This is the first in a three-part series of posts on partnerships. In this series I’m going to talk a little bit about partnerships, go into the legal structures, the different types of partnerships, and how to model each type.
Partnerships
People who are just starting out in real estate (like most of us), who have no track record or reputation, often have to call upon friends, family members, or clients to act as partners in their first deals. Or FFF as it’s often referred to – friends, family, and fools. One of the selling points to potential investors is the structure of the proposed deal. The deal that you ultimately strike is represented in a document known as the partnership agreement. It identifies the general partner (GP) (you) who is responsible for managing the partnership and the property, and the limited partners (LP), who play the role of passive investor. The GP can either be an individual or a corporation (the corporate approach helps limit personal liability). An individual or corporation can be both the GP and LP in the same deal. Most deals are done using a limited liability corporation (LLC).
Limited Liability Corporation (LLC)
The LLC provides better liability protection, more flexible capitalization opportunities, and more latitude for control being exerted by the managing partner. Lots of questions need to be answered in the partnership agreement such as: How will cash flow be distributed? What happens if more money is needed? Can the GP sell the property without the approval of the limited partners? Do the limited partners get the tax and depreciation benefits? What happens at the end of the deal? How is the timing of the sale determined? When the property is sold, do the limited partners get their capital back first, or does the GP get fees or some kind of guaranteed return first? All of these questions need to be answered.
From an investors stand point, it’s crucial to realize that the GP has very limited personal exposure in the transaction. Therefore, it’s imperative to ensure interests are generally in alignment. It’s important to go through what Bill Poorvu calls, Follow the Cash. Learn exactly who gets what, in what order, for assuming what level of risk.
Your first deals are likely to be in the forms of partnerships. In the next installment of this series I’m going to walk through some of the basic partnership structures and how they’re modeled looking in particularly at the country club model, the wall street model, and catchups and clawbacks.
What are some important things to keep in mind while structuring partnership deals?
Similar Posts:
- Partnership Series (Part 2 of 3)
- IRR Miscalculations Waste Time and Money
- Real Estate Investors Are Just Monkeys
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