make it worth your while and then figure out how much you can offer investor(s). There is s contrary rule of thumb for these types of investments, i.e, don't offer too high of a return or no-one will believe it and it will actually be harder for you to find investors than if you offered a "reasonable" return. Additionally, if you pay them too much, you may ruin your investors for future deals that don't yield as much. 

A reasonable return in a passive investor's funds in today's marketplace is an 8% annualized return plus a share of profits that could bump up the annualized return to the high teens/low 20s. Or you could simply offer them 10-12% annulized interest on a note and keep the rest - which is what a lot of flippers do. 

Another option for you is to offer shared appreciation loans (instead of partnerships or LLC interests). It will be cheaper to have an attorney draft a shared appreciation promissory note with your company as the borrower than it will be to form a company and draft an operating agreement. A shared appreciation promissory note (aka a "participation loan") allows you to: a) simply split profits after pre-defined expenses are deducted or b) you could offer a much lower fixed return (e.g., 6%) plus a share of profits. If these are fix and flip deals, it usually doesn't make sense for you to make periodic interest payments as you are really just borrowing more money to pay back to your investors.

One last comment, notes and LLC or LP interests are securities, so you will want to make sure you are giving your investors an appropriate risk disclosure document so they understand the risks before they invest. A well-drafted disclosure document can shift the risk of loss from you to the investor (they "assume the risk"), and you could be required to do some securities notice filings too. It's best to talk to a syndication/securities attorney about this before you do it.

Originally posted by @KimLisa Taylor :

My suggestion would be to start your calculation with what you want to get out of the deal to make it worth your while and then figure out how much you can offer investor(s). There is s contrary rule of thumb for these types of investments, i.e, don't offer too high of a return or no-one will believe it and it will actually be harder for you to find investors than if you offered a "reasonable" return. Additionally, if you pay them too much, you may ruin your investors for future deals that don't yield as much. 

A reasonable return in a passive investor's funds in today's marketplace is an 8% annualized return plus a share of profits that could bump up the annualized return to the high teens/low 20s. Or you could simply offer them 10-12% annulized interest on a note and keep the rest - which is what a lot of flippers do. 

Another option for you is to offer shared appreciation loans (instead of partnerships or LLC interests). It will be cheaper to have an attorney draft a shared appreciation promissory note with your company as the borrower than it will be to form a company and draft an operating agreement. A shared appreciation promissory note (aka a "participation loan") allows you to: a) simply split profits after pre-defined expenses are deducted or b) you could offer a much lower fixed return (e.g., 6%) plus a share of profits. If these are fix and flip deals, it usually doesn't make sense for you to make periodic interest payments as you are really just borrowing more money to pay back to your investors.

One last comment, notes and LLC or LP interests are securities, so you will want to make sure you are giving your investors an appropriate risk disclosure document so they understand the risks before they invest. A well-drafted disclosure document can shift the risk of loss from you to the investor (they "assume the risk"), and you could be required to do some securities notice filings too. It's best to talk to a syndication/securities attorney about this before you do it.

That's good that you mention this, I thought no one would care touch this subject. Without taking the necessary attention to this one could be in serious trouble, even if you draft the documents right. Don't forget that once you are a GP on a structure like this and you are offering interests to investors, no matter if equity or debt, you are in securities land and if your not able to claim an exemption from registration, for you as the manager and for the securities offering or indeed get those registrations done you can have the best-drafted document and it won't matter. Don't forget that as a GP you are providing "investment advice" for the investment entity. The regulations vary by state so better to talk to an attorney in your area for your specific situation, who and how many are your investors, size of the investment, etc, everything counts and needs to be analyzed.

As an example, I personally have two agreements: one is a monthly management fee with 80/20 profit share above 8% and the other is a fixed loan of 8% where I get to keep all profits (and losses).

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