I've been asked by an old acquaintance to consider designing a mixed-use development for a property he's tying up in exchange for either a long-term partnership stake in the property or a cash-out (similar to an investor stake) upon the property cash-flowing. I told him I would consider the long-term partnership stake, but am unsure of how best to structure it and value my time.
While I'm comfortable putting numbers to the effort I think this project will require on my end, I'm unsure of how to translate them to a partnership or investor stake.
One concern is that upon completing my work, should there be a lack of investment, or construction prices climb outside of this group's grasp, they could simply sell the property, and as a minority stakeholder I would be powerless to stop it. Is it appropriate to add some small multiplier to the regular rate due to the risk that I work through CDs and permitting with no ability to bill for it should they simply decide to sit on the property for years and do nothing with it? Should I include a clause that if construction doesn't begin within X months I have the option to have them purchase my stake for the full cost of my services?
Has anyone worked with such an arrangement before? Any thoughts or insights would be much appreciated.
Josh Mings
Sep 10, 17 9:14 pm
That's a tough one. Make sure to protect yourself no matter what. You could end up with a lot more money than usual or you could end up not being paid a dime. Make sure you get a minimum payment into that contract.
stone
Sep 10, 17 10:37 pm
Essentially, since you're being invited to become a partner in the deal, there should be a partnership agreement that spells out everybody's obligations, risks and how returns, if any, are to be divided. If you're going to front a fair amount of design services, then the value of those services represents your equity in the deal -- that's a value that you should be able to calculate, or at least estimate.
Similarly, your "old acquaintance" (presumably) is putting up some cash to tie up the deal, along with some of his time. There should be a way to quantify the cash and estimate the value of his services -- that would represent his equity in the deal.
So, for example, if your "old acquaintance" puts up $350,000 in cash and development services and you front design services worth $150,000, then you should receive 30% ($150k ÷ $500k) of any future net proceeds of the venture, those net proceeds being determined after deducting any legitimate expenses, such as legal fees, engineering services, surveys, brokerage commissions, etc.
Your "old acquaintance" probably will insist on being the general partner in the partnership and probably will insist on you being a limited partner. That gives him the ultimate decision making authority and -- going forward -- exposes him to more financial risk, but also entitles him to receive compensation for his management services. But, that should not cause him to seriously dilute your percentage of the partnership, as described in the paragraph above.
Note: be sure the partnership agreement gives you unrestricted access to the financial records of the partnership. Also be sure to ask about the kind of financing the project might require and whether that financing will require you to provide any sort of personal guarantees in connection with the loan.
Hire an attorney with substantial real estate development experience to help you navigate the negotiation with your "old acquaintance".
Once you commit to a deal such as this, you're in for the ride -- if you can't afford to front the services without compensation for an indefinite period of time (projects always encounter delays) then you probably should not pursue the deal (IMHO).
greenlander1
Sep 11, 17 2:42 pm
CB,
I'm on board w Stone's comments. You are basically converting your fee into equity which will need to be treated as such. Some things you will need to consider is what is the risk of the deal not happening or being profitable. First thing I would demand is complete access to all investor documents and treat the deal exactly the same as if you were giving him cash to invest. I'll try and write more comments later as I have been on the other side of this.
CrummyBuilding
Sep 11, 17 4:11 pm
Stone, Greenlander, thank you sincerely for the insights. I'm generally positive about the project (I won't be sunk should things fall through) but am not accustomed to having to working on contracts or thinking through how to structure the deal. Definitely getting a deeply competent attorney for help in these matters, and will assuredly make sure to have access to all investor documents.
Thank you, sincerely.
stone
Sep 11, 17 6:32 pm
A couple of additional thoughts -- you will find that nearly all aspects of the deal between you and your old acquaintance is subject to negotiation. In the end, each party's % ownership should reasonably reflect both contribution to the project's success -- i.e. both money and the value of professional expertise -- and the amount of risk being taken. To a great extent, many of those aspects are a matter of judgment -- especially the risk part.
You also should be aware that if the project cost starts to exceed original expectations, the partnership might need to make a "capital call' on all of the partners to keep the project moving forward. You will need to assess your own ability (and willingness) to comply with such demands for cash infusion. If you can't or won't pony up the cash, your % ownership will be diluted appropriately.
CrummyBuilding
Sep 12, 17 10:54 pm
Very helpful. Quietly running some feasibility study massings through the pro forma with a range of numbers to assess the range of outcomes and my ability to participate.
Thank you again, sincerely.
greenlander1
Sep 28, 17 4:30 pm
Crummy apologies for the late response but here are some thoughts (I could really go on for a while on this but I will try and keep this focused).
Not to complicate things, but before you get into the mechanics of how the deal is structured you want to look at the deal as if you were only an investor.
-how much experience does your colleague have executing the proposed deal? if he has done this before, how big of a project is it relative to his previous ones?
-how well is he capitalized? where is his source of funds? and what kind of sources is he seeing to tap into?
-how profitable does this deal look? does his assumptions for rent, sales revenue, etc look realistic? does his assumptions for construction cost and soft costs look realistic?
-what is the timeline for the project? at least here in Los Angeles, myself and many colleagues are treading somewhat carefully knowing that a market peak is very likely around the corner.
If and only if the project seems feasible then you can start discussions about deal structure because if in the end the project blows up, your equity will too.
-before you start thinking about the structure, if would need to assess how risky is the deal. And adjust your demands to adequately offset the risk. If it is a very safe project (probably not entirely likely since he is looking to defer payment on architectural fees) then the investor would be less in position to demand stuff.
-some things that come to mind would be how proceeds are paid out to investors (the order in which they are paid and also amount), liability, capital calls, termination events, decision making structure, relevant contracts, etc.
-proceeds to investors. are all equity holders paid pari passu? are certain equity holders paid before others? perhaps if you think the project is dodgey, maybe you can propose debt instead of equity. perhaps debt backstopped by a personal guarantee, i.e. you get paid a pre-determined interest rate and in the event of default you can personally sue him instead of just the project company (helps if he has personal assets but if he is personally BK this doesn't help you). You could also remain as equity but say you want to be paid out first before other investors or perhaps get a higher return since you were early to commit. Really just depends.
-liability. as an LP, you would want to not liable for anything
-capital calls. would you be liable to put in more cash if project goes over budget? how is the payout structure affected in the event of new investors generated by a capital call?
-voting rights. what level of say do you want? as LP would be typical that you have not much day to day say except in event where the project is totally f'ed up and there is need to make changes.
-contracts. You will want to see his investor memorandum w proforma + operating agreement.
I've been asked by an old acquaintance to consider designing a mixed-use development for a property he's tying up in exchange for either a long-term partnership stake in the property or a cash-out (similar to an investor stake) upon the property cash-flowing. I told him I would consider the long-term partnership stake, but am unsure of how best to structure it and value my time.
While I'm comfortable putting numbers to the effort I think this project will require on my end, I'm unsure of how to translate them to a partnership or investor stake.
One concern is that upon completing my work, should there be a lack of investment, or construction prices climb outside of this group's grasp, they could simply sell the property, and as a minority stakeholder I would be powerless to stop it. Is it appropriate to add some small multiplier to the regular rate due to the risk that I work through CDs and permitting with no ability to bill for it should they simply decide to sit on the property for years and do nothing with it? Should I include a clause that if construction doesn't begin within X months I have the option to have them purchase my stake for the full cost of my services?
Has anyone worked with such an arrangement before? Any thoughts or insights would be much appreciated.
That's a tough one. Make sure to protect yourself no matter what. You could end up with a lot more money than usual or you could end up not being paid a dime. Make sure you get a minimum payment into that contract.
Essentially, since you're being invited to become a partner in the deal, there should be a partnership agreement that spells out everybody's obligations, risks and how returns, if any, are to be divided. If you're going to front a fair amount of design services, then the value of those services represents your equity in the deal -- that's a value that you should be able to calculate, or at least estimate.
Similarly, your "old acquaintance" (presumably) is putting up some cash to tie up the deal, along with some of his time. There should be a way to quantify the cash and estimate the value of his services -- that would represent his equity in the deal.
So, for example, if your "old acquaintance" puts up $350,000 in cash and development services and you front design services worth $150,000, then you should receive 30% ($150k ÷ $500k) of any future net proceeds of the venture, those net proceeds being determined after deducting any legitimate expenses, such as legal fees, engineering services, surveys, brokerage commissions, etc.
Your "old acquaintance" probably will insist on being the general partner in the partnership and probably will insist on you being a limited partner. That gives him the ultimate decision making authority and -- going forward -- exposes him to more financial risk, but also entitles him to receive compensation for his management services. But, that should not cause him to seriously dilute your percentage of the partnership, as described in the paragraph above.
Note: be sure the partnership agreement gives you unrestricted access to the financial records of the partnership. Also be sure to ask about the kind of financing the project might require and whether that financing will require you to provide any sort of personal guarantees in connection with the loan.
Hire an attorney with substantial real estate development experience to help you navigate the negotiation with your "old acquaintance".
Once you commit to a deal such as this, you're in for the ride -- if you can't afford to front the services without compensation for an indefinite period of time (projects always encounter delays) then you probably should not pursue the deal (IMHO).
CB,
I'm on board w Stone's comments. You are basically converting your fee into equity which will need to be treated as such. Some things you will need to consider is what is the risk of the deal not happening or being profitable. First thing I would demand is complete access to all investor documents and treat the deal exactly the same as if you were giving him cash to invest. I'll try and write more comments later as I have been on the other side of this.
Stone, Greenlander, thank you sincerely for the insights. I'm generally positive about the project (I won't be sunk should things fall through) but am not accustomed to having to working on contracts or thinking through how to structure the deal. Definitely getting a deeply competent attorney for help in these matters, and will assuredly make sure to have access to all investor documents.
Thank you, sincerely.
A couple of additional thoughts -- you will find that nearly all aspects of the deal between you and your old acquaintance is subject to negotiation. In the end, each party's % ownership should reasonably reflect both contribution to the project's success -- i.e. both money and the value of professional expertise -- and the amount of risk being taken. To a great extent, many of those aspects are a matter of judgment -- especially the risk part.
You also should be aware that if the project cost starts to exceed original expectations, the partnership might need to make a "capital call' on all of the partners to keep the project moving forward. You will need to assess your own ability (and willingness) to comply with such demands for cash infusion. If you can't or won't pony up the cash, your % ownership will be diluted appropriately.
Very helpful. Quietly running some feasibility study massings through the pro forma with a range of numbers to assess the range of outcomes and my ability to participate.
Thank you again, sincerely.
Crummy apologies for the late response but here are some thoughts (I could really go on for a while on this but I will try and keep this focused).
Not to complicate things, but before you get into the mechanics of how the deal is structured you want to look at the deal as if you were only an investor.
-how much experience does your colleague have executing the proposed deal? if he has done this before, how big of a project is it relative to his previous ones?
-how well is he capitalized? where is his source of funds? and what kind of sources is he seeing to tap into?
-how profitable does this deal look? does his assumptions for rent, sales revenue, etc look realistic? does his assumptions for construction cost and soft costs look realistic?
-what is the timeline for the project? at least here in Los Angeles, myself and many colleagues are treading somewhat carefully knowing that a market peak is very likely around the corner.
If and only if the project seems feasible then you can start discussions about deal structure because if in the end the project blows up, your equity will too.
-before you start thinking about the structure, if would need to assess how risky is the deal. And adjust your demands to adequately offset the risk. If it is a very safe project (probably not entirely likely since he is looking to defer payment on architectural fees) then the investor would be less in position to demand stuff.
-some things that come to mind would be how proceeds are paid out to investors (the order in which they are paid and also amount), liability, capital calls, termination events, decision making structure, relevant contracts, etc.
-proceeds to investors. are all equity holders paid pari passu? are certain equity holders paid before others? perhaps if you think the project is dodgey, maybe you can propose debt instead of equity. perhaps debt backstopped by a personal guarantee, i.e. you get paid a pre-determined interest rate and in the event of default you can personally sue him instead of just the project company (helps if he has personal assets but if he is personally BK this doesn't help you). You could also remain as equity but say you want to be paid out first before other investors or perhaps get a higher return since you were early to commit. Really just depends.
-liability. as an LP, you would want to not liable for anything
-capital calls. would you be liable to put in more cash if project goes over budget? how is the payout structure affected in the event of new investors generated by a capital call?
-voting rights. what level of say do you want? as LP would be typical that you have not much day to day say except in event where the project is totally f'ed up and there is need to make changes.
-contracts. You will want to see his investor memorandum w proforma + operating agreement.