Photo:
Getty
“Can we play Cash Flow, Dad?” My daughters (ages 9 and 11) have been asking. The idea of the game is to manage your investments so you get out of the “rat race.” The rat race is the monthly grind of working to pay your bills. You accomplish this by having investment income that is higher than your monthly expenses.
In the beginning of the game, you need to focus your investments on “small” deals. These could be stock purchases or small real estate deals. As you acquire more cash, you can start looking at “big” deals, which have much higher cash flow. These might be commercial buildings, businesses or apartments. It is the “big” deals in the game that catapult you to your goal of getting out of the rat race. As you become better educated and play the game more, you can start to think outside the box: You can start to partner with other players to buy big deals that will benefit you both. That’s not just true in the game version; it is because of partnerships that I have started participating in real-life big deals.
My first fix-and-flip deal was only accomplished because I brought in a partner to help me. I met a motivated seller, but I didn’t personally know how to put the deal together. Chris agreed to meet with us and was successful in negotiating the deal. After leaving the meeting, he said, “Congratulations. We just made some money today.” He explained that in real estate, you make your money when you buy, and we had just made a great buy. We fixed that house and sold it, and we each made over $17,000. It was at this point that I realized how powerful and important partnerships can be.
With all this said, partnerships can be dangerous. It is possible for a partnership to go bad. In fact, later on a partnership with Chris went bad, which almost ruined me. The same guy who helped launch my success almost made me give up entirely. Partnerships can help you reach big deals, but you should go in with your eyes open.
Stick to a single transaction. It is my opinion that you should only structure partners on a per-deal basis. It is much easier to dissolve a partnership if it entails one transaction than if it is an entire business. It is also much easier to get along with a partner on just one deal. There are fewer decisions to make and fewer moving parts.
There should be a chief. Most partnerships I see are 50/50: Each partner shares equally in responsibility and profits. These rarely work. The most common problem with this is that one partner no longer feels their share is 50%. They believe they deserve more. And the partnership would be lucky if just one of the two felt this way. Many times, both partners feel they are getting shorted. Another issue I see with this arrangement is not having a decision-maker. What if the two partners don’t agree?
Clearly identify both roles. Another area of conflict comes from undefined roles. The most successful partnerships have partners who each bring a certain value to the group. Take my example with Chris. He had the knowledge; I had the deal. We each had a role, and we each brought value. If two people have the same skill set, it generally does not create a valuable partnership. The best partners have different skill sets and defined roles.
Have a conflict-resolution system. There is always a chance for conflict. I would recommend that you build some conflict resolution plans into the agreement. Here are two things you can build in to help you resolve any conflicts:
• Enlist a third-party decision-maker. I have done a handful of partnerships where I shared management with one other person. In these cases, we designated a third party we both trusted and believed to be neutral to resolve a conflict. This is important anytime you participate in a partnership with an even number of decision-makers.
• Include buy-out provisions. It is common to see buy-out provisions to handle problems with life events outside the partnerships or general conflicts. A buyout provision typically gives one or all partners the right to buy out the other partners. Some examples of reasons you would exercise this are if one partner is no longer able to perform their defined roles, one partner becomes bankrupt, a partner gets sued for another matter or a partner’s divorce creates the need for liquidity.
Investing in someone else’s partnership is also an option, like in an apartment syndication. I have mixed feelings on this but will say that it carries more risk than the average investor will see. In this case, you will be a silent partner, with your risk limited to your investment, and there will be one or more general partners who run the deal. I know there are some fantastic operators producing attractive results, so I am not saying not to look at this as an option. But, I would encourage you to go in knowing that the returns are higher because the risk is higher. Mortgage funds are similar, in that a manager manages the money and makes the decisions. The difference is that a mortgage fund can be liquid, and the money is diversified over multiple projects and invested in a more secure position. Having a loan on a piece of property is generally safer than owning the property, as lenders are always paid first.
My hope is to shed clarifying light on some pitfalls I have seen with partnerships and syndications, but I also hope that I’ve not scared you away from considering partners or investing in someone else’s deal. Overall, my experience with partners has been extremely positive, and I would not be where I am now without them.
