Investing with friend- Ways to structure this?

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Topic Author
Gardener
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Investing with friend- Ways to structure this?

Post by Gardener »

I have a friend that I have invested with before. He has integrity and has sound character that I have known for 20 years. He has built vacation cabins on a mountain and continues to expand, putting more cabins on this mountain. He has 8 cabins now and looking to add 8-16 more cabins over time.

He has invested about $2M into these cabins (land development, cabin build, zoning, permits, etc) most of which is financed. It has a low vacancy rate and he has a good margin.

Anyway, my friend has hinted at getting more money in order to continue to expand and add more cabins on this mountain.I am well aware of the numerous pitfalls of going into business with a friend or anyone for that matter. I know that this carries some risk. I would not be parting with funds that I could not afford to lose or that would greatly impact my retirement.

For my part, I'd be willing to:

1. Put an initial $50-$100k in this business to help with expansion and operations
2. Invest another $2-$4k monthly into this business.

My question is this. I would be interested in investing some funds in these cabins and the business. But, what would be the most sensible way to approach this? What kind offer/arrangement could I make that would make sense to him and me? I would want to stay out of day to day business activities and for the most part just steadily invest each month and let him continue to do what he's doing.
LeftCoastIV
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Re: Investing with friend- Ways to structure this?

Post by LeftCoastIV »

How is your friend's business structured currently? Does he/she have an LLC that covers all of the property, cabins, etc,?

There's a lot of nuance here to consider, including:

[1] Are you buying a share in the existing business, and as such entitled to a pro-rata share of any profit, as well as pro-rata obligation for any cash calls?
[2] As a minority shareholder, what voting rights if any do you have? I know you're friend is trustworthy, but is he entitled to pay himself a salary, for example?
[3] If either of you decides to sell your interest in the business, does the other have a preferred right to buy the other's shares? Could you be blocked from selling your equity if you needed to?
[4] Will you be taking on any personal liability that needs to be insured against? (e.g. cabin burns down with people inside, etc...)

But let's start with... how is it structured right now?
Topic Author
Gardener
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Re: Investing with friend- Ways to structure this?

Post by Gardener »

Thanks @Leftcoast

Those are good and helpful questions.

I am going to show my ignorance here with my responses. I obviously need to do a little more homework and gain more knowledge.

He currently has it structured as an LLC.

1. I would like to buy a share of the existing business. I don't know if he would or wouldn't like that set up. I wanted to get a little more knowledge before approaching him with an offer. But, I actually don't know a pro-rata oblibation for any cash calls means, but I will look it up.

2. Very good question on voting rights. I wanted to almost be like a silent investor, if that's the right word. In my head, I was picturing me having maybe a 5% share in the company. And then keep adding more money to get up to say 10-20% equity? Then, I would of course be responsible for 10-20% of the liabilities, but reap 10-20% of the profits, correct?

3. I would like it to be set up where the other 'stakeholder' has first right of refusal on shares.

4. Yes, I would think I would need to take on personal liability since ideally I would want a stake in the company.
GuyInFL
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Re: Investing with friend- Ways to structure this?

Post by GuyInFL »

Regarding 2.
Obviously this is pretty illiquid. You mention profits. What if he chooses to continue investing profits in the business and you'd prefer cash flow. You likely can't just sell a few shares like a REIT. Just another topic for discussion.
dknightd
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Re: Investing with friend- Ways to structure this?

Post by dknightd »

I would not do this
Retired 2019. So far, so good. I want to wake up every morning. But I want to die in my sleep. Just another conundrum. I think the solution might be afternoon naps ;)
aristotelian
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Re: Investing with friend- Ways to structure this?

Post by aristotelian »

dknightd wrote: Tue Oct 26, 2021 8:12 am I would not do this
+1. If you want to invest in cabins, just do it yourself. Way simpler and will not risk your friendship. Friend signaling need for money is a major red flag. If a bank will not give him a loan, he may be stretched thinner than he is letting on.

If you really want a piece of this, do a personal loan for an amount you can afford to lose which leaves all the ownership and responsibility with the friend.
Faisal
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Re: Investing with friend- Ways to structure this?

Post by Faisal »

Mixing friends and money is a good way to lose friends and money. As others have said. This is a bad idea.
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BolderBoy
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Re: Investing with friend- Ways to structure this?

Post by BolderBoy »

Faisal wrote: Tue Oct 26, 2021 8:30 amMixing friends and money is a good way to lose friends and money. As others have said. This is a bad idea.
+1.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect
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Watty
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Re: Investing with friend- Ways to structure this?

Post by Watty »

Gardener wrote: Tue Oct 26, 2021 4:15 am He has 8 cabins now and looking to add 8-16 more cabins over time.
.....
I am well aware of the numerous pitfalls of going into business with a friend or anyone for that matter. I know that this carries some risk.
I have a hard time understanding what your friend gets out of having you invest in the business.

If is going to build 8 cabin and you fund the extra money to build an additional 8 for a total of 16, then how does he come out ahead by having you involved?

Even if things go well one big risk to consider is that your friend could unexpectedly die in a car accident or of a heart attack or become disabled for some reason.

You really need to have a contingency plan for that scenario.

It was a lot different situation but there was a post a few years ago by someone who was having a custom house build and they had a great builder and things were going well until the builder unexpectedly died in something like a car accident. They then had a big mess with a half finished house. There were lots of problems with unpaid subcontractors, missing plans, and trying to transfer building permits to someone else. They could not get another contractor to work on the house because of all the issues and liability. I never heard how that turned out.

Instead of trying to merge your ownership with him on 8+ new cabins, or his existing cabins, it might make more sense for you to do something like own 4 cabins in your name so things will be cleaner and easier to unwind if you need to. You might still be able to operate the rental business as some sort of joint partnership.

I would also be cautious about assuming that the strong rentals will continue. With the pandemic lots of people have been renting places like mountain cabins and beach houses. I have heard of beach houses renting for several times what they cost a few years ago. Once things get back to normal the demand could change a lot.
Topic Author
Gardener
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Re: Investing with friend- Ways to structure this?

Post by Gardener »

Just wanted to thank you all for the posts.

I figured there would be a lot of posts advising against it. It does seem complicated and I am probably in over my head.

I guess I was just (maybe naiively) hoping I could just make steady stream of investments (not unlike we do here on Bogleheads with our index funds) and see a return in the future.

Agreed with Watty- Admittedly, he needs me less than I need him. I just believe in him as a business man as well as his current business model.

Thanks
Topic Author
Gardener
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Re: Investing with friend- Ways to structure this?

Post by Gardener »

Just another thought on this. And just thinking out loud.

I think I was looking at this opportunity to try to grow wealth faster.

But, what I have has been working, but its more along the lines of hitting a constant stream of singles and doubles. I think I was looking for the quick homerun! But, I should just stick with this system. I just wanted to get a little more aggressive, but theres probably no need.

I have an excellent paying job (half time or less with excellent benefits) plus a side job that I put in maybe 40-45 hours a week on. In turn, I invest a good chunk of that into index funds.

Thanks all
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JPH
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Re: Investing with friend- Ways to structure this?

Post by JPH »

Is he willing to accept you at a totally silent partner? Or are you expected to do something other than write checks and receive the same as profits are realized? If you trust him, then let him run the operation. Friction develops when there are too many cooks in the kitchen.
While the moments do summersaults into eternity | Cling to their coattails and beg them to stay - Townes Van Zandt
Zeno
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Re: Investing with friend- Ways to structure this?

Post by Zeno »

Gardener wrote: Tue Oct 26, 2021 4:15 am I have a friend that I have invested with before. He has integrity and has sound character that I have known for 20 years. He has built vacation cabins on a mountain and continues to expand, putting more cabins on this mountain. He has 8 cabins now and looking to add 8-16 more cabins over time.

He has invested about $2M into these cabins (land development, cabin build, zoning, permits, etc) most of which is financed. It has a low vacancy rate and he has a good margin.

Anyway, my friend has hinted at getting more money in order to continue to expand and add more cabins on this mountain.I am well aware of the numerous pitfalls of going into business with a friend or anyone for that matter. I know that this carries some risk. I would not be parting with funds that I could not afford to lose or that would greatly impact my retirement.

For my part, I'd be willing to:

1. Put an initial $50-$100k in this business to help with expansion and operations
2. Invest another $2-$4k monthly into this business.

My question is this. I would be interested in investing some funds in these cabins and the business. But, what would be the most sensible way to approach this? What kind offer/arrangement could I make that would make sense to him and me? I would want to stay out of day to day business activities and for the most part just steadily invest each month and let him continue to do what he's doing.
You really need to consult a competent business lawyer. A lawyer can advise you on legal structures (it sounds as if you would be a limited partner, so you might need a partnership agreement, with your participation as a LLC), investment agreements, ways to mitigate your risks (what happens if her business gets sued?), capitalization agreements, mechanisms for you to exit, and an infinite number of other things.

I remain puzzled why people seem unwilling to seek legal advice as a general matter. It is one thing to DIY repairing a fence; it is quite another thing to endeavor to DIY a +$100,000 investment in a business, or countless other things that come up on these boards. Lawyers play a critical role in society, plus they provide a form of insurance as they themselves can be liable for malpractice in the highly unlikely event they provide faulty advice.

You may spend $5,000 or more in legal fees to do this right. The other alternative is to not do it right and hope nothing goes wrong. In business, however, things always goes wrong. And that is also why when one is crafting a partnership agreement the lawyer’s role shines. The lawyer, having seen a huge number of similar deals where friends became enemies, can represent you in drafting an agreement that protects your downside risks. We live in a litigious society. Your friend and business partner today can sue you tomorrow. You need a lawyer.
Last edited by Zeno on Wed Oct 27, 2021 8:05 pm, edited 3 times in total.
Topic Author
Gardener
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Joined: Sun Nov 18, 2012 2:03 pm

Re: Investing with friend- Ways to structure this?

Post by Gardener »

WyomingFIRE wrote: Wed Oct 27, 2021 5:10 pm
Gardener wrote: Tue Oct 26, 2021 4:15 am I have a friend that I have invested with before. He has integrity and has sound character that I have known for 20 years. He has built vacation cabins on a mountain and continues to expand, putting more cabins on this mountain. He has 8 cabins now and looking to add 8-16 more cabins over time.

He has invested about $2M into these cabins (land development, cabin build, zoning, permits, etc) most of which is financed. It has a low vacancy rate and he has a good margin.

Anyway, my friend has hinted at getting more money in order to continue to expand and add more cabins on this mountain.I am well aware of the numerous pitfalls of going into business with a friend or anyone for that matter. I know that this carries some risk. I would not be parting with funds that I could not afford to lose or that would greatly impact my retirement.

For my part, I'd be willing to:

1. Put an initial $50-$100k in this business to help with expansion and operations
2. Invest another $2-$4k monthly into this business.

My question is this. I would be interested in investing some funds in these cabins and the business. But, what would be the most sensible way to approach this? What kind offer/arrangement could I make that would make sense to him and me? I would want to stay out of day to day business activities and for the most part just steadily invest each month and let him continue to do what he's doing.
You really need to consult a competent business lawyer. I lawyer can advise you on legal structures (it sounds as if you would be a limited partner, so you might need a partnership agreement, with your participation as a LLC), investment agreements, ways to mitigate your risks (what happens if his business gets sued)? capitalization agreements, mechanisms for you to exit, and an infinite number of other things.

I remain puzzled why people seem unwilling to seek legal advice as a general matter. It is one thing to DIY repairing a fence; it is quite another thing to endeavor to DIY a +$100,000 investment in a business, or countless other things that come up on these boards. Lawyers play a critical role in society, plus they provide a form of insurance as they themselves can be liable for malpractice in the highly unlikely event they provide faulty advice.

You may spend $5,000 or more in legal fees to do this right. The other alternative is to not do it right and hope nothing goes wrong. In business, however, things always goes wrong.
Completely agree with what you said.

I would absolutely seek the advice of an attorney and get something written up formally.

I am just at the very early brainstorming stage and just wanted to get a better idea so that if I did something like this, at least I could have a better sense of what something like this might look like. And what rough idea of a proposal I could make that would be attractive to both him and I.

I agree with the general consensus that if I did something like this, to go in cautiously and eyes wide open.
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celia
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Re: Investing with friend- Ways to structure this?

Post by celia »

How do both of you see the partnership ending? (It needs to be agreed on and documented up front.)

What happens to your respective shares when either of you die? Or you both die? What if a beneficiary wants cash instead of cabins? What if a beneficiary dies soon after inheriting and SHE has multiple beneficiaries?
LeftCoastIV
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Re: Investing with friend- Ways to structure this?

Post by LeftCoastIV »

If I was in your position, I would ask the friend for financial statements for the past three years, as well as the forecast for the next few years inclusive of the cabin expansions. Before getting into the legal structuring of your potential involvement, I would first want to understand if the venture would be sustainably profitable under reasonable assumptions, and the key sensitivities (like rental rates and utilization) that could materially impact the profit/loss of the venture.

Only if the financials look compelling is it then worth sorting out if there is a palatable legal structure for your involvement.
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