Partnership Agreements & What To Choose
When planning to do a partnership, there are a lot of different types of entities to choose from. You can form a joint venture, limited partnership, general partnership, use a land trust, form a limited liability company, or use an S or C corporation.
The Definition Of A Partnership
A partnership is two or more people coming together to do business. For the purposes of this course, this means you and someone else partnering up to buy, sell and lease real estate.
It is usually best to partner with someone who compliments your weaknesses. In other words, if you don’t have money or credit, your partner should. We also spoke of working with partners on a deal-by-deal basis. For this reason, in this section we will mainly focus on joint ventures and limited partnerships. These types of partnerships are the best suited arrangements for buying and selling real estate as a small investor.
Forming A Partnership
Forming a partnership with another investor (or lender) does not require any formal partnership agreements or filing of official paperwork. If you don’t have a written partnership agreement and you conduct business with someone in a manner in which the general public would think you do have a partnership, you in essence have created what is called a “de facto partnership”.
However, you should always have a written partnership agreement which clearly states the responsibilities of each partner and the liability each partner will have in the investment. Your partnership agreement should clearly outline the limitations of the relationship as well. For instance, you don’t want your partner, or the general public, to feel you have a general partnership when you are only doing a joint venture on one specific deal.
Partnering Under A Land Trust
The most popular way to structure a partnership when doing real estate investments on a deal-by-deal basis, is to put the investment property into a land trust and draw up a Beneficiaries Agreement. We just covered this in the previous section on land trusts.
There are just so many benefits to using land trusts and they are perfect for doing deals both large and small.
A joint venture should be used when you are investing on a deal-by-deal basis and plan to take title in the names of you and your partner. This form of title holding is referred to as “tenants in common”, and the ownership of the property is divided between you.
Liability You won’t have the liability protection a land trust offers and you will have joint and severable liability for the actions of your partners, which means a creditor, or someone suing, can go after any (or all) of the individuals in the partnership individually.
Because you are jointly and severally liable for everything your partner does, you should definitely always operate on a deal-by-deal basis under a separate joint venture agreement for each deal, or consider going the land trust route.
Guaranteeing Your Partner A Profit Margin
Whether you are using the beneficiaries agreement under a land trust, or doing a joint venture agreement, you can make a deal look more attractive to your partner by guaranteeing them that they will receive all of the funds that they had advanced plus collect a certain amount of profit, prior to you making any money.
In other words, if you project a $50,000 profit on the investment, you can guarantee your partner that they will at least receive $25,000. This would be 50% of the projected profit. In such a case, if the profit turned out to be only $40,000, your partner would take their $25,000 profit first, and you would receive the remaining $15,000.
In both the joint venture agreement and the beneficiary’s agreement, you can guarantee that your partner will get a certain amount of the profits.
This makes your partner feel more secure that they will get an adequate return on the money they invested and it increases the chance of getting them to invest in your deal. Private lenders and money partners are very valuable to you as a real estate investor, so it is in your best interest to keep them happy at all costs possible. So, even if things fall short, your partner should still be very interested in doing investments with you in the future.
Escrow Repair Money Another important issue to address, is to make sure you have a guarantee from your money partner that any money for repairs will be available when you need it.
The best thing to do is have your money partner deposit the repair money in escrow when you purchase the property. This way you know that you’ll have access to the funds needed to get the property fixed up. You should also have an escrow agreement as to how and when the money will be dispersed and to whom.
Other than that, the Joint Venture Agreement and Beneficiaries Agreement are pretty self-explanatory. Be sure to read over them in detail when you have a chance.
Another type of partnership entity is the limited partnership. Limited partnerships are usually used on larger more long term investments such as when partnering on apartment complexes.
Limited Partners And General Partners
Under a limited partnership, there are general partners and limited partners.
The general partners are usually the investors putting up the least amount of capital and are the partners who will manage the property. The limited partners are basically silent partners. They are the ones who put up most (if not all) of the money and they have no control or say over the partnership activities.
If the limited partnership is sued, the limited partners cannot be sued for any more than the investment that they put up. They have no personal liability, but the general partners in the limited partnership do have personal liability.
Use An Attorney Because limited partnerships are a more complicated long term relationship, you should heavily consider getting some guidance from a competent local attorney.
What About General Partnerships?
The last type of partnership entity most people have heard of is a General Partnership, which is very similar to a Limited Partnership. However, general partnerships are not the best entity to use when doing real estate investments.
If you plan to do business on a long-term basis, it is better to form an LLC or other corporation so that you can limit your individual liability and take advantage of the tax benefits of a corporation. If you plan to do business with your partner on a short-term basis (or on a case-by-case basis), it may be better to do a joint venture or partner under a land trust.