I recently taught a class about using hard money and two young motivated entrepreneurs were in the room. They were in the front row and were eager to learn. I am always really excited to see the young, motivated new investors getting started. These two really reminded me of myself when I was getting started. Both had some great questions and stayed after the class to ask several more. It came up that they are high school buddies and were excited to go into business together. I must have cringed because I got a very strange look. I told them that I had to be candid before telling them I thought they were making a big mistake.
I explained that I have seen, on more than one occasion, best friends become enemies because of being in business together. One case there were lawyers involved, and these two were the best man in each other’s weddings. I mentioned that they need to be smart about how they enter business together. One of them suggested that they have a strong friendship and that they would make it work. I disagree for 3 reasons.
NO CHIEF: The primary problem I see with a 50/50 partnership is there are two chiefs and nothing in place to break the tie. If you have more than one chief, it is just like having none. No one person to take feedback and make a decision. If there is a disagreement about something, it could easily escalate into a much larger problem. Often times, the real problem is no longer the issue being disputed, but the dispute itself.
This is easy enough to handle if you are aware of it. Put something
in the partnership agreement that if there is a dispute that a neutral third party, picked in advance, makes the decision for the partnership. Another way to do it is to have defined roles and defined aspects of the business each is responsible for.
NO DEFINED ROLES: I did not get into this with them because of our limited time, but I sensed not much thought was put into it. They each had a vaguely defined role based on what they like or did not like to do, but did not have precise roles earmarked for each of them to take responsibility for. Of the partnerships that I have seen go bad, this is the leading culprit. One partner believes they are doing most of the work, or at least more than their share. They start getting disgruntle and stop working so hard, or they might keep their issue to themselves until they let it out with an explosion. It typically does not go well to explode on a business partner and friend.
Much of this is avoided with specific defined roles and penalties if things are not getting done.
NO GOOD REASON TO PARTNER: One of the gentlemen was a mortgage broker and one was a Realtor. They believed that having each of these professions inside a company would make the company stronger and better equipped to be successful. They believe that their profession outside the business provided enough value to be included in the partnership.
I love partnerships when they are set up correctly and for the right reasons. In fact, I believe partners are essential to reaching your potential, but the reason to partner is to help you get something done you could not do without the partner. In their example, either one of them can get the skills the other is bringing without a partner. For example, I can go find and use a mortgage broker or a Realtor simply by paying the fee. I don’t see a compelling reason to partner with someone to get skills I can get without the partnership. I see this with people wanting to partner with contractors a lot. I feel strongly there are better ways to in-cent a contractor than to partner.
One of the other questions from the audience that day was how do you build a rental portfolio with no income. We were talking about how to use hard money to purchase several properties with little or no money down. His question was extremely valid because many business owners have trouble showing enough income to qualify for conventional loans. Of course my response was, why don’t you use a partner? You can find and rehab the house and they can purchase and refinance it. You can share the profit anyway the two of you agree. This is a prime example of when a partner makes a lot of sense. One partner might not have the knowledge and/or time to locate and rehab houses and the other cannot qualify for a loan. They both need each other.
One final thought is you might consider a joint venture on a deal by deal basis. This way you can easily define roles, responsibilities and profit splits and you don’t get tied to someone long term. I really like partners on individual deals where each partner is free to do other deals on their own as well. This is exactly what Travis in our office did on his first town-home development. He brought in partners to help with the funding and did the deal. Now he is doing these deals without partners because he no longer needs them. It was truly a win-win on the first deal, and there are no hard feelings on anything he is doing now. This is exactly how I believe it should be done.