read like a joint venture you would feel comfortable investing in? Further, why not embody the expectations of the parties in a thorough agreement, so expectations are not violated and outcomes are somewhat predictable? If this is something you have been looking for, then my Best strategy is your answer— establish a special purpose limited liability company, “SPLLC.” An SPLLC is a limited liability company established for the acquisition, rehab and sale of a specific property. The SPLLC agreement can provide for a split of profits and a preferred return for the money partner, i.e., interest on the contributed gap funds. I am positive George’s joint venture with Ian would have ended quite differently if they used an SPLLC in place of a standard joint venture agreement. First, George would not have been sued because an SPLLC offers liability protection for its members. Second, if the project was running over budget or missing deadlines, the SPLLC could have given George the ability to take over the project before costs spiraled of control. A well-drafted SPLLC should address the following: • Profit split on the sale of the property. • Timing of profit distributions to ensure all partners are paid once the property sells. • How the sale price is determined and what happens if a price reduction is warranted. • What happens if the property does not sell within a set period.
• Will the property be rented and, if so, for how long? • Refinancing considerations. • If and how much the investor should receive for managing the project. • Prevent either party from profiting with side deals. • How to remove the investor for nonperformance. • Matters that require unanimous consent of both partners. The advantages to using an SPLLC are numerous, and this is why I refer to it as the Best strategy. The key to a successful joint venture is an arrangement where expectations are met and not violated. Many investors have lost a lot of money in bad joint ventures and the resulting legal fees incurred in trying to unwind the agreement. Spend some time and money before you begin a joint venture, and you will be rewarded in the end. •
ment altogether for just a promissory note but with a twist. Most investors think of promissory notes as only involving interest, i.e., you loan money to a borrower in exchange for a specified rate of interest on the loan. Ideally, as a lender, you might want to charge 40 percent interest on your money and forego the profit interest you receive in a joint venture. The ad- vantage to the lender is obvious; you begin making money on Day One regardless of the amount of profit ultimately recog- nized when the property is sold. From a borrower perspective, such a loan is too risky for the same reasons it is attractive to the lender. A better middle ground would be a participating loan, otherwise known as a shared appreciation mortgage. A participating loan is a financing arrangement that is a cross between a joint venture agreement and a traditional note. In a participating loan arrangement, the promissory note provides the lender interest on the money loaned plus a percentage of the profits on the sale of the property. Unlike a typical joint venture arrangement, the only documents are a promissory note containing all of the terms and a deed of trust securing the loan. The gap funder is viewed as a lender and does not run the risk of liability exposure for mishaps associat- ed with the property. Now before you stop reading, thinking you just found the perfect solution to your joint venture arrangements, keep in mind this is only the Better scenario. There is still risk in this situation even though you have a secured interest in the property. Gap funder Larry learned this costly lesson when he relied solely on the Better strategy for his lending. Larry was approached by an investor, Sam, offering 10 percent interest plus 50 percent of the profits on a rehab deal in California in exchange for $400,000 in gap/rehab money. Sam offered to secure Larry’s money against the property behind a $600,000 first deed of trust in favor of a private money lender. After crunching the numbers, Larry prepared a participat- ing loan agreement memorializing the terms and recorded it
against the property. Larry and Sam were set to make some money. Two months into the project, Sam calls Larry and informs him he needs an additional $500,000 to finish the rehab. Larry cannot believe this turn of events and asks to meet Sam at the project. To Larry’s astonishment, Sam bulldozed the house he was working on, thinking they could make even more money if they built anew. Larry refused Sam’s request and threatened to sue. Sam could not find other financing and abandoned the project. The first position lender foreclosed and took the property, wiping out Larry’s loan. Larry lost $400,000 because he did not have any control over the project. The primary risk in using a participating loan is re- lying upon the investing experience of the investor. Larry should have asked for more security before loaning Sam $400,000. When using a participating loan, do or ask for the following: • Secure the interest against the project.
Clint Coons is a founding partner of Anderson Law Group and current manager of theWashington state office of Anderson Advisors, a legal, business and tax specialty company. Real estate investing is a major focus of his practice. A noted author and presenter on asset protec- tion and tax reductions, Coons has gained national recognition as an expert in his field and is noted for his ability to take a complicated law or struc- ture and explain it in clearly understandable terms. For more information, visit www.andersonadvisors.com.
• Receive a personal guarantee from the investor. • Request additional collateral in other assets.
Do not make this your story. Request the investor to provide you a personal guarantee and outside collateral. One would assume a successful investor should have other assets.
THE ‘BEST’ STRATEGY Up to this point, you may have noticed I refer to the lack of control as a recurring problem for investors entering into joint ventures. If this was not lost on you, then congratulate yourself for noticing the issue. I can appreciate control is not always desired nor is it offered by the investor. However, consider this: What if you could create an arrangement where you have ownership of the investment, control over major decisions and protections from an investor who goes off the reservation and acts contrary to the best interest of the joint venture? Does this
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