When you are starting out, you should start small. You will want to learn and be in control. You probably will use your own money as you learn. You are taking a risk. It’s a lot easier to lose your own money than other peoples’ money. And if you don’t agree with that, you need to get out of investing. Inevitably, you’ll either drop out or you’ll want to get bigger. And to get bigger quickly will require outside sources of cash. One way to do it is to partner.
Just to be clear, this isn’t a post about finding the right partner. I’m going to assume you have already found somebody and vetted them and are willing to trust multi thousands of dollars into their care. If you don’t have that, don’t partner up. It’s better to let the deal go than to get into a bad partnership.
It Starts With a Vision
Your partner and your long-term goals need to be aligned. If not, it will be likely that one of you wants to sell when the partner doesn’t, or the partner wants to buy when you don’t. Talk about your vision for this and future investments and settle on an idea for what you both want. Seems goofy, but write it down. You may need to refer to this later.
Next Comes Strategy
What are the steps you will take to achieve your vision? Maybe you want to purchase $100,000 worth of property a year for the next 5 years. Maybe you want to focus on multifamily instead of single family. Decide what third party resources you will use, such as a banker and accountant. Write it down.
Decide on Time, Work, Finances, and Knowledge
Consider what each of you bring to the table. If you found the right partner, that person will bring something you can’t, or won’t. Time and work are very similar, but you do need to have a discussion about primary income sources (your jobs) and how much time you will dedicate to the investments. Work in this context is work on the project. That might be talking to contractors, paying bills, doing the bookkeeping, finding deals, swinging a hammer, or many other things.
Additionally, decide who is bringing the money to the deals? How much? Are they also going to personally guarantee the loans? To someone starting out, this may seem easy, but it carries a significant amount of risk. A partner doing the construction can simply walk away with time lost, but the equity partner (the one bringing the money) is going to lose that money by walking away.
Maybe the partnership is going to need outside knowledge about how to do this kind of deal. This person is a thought partner who is not going to do any work or bring any money, but has experience and is going to guide the others every step of the way. There’s value there. Do I have to tell you to write all of this down?
Decide on Ownership/Control/Pay
This is a completely separate discussion from the time, work, finances, and knowledge one. Though they seem similar, this decision might be completely different. It usually will boil down to percentages. One list will be created for ownership and one for control, or decision-making capacity. If the project makes $100 in income and the owners decide to take it out as profit, it will be divided up between the owners by ownership percentage. But the decision on whether to take that $100 out or invest it back in the property will be made based on the control percentages. Ownership and control percentages do not have to be the same, though they often are. That’s up to you to decide, and it’s why you are taking all this time right now. These are also sometimes called ‘splits’ as in ownership splits.
Also, you’ll want to figure out if anyone gets paid for doing work. How is that going to be set up? What happens if there isn’t enough money to pay them?
Deadlock
This is a critically-important decision to make up-front. It’s always tempting to have a 50/50 partnership because, why not? The reason is there will come a time when you disagree. If you are 50/50 you have deadlock and nothing can get done. That is terrible for your deal. You need to have something like a Texas Shootout, an uninterested 3rd party, investor vote, or some other way to break a deadlock. Or, just don’t have a deadlock – split the control 49/51 or have three partners.
Dissolution
Figure out how you will decide when to dissolve the partnership. At some point it will have to go away. You don’t want your heirs dealing with this thing. What happens when one of you dies? Who takes control? A spouse maybe? That could spell doom for the business. Figure it out now.
Miscellaneous Things
Now is the time to think about and document any specific things you want in the deal. Maybe you live in Antarctica in February every year and cannot be reached. Whatever that might be, talk about it now.
Consider what happens if one partner is not doing their job in the deal. Who decides they didn’t do their job? Do they lose some of their ownership? Do they not get paid? Really take some time to think about these things.
Ink the Deal
This is of course your final step. This is why you documented all that stuff before. Take it to an attorney and set up an operating agreement for your new LLC. Now, you have a good framework for your agreement and will hopefully file it away somewhere and only need it when you plan to sell everything and retire. If not, it’s there to help solve disagreements. Happy partnering!
