I will be investing with two other partners. We have already decided how we will handle the first deal. Partner #1 will provide all funds and be a silent investor for 50% profit/loss. Partner # 2 & 3 will handle everything else. Finding, Analyzing, Closing & Rehab. For their efforts each will receive 25%.
We would like to do many deals together in the future, so our plan is to setup a primary LLC, which we each own 33.33% in. However, my question is how best to handle varying splits for each property? I mentioned how the first project will be handled above, but let's say for future deals all 3 partners wanted to contribute both financing and efforts evenly. How can we best change the allocation.
Does it make the most sense to create separate LLC's for each deal to handling the changing profit sharing, or would it be better to mention a profit split addendum for which we could modify easily(?) for each deal and only work under our core LLC? For the foreseeable future we will only be doing 1 flip at a time, so the LLC per property just to handle profit sharing seems like overkill to me. I would rather just either create a formula in the operating agreement where you could plug in Cash & Effort to get % profit per deal or somehow add an addendum to the operating agreement to cover changing profit sharing.
Can anyone provide insight into the best way to approach this? We will be meeting with our attorney tomorrow and just want to make sure I understand the pro's/con's.
@Shawn Clark I am neither a lawyer, nor an accountant, but it would seem to me that it could be handled easily with an operating agreement that says you each own 33.3% of the LLC, and that each deal as you progress would have it's own addendum to the operating agreement that defines the amount invested by each, and the returns for each partner.
@Walt Payne - Thanks for the reply! Yes, that's what I was hoping to hear. I will bring it up with the attorney tomorrow. Up until I mentioned the varying splits he was all for a single LLC, once I mentioned that he leaned toward separate LLC's for each deal. Not sure why though, will need to follow up with him.
In addition to the added costs, I feel it just adds a lot of unnecessary complexity since we will only be doing 1 property at a time to start.
I am also neither and accountant nor an attorney. I would encourage you to think about this from the perspective of where you want to be and not of where you are now. If your goal is to never do more than 1 property at a time, 1 LLC is probably great. If your goal is to do 10 at a time, things will be more complicated. If you have a rehab manager, how is his time split? Are you going to make a separate trip to Lowes for each house? Do you have the time and skills to track every dime so that each partner get his/her appropriate share? What if one of your partners is only comfortable doing 1-2 at a time and the other 2 of you want to do 10-20? What happens if you have 10 props going and someone wants out?
I don't know whether there are right or wrong answers, but I assure you that starting out without thinking through as many scenarios as possible is setting yourself up for a disaster. Even when everyone is on the same page, partnerships can be tough. Spend time aligning your goals and expectations now.
@Erik Hitzelberger - Thanks. I understand what you are saying. We have been informally reviewing and documenting a lot of the questions you brought up and building a mock Operating Agreement. We are taking it very seriously as we are all good friends and don't want to screw that up. Tomorrow we will formalize/finalize these points with our attorney.
We all would like to do multiple flips at a time in the future, but realize that is a ways off as we are all currently full-time employees. When the time arises that we start having a single LLC portfolio with too much equity, we will re-evaluate and consider creating multiple LLC's to reduce risk. In the short term, I think the solution will be to go the addendum route for each property, assuming our attorney agrees.
@Shawn Clark Keep us in the loop on how this turns out. I am beginning a similar thing with two friends but the business is buy-and-holds. Our attorney advised that using an addendum for separate deals was not workable. He explained several reasons but here is one. Let's say your LLC did two deals...you participated heavily in the first deal but you were unable to contribute to the LLC's second deal (e.g. on vacation, death in the family, etc). Both deals are titled under the LLC. Contractor for Property #2, which you are not participating in, sues the LLC. This could potentially mean you lose equity in the first property even though you did not participate in the deal that brought the lawsuit!
Recommend inquiring about a "series LLC"...more complicated (and costly) but may be a good solution. Disclaimer: I am not an attorney.
Also you mentioned that the LLC members are going to decide how much effort everyone contributed to a deal, and that this would roughly correspond with equity. Seems to me this could lead to some arguments and hard feelings. If you are working with friends I would want to ensure this formula was as objective as possible.
What does Mass charge LLCs to stay active? In Maryland we must file $300 per year just to exist! Even if there is no active business. Really acts as a disincentive for forming multiple LLCs for this type of business.
Good luck and keep us posted!
You can use a deal addendum to specify the split for individual deals, using only 1 LLC, as I know a group of 3 partners who does it regularly. In buy and hold, the situation becomes more complicated, but in rehabbing, it can work.
@Matthew Loring MA LLCs are $500 to form and $500 per year. Series LLCs, such as those available in Delaware, are interesting, but you must then register the company as a foreign entity doing business in MA, which costs the same as creating a MA entity. So it defeats the purpose and creates two sets of fees.
This is not legal or tax advice, I am not an attorney or accountant.
@Ann Bellamy - Thanks! Very helpful information.
Thanks all for the advice. Met with our attorney tonight. It was concluded that a deal addendum with a single LLC was the best route to go. For comparison purposes for those in MA, our attorney is charging us $750 to do the Operating Agreement, LLC filing, and EIN. That later two items are simple, and can be done on our own, but he is not charging extra and I am told it's better to have the attorney file the LLC so his name and address will be on the document. That way, any frivolous lawsuits will have to go through him before we ever even hear about them.
Well, that sounds as if he is acting as the registered agent for the company. You can enter anyone you want as the registered agent, even your attorney, when you file it yourself. Not suggesting you should do that, if you're comfortable with him handling it, then go for it. But you might consider trying the process yourself without actually paying for it. Then you can see what's involved for future reference. Here is the link. Also, explore this section of mass.gov
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