How to value LP cash contributed to a deal?

Question

Hi -

I'm wondering how to think about valuing cash from an LP in a deal. For a simple example:

Two GPs of an LLC  find a deal for a $100k property, and get a loan for $80k.

They want to use other people's money for the down payment, and bring on an LP for $20k

How much equity do they give the LP?

Obviously the $20k should be worth about 20%. But should it be worth more given LP is the only one putting down cash? Or should it be worth less because his name is not on the mortgage, or if we're don't want to complicate things with management fees and carry, the GPs will be putting in work by managing the property for a decade plus?

Thoughts?

John Krudy · Answer

Thank you!!

Ron Pach · Answer

There is two options:

Option 1: Take on the LP funds as additional debt, not equity. This protects LP's downside as they have recourse to the property in case the deal falls apart and they get paid before you do since they're debt. This also gives you, the GP, more upside if you do really well since the LP will not participate in the upside, and only receive the interest rate on their loan.

Option 2: This is directly answering your question; you could do a 'waterfall' model of distribution of cash flow. Since you have no money in the deal, I'd suggest offering your LP investor this:

LP Investor receives all their money back first, before GP gets paid

After initial return of capital, LP gets 8% annual return before GP gets paid

After 8% return (can change depending on the deal...), the profits are split 50/50 between you and the LP.

After 12% return, GP keeps 75% profits, LP keeps 25%. A structure like this gives you the GP incentive to do well on the deal, which should give comfort the LP.

Taylor L. · Answer

The investor is taking all of the risk, so they should have a majority of the equity. The lender is probably going to want the investor to sign on the loan as well if they have that much equity in the deal. Also be sure to read up on the legalities of bringing passive investors into a deal and what it takes to remain in compliance.