IC E Lesson: Things I Was Wrong About Part 1: All Partners are Bad
Like a lot of seasoned investors, I have a LOT of opinions about the “right” way to do things. In fact, I’m afraid that, once I form a particular belief about something, I might be even MORE likely to stick to it like white on rice than the average person, ‘cause I’ve been around the real estate block so many times that I figure I just MUST be right.
Except, of course, when I’m not.
The longer I’m in the real estate business and the more I observe about what actually works for individuals, as opposed to how I think things should be in an ideal world, the more I find myself saying “I still believe X, except in the case of Y and Z”.
One example of a formerly hard-and-fast rule that I’ve “gotten over” in the past few year is one you might have heard me espouse in the past: Partners are bad.
My experience with partners over the years has been…contentious, and I’ve made no secret of it. The fact that I’ve rarely seen partnerships between 2 unrelated people (and even less so between RELATED people) that didn’t limp along to the dissatisfaction of both parties and/or blow up, leaving emotional and financial wreckage that in many cases lasts for YEARS, hasn’t added to my bag o’ reasons to do them.
However, as time has passed and I’ve become more experienced and more aware of my own preferences and limitations, I’ve discovered that there are particular KINDS of partnerships that don’t work, and some that do.
The partnerships that I’ve seen fail, and that I continue to discourage, tend to fall into the category of what I call “handholding” partnerships. Handholding partnerships typically begin with one or more of the following expectations:
a. I’m inexperienced and scared. You’re inexperienced and scared. If we partner up, we can hold hands, and it will still be the case that neither of us knows what we’re doing, but maybe we’ll be less scared.
b. I can’t do all the work this business requires, but I [don’t want to/don’t know how to/can’t afford to] hire people to do the work, so you’ll do what I can’t do and we’ll split the profits.
c. I’m really bad at/hate/don’t understand part of the work required here, and you’re good at/like/know that part of the work, so rather than hire someone to do it (see above), we’ll partner up and split the profits.
d. I have money/credit but no understanding about how to do rehab. You’re a contractor. I’ll put up the money, you do the work, and we’ll split the profits.
e. We’ve been friends/relatives forever. You’re out of a job/helpless/hopeless, I have a pretty good thing going here, and I want to bring you up in the world. We’ll partner up and split the profits.
The problems with these kinds of partnerships are myriad.
They’re rarely well thought out or documented: sure, we’re going to split the work, but who does what, EXACTLY, and what happens if one person doesn’t carry their part of the load?
They’re usually entered into with very different expectations on each side—and neither side knows it, because the exact responsibilities and the consequences of not fulfilling those responsibilities haven’t been defined.
There’s no agreement about a “trial period” or an exit strategy for the partnership if it doesn’t work out…if that friend/relative can’t get up to speed in 6 months, then what? If that contractor doesn’t finish the rehab in 3 months because he’s taking every side job he can get so that he can have money coming in, then what?
And they’re often documented in such a way that one partner can hold the other hostage when things go south. For instance, if you and your contractor partner own the property in question together, what happens when he doesn’t do his job, you have to hire another contractor to finish the work, and HE STILL WANTS HIS HALF? What happens when your “partner”, who’s in charge of the bookkeeping you hate/don’t understand refuses to turn over the QuickBooks files to you when you decide to end the partnership?
So what in the world would make me change my mind about this?
Here’s what: there are other kinds of partnerships that DO work. These also have a definable set of characteristics:
a. Each partner brings something very valuable and very unique to the partnership, and understands exactly what his role is. There are 3 things that have to go into every real estate deal: money (or credit), time, and knowledge (or skill). When the partners BOTH have ONE of these things (2 people with money, 2 people with time, 2 people with skill), the partnership doesn’t work because neither person really “needs” the other. But when they have different legs of the stool—one has money, the other has skill—the arrangement can be really positive for both people.
I have several partnerships where the partner is strictly the money/credit person and I am strictly the experience/work person. In these partnerships, there’s no friction because my partner doesn’t know and doesn’t care about vacancies, management issues, what color we paint the trim, who the tenant is, etc. He cares about getting the return he wants, and lets me do my job and to use my deal-finding skills, staff, and experience to get that return. Plus, I don’t get paid unless he does, so he knows I have every reason to do my best to make that property as profitable as possible.
b. Both partners are very experienced, but have drastically different skill sets and/or resources. With two experienced partners (as opposed to two inexperienced people in a hand-holding partnerships), it’s sometimes possible to create a “1+1=3” situation based on similar levels of experience, but differing resources.
For instance, I have a partnership with a local investor who has done in excess of 1,000 deals in the past 20 years. This partnership (which also includes about a dozen “money people” who’ve invested in a fund we set up for the purpose) invests in unusual, high-yield, one-off deals like buying and repositioning apartment buildings, buying and working out defaulted commercial paper, buying bulk packages and “noting them out”, etc.
Our careers until now have followed largely similar, but not identical, paths. He’s done more rentals, commercial deals, and rehabs than I have; I’ve done more wholesaling, land contracts, and creative deals than he has. He’s very good at managing people and systems; I suck at/hate those things. I’m very good at public speaking, sales, and marketing, which are kind of necessary to the fundraising part of this venture; he doesn’t like and doesn’t think he’s good at those things. He’s better at rental management; I’m better at analyzing and structuring deals.
Could we, separately, do our own funds and make lots of money? Maybe. Will we do a better, more profitable fund together than separately? Yep.
But at the same time, our experience tells us that things can go wrong in partnerships and in new ventures in general—and this might be the most important part of why I’m willing to enter such a huge potential partnership.
We have a buy-sell agreement in the underlying entity that allows either of us to get out if we become unhappy; we also agreed to start with a smaller fund of around $2 million, see how it goes over the 6 months or so, and then enter a larger one if we feel that the partnership is working. If not, no long-term commitment and, hopefully, no hard feelings.
So. Handholding, split-the-work, rose-colored-glasses partnerships? FAIL.
Partnerships where both parties understand every duty, responsibility, weakness, and potential bad outcome, and are each bringing something different and useful to the table? Yes.
Which one are you contemplating?
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