Raising Friends and Family Money / First Deals
Looking to start setting up some of my own deals within the next year or two and starting to plan ahead here. This might be a better question for Bigger Pockets but I appreciate the institutional experience most monkeys have here.
My questions are for all the other monkeys who have gone the entrepreneurial route. Is an SPV overkill for a first deal where LPs will likely be my fam?
First off: I am thinking about using an SPV and am curious about tips/vendors/costs etc. from others with more experience. I am hoping to set things up the right way on the first go and want to avoid any major pitfalls. I have been reading various articles/publications on this and am looking for some personal insight here.
Second: I am curious on a more general level what advice/areas to avoid from others who have gone this route? Mostly looking for guidance on structure/operational topics here as everyone's investment thesis is going to be different.
Please comment if you don't have experience in this specific vein but have any ideas or want to throw in anything else I am not considering here.
Thanks in advance!
How much commitment do you plan to raise from your family. SPV will be overkill for 90 percent of cases here
That is kind of my thinking. I only really have experience with the Fund and SPV structure and am trying to figure out a something a notch or two below that. I really dont want to do K1s haha.
Target deal size is ~$10-20M so Id raise around half that.
If you have multiple investors, I think you should still create an SPE with an operating agreement, even if it's just F&F money. It's chump change on an annual basis and extremely easy to do. Helps with liability and keeps your investors' identities private.
I would go further saying that you absolutely need at least one layer of protection (I.e. LLC), especially if you have multiple investors and are using any form debt. For a $10-20mm deal ($5-10mm equity check), the costs to get a standard OA doc set should be relatively unburdensom. Depending on the strength of your connections, not sure if you want to do the full Reg D belt and suspenders, but that's up to you. At this size, you should also probably have a manager LLC/GP for personal liability as well. It would be embarrassing to have the place burn down or fall down and kill someone with your family being on the hook for some crazy unforeseen liability.
Thats my exact worry re liability. Two layer DLLC org for sure. Much appreciated.
You should absolutely have an SPV for any transaction you are doing. From context, I gather you have a good relationship with your family, but nothing gets in between people like money, and while I dislike sending K1s as well, the idea that you're going to run a major investment (which is what it will be if you've got hundreds of thousands or millions of dollars of equity at stake) in such an informal manner screams danger.
As far as advice goes, it really depends on what it is you are buying, and where. Pitfalls in running a 10 unit multifamily building in Brooklyn are going to be very different from a 30 unit townhome development in Raleigh, ya know?
Appreciate the sober advice here. I have seen the outcomes of a deal gone wrong on the other side of my family which is why I am keen on doing this the correct way the first time around and starting planning for this early.
The general advice im looking for is more on the organizational structure as opposed to the real estate / deal structure side. Considering brining someone on to handle wires, 3rd parties, reporting etc and having an external CPA & lawyer. Wondering if thats the general structure others have taken or should I just suck it up and handle that stuff myself.
Certainly hire a CPA for tax work, but handle the rest yourself. It's not fun, especially around closing and tax time, but that should be in your court until you have some scale. It's probably 10-15 hours at closing and another 20-25 hours a year per deal, depending on the number of investors.
Talk to an attorney and CPA in your market for the best advice and clear understanding of costs and administrative work involved. The advice you get from them will be 100x better than crowdsourcing on message boards and tailored to exactly what you are trying to accomplish.
I personally found the richard williamson book on asset protection to be helpful and well written too (~$25 on amazon).
You absolutely want to own investment investment properties in an LLC, especially with outside investors.
Much appreciated. Just bought that and Ill give it a read.
Definitely will down the line WSO is free and I wanted to get some outside perspective before I start paying someone hourly.
I was able to have intro convos with attorneys and CPAs for free to go over my goals/needs and get general advice on what strategies to use and what everything would cost. You don't pay anything until they actually draft documents / files tax returns for you. Most people are surprisingly willing to give out free advice up front with the expectation you'll hire them later on (and you will need to, there's a ton of legal docs that you'll want done professionally).
I'm up for investing
Do you even work in real estate? Fuck yes you need a SPV - a SPE that it bankruptcy-remote.
And why would you use 50% debt/equity? Man oh man for your sake let’s hope your friends and family have zero understanding of investing let alone real estate.
I can think of a few reasons to buy a property with low leverage. That isn't a bad sign, at all. Also, at some point you have to raise money, and you might have conservative friends and family who are uncomfortable with the idea of high leverage and can't be talked out of it. I'd rather own an asset at low leverage and take a lower return than insist on 70% LTV and own nothing.
The math is basic. If your returns are higher than the loan interest rate, then you have positive leverage and improve your returns by using more debt. If your friends and family think otherwise, educate them. you’re still going to be safely restricted by DSCR, debt yield, and LTV of maybe 70%.
But sure, if your only potential investors insist on this then I guess you’ll have to accommodate them. That doesn’t mean it is the best decision.
Haha there are different strategies besides charging a 2% acq fee, slapping some floating debt on at 70% LTV, juicing rents, executing some BS rehab, and praying there is a greater fool in 3 years.
You know there are more than those two options of doing a shitty deal with low leverage and doing a shitty deal with high leverage. You can do a good deal too. I don’t know why you would use floating debt either. If you did, you would want to get interest caps. Anyway, I do ground up development of $100-$150 million buildings soooo not sure what you’re describing.
What’s your strategy under which it would be beneficial to use 50% debt?
Don't want to hijack the thread, but did want to add a question that may be of interest to other readers.
1. On some of the smaller deals (i.e. sub $15M total capitalization) who would use their balance sheet to guarantee the debt? Would it be the GP (that likely doesn't have the financial wherewithal) or bring on one of the LPs? In challenging debt market combined with increasing requirements for recourse debt, this would seem to be a pretty sizeable hurdle to surpass.
Has anyone had this challenge where they didn't have sufficient PNW to guarantee the debt?
Lots of people have trouble covering the loan guarantees. Even larger operators.
You may want to engage a debt broker to find some alternatives. Generally yes you'll want/need an LP that helps meet the net worth criteria even on a non-recourse loan. Might need to start smaller. Curious to hear what others have done.
For what sort of loan? If it's an asset-backed debt vehicle (e.g. not new construction financing) then you don't really need to guarantee much other than bad boy and environmental, which generally isn't a problem for most sponsors. Or not in my experience, at least.
Interesting - my experience has been different as our firm plays in the entrepreneurial space ($10M-$50M total capitalization) and we typically are seeing personal guarantees (full recourse) on conventional debt.
We only see the recourse limited to bad boy carve and environmental carve outs with CMBS debt.
Loans would be acquisition facilities plus non-revolving LOCs for any capex we're pumping into the asset (TIs etc. depending on the asset class).
What type of loans is your shop doing and what size? Is it for smaller GPs, which may be using friends and family LP capital in the stack?
You'll want to own the property in an entity no matter what, usually an LLC. Next question is how to structure the LLC - a full blown syndication where you're offering a private security, which usually requires an operating agreement, private placement memorandum, subscription agreement, etc, or a simple LLC of members with an operating agreement. If you're looking to truly create limited partners and give yourself, the manager, full control essentially, you'd likely be viewed as offering a private security and need the full set of docs. You'll need to consult an attorney, but if you're looking to continue raising money for deals, I'd plan to get setup with the full set of docs.
If this project consists of one property, I'd have this entity own the real estate to keep it simple. Having this entity own 100% of an SPE that actually owns the real estate might make it easier to sell that SPE to a buyer in the future, though. If there are multiple properties such as acquiring a portfolio or there may be multiple properties in the future such as excess land for development, I'd consider putting each property/parcel in an SPE and having the investment entity own 100% of each.
You'll likely have two classes of members - one being the investors who put up the capital and one being the entity where the sponsor earns the promote. I'd create a separate promote entity (LLC) for each different investment entity created. You can have this promote entity serve as the Manager, though I'd prefer to have a separate management entity which can serve as the manager for all your deals and this is the entity where you'll collect fees.
If you'll be contributing money as the sponsor, you'll have the choice of contributing it as an investor member or into the promote entity. I like the idea of contributing as an investor member if I am writing a check. With somewhat less sophisticated investors, it makes the splits easier to explain. If there's a 20% promote, they see 80% going to the investor members (including the sponsor) and 20% going to the promote entity. If the sponsor contributed 10% of the equity to the promote entity, then you have to explain why the split is 72/28 instead, which isn't the end of the world, but why not keep it simple.
If you're deferring fees for equity stake, the choice gets tougher. If you defer the equity into an investor member interest, it'll be taxable income which is good and bad. You have to pay taxes on income not really received as it was immediately invested as equity, but you'll have more income to show the bank when signing guarantees or if you need to show income for other personal reasons like a home mortgage, etc. If you defer the fees into the promote entity and the promote entity's interest is subordinate to the investor members, those fees will not be taxable income, which is the risk to doing it this way. If there's only enough proceeds to pay back the investor capital on a sale, for instance, your deferred fee is just gone. However, if you've owned the property long enough to receive LTCG treatment, this deferred fee will also receive that treatment. If the investor members class and promote entity class are pari passu, I would think you'd then be facing taxable income from the deferred fee.
Prices vary wildly across the country I'm sure, but I think you'd be able to get the full set of docs setup for under $50k. If each deal going forward essentially uses the same structure, there aren't many changes to make from deal to deal so the cost should be a fraction of that.
Good response. I haven’t seen this mentioned and maybe I missed it but any lender will require a stand-alone special purpose entity (SPE) be created to be the borrowing/ownership entity. If you have a small number of LPs, you can always make them members of the LLC vs syndication (saves some upfront $ but can create other issues) but I think doing a formal private placement offering is cleaner (THIS IS NOT LEGAL OR ACCOUNTING ADVICE, TALK TO PROFESSIONALS). Depending on deal type, complexity and what attorney you use, costs could be as low as $20k-$25k for an offering. There are so many good investor/deal management platforms out there these days that aid with fundraising and reporting as well.
Hello, I read your response and thought I might ask you a question about trying to identify what kind of deal this is. I am completely new to this industry and was given the opportunity to help raise capital for a small commercial real estate investment firm in Germany. The GP acquired a property ( I suppose with loans) and now he is trying to sell ownership of that property or acquisition I am not sure how to refer to it. They own 10% and the rest is being sold to a list of small investors. What kind of deal is this? Is this a typical deal structure? The firm operates in Germany and the property acquired is in Berlin. They hold c.a 250M in properties.
Wow just came back to this after over 2 years.... I have learned a lot since then!
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