Structuring an Equity Partnership relationship with a Real Estate project, commonly utilizes an incentive mechanism known as a share of profits (Equity). Experienced investors are always willing to put up money to be a partner in a profitable real estate transaction. As with many businesses, talent is more important than cash; if you can find a good real estate deal with a General Partner (Development Company) that has a great track record, successful business practices and excellent management skills, the money will usually find its way to the project!
Limited Equity Partners rely upon General Partners, among other things, to do the following in a Joint Venture deal:
- Source and identify assets
- Underwrite and discover hidden value
- Pursue, negotiate and win deals
- Develop asset business plans
- Negotiate purchase and sale agreements
- Conduct thorough due diligence
- Secure financing
- Close deals
- Manage assets
- Execute asset business plans
- Dispose of assets; and
- Deliver investment returns
Considering that General Partners do most of the heavy lifting in a Joint Venture deal, it is fair and logical for General Partners to earn a share of profits. In addition, because Limited Partners rely upon General Partners to manage and execute the items listed above, they rely on the General Partners ability to keep their eye on the project and there is no better way to do this than a share of the profits.
So how can individual investors benefit from the General Partner / Limited Partner Joint Venture relationship? The answer is to invest directly into the General Partners entity and earn a percentage of its profits. This is commonly referred to as a “General Partner co-investment.” By receiving a share of a General Partner's profits, the individual investor is able to move up to a superior risk-reward level and earn greater returns.
For the General Partner, whose business is to acquire and manage assets as feasibly possible, the highest and best use of its capital is to scale its operations, not heavily invest in each deal, no matter how attractive the deal may look.
To solve this problem, General Partners look to reduce the amount of balance sheet capital they invest in each deal, in order to sprinkle capital into more deals rather than concentrate it into fewer deals. At the same time, while Limited Partners always want General Partners to have equity participation or “skin in the game,” they often do not require it in large amounts, particularly when the deals become large.
As a result, General Partners are often permitted by Limited Partners to find other investors to help fund a General Partners co-investment requirements and those other investors often comprise high net worth individuals. To attain the General Partner co-investment dollars, General Partners are willing to share a portion of their profit since those co-investment dollars enable the General Partner to; a) do the deal b) enjoy the opportunity to earn a profit and c) preserve precious balance sheet capital to fund the next deal.
A common Joint Venture structure is a structure whereby the capital member and the operating member form a new Limited Liability Company (LLC). The parties then enter into an Operating Agreement and a Joint Venture Agreement. These agreements set forth the parties’ agreement as to their respective rights regarding (1) distributions of profits, (2) management rights and control over decisions of the limited liability company, (3) exit rights and transfer rights with respect to the sale or transfer of membership interests in the joint venture, and (4) all other applicable rights and remedies.
Members of the project LLC can participate as individuals, sole proprietors, their own Companies (LLC or Corporation) or a group of investors participating in their own “Single Purpose LLC," which becomes a member (Limited Partner) of the Real Estate project’s LLC.
Use Your Self Directed IRA: It is very popular and extremely easy for Equity Partners to participate with their Self-Directed IRA’s and Qualified Retirement Plans. The returns in these tax-free or tax-deferred plans make the original excellent double digit returns even more attractive because of the heightened non-taxable return on investment (ROI).