S.E.C. Real Estate Observer

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There are many ways to form a partnership, but over time, most profit sharing methods in partnerships don’t work. Here’s a way that does work.

The traditional share-and-share-alike agreement seems like a fair arrangement at the beginning of every partnership. Does this sound familiar, “We will both share the effort and split the profits 50/50.” Even with the best of intensions, somehow, over time, the equal sharing of effort, time, and risk seems to fade away and the partners are no longer participating on an equal basis. Inevitably, one partner ends up pulling more than half of the weight. However, under their partnership agreement, both partners continue to share equally in the profits. In our opinion, this is a sure-fire formula for a partnership to fail.

The G5 Concept

A few years ago, five brokers, who knew each other for many years from their monthly local exchange meetings, got together to see if they could make some money and have some fun doing it. The five brokers, Chet Allen, S.E.C., Dan Harrison, Greg La Marca, Virgil Opfer, S.E.C., and Bob Stewart decided to join together to seek exceptional real estate opportunities.

This decision led to a series of organizational meetings. At the early meetings, we decided to define in writing our goals and objectives. The impetus for that important decision was the direct result of the Business Symposiums sponsored by S.E.C. and, in particular, the Denver symposium at which Harry Kennerk, S.E.C., clearly defined the importance of setting specific goals, and to define the obstacles in achieving those objectives.

At one of the early meetings, Chet Allen brought a unique idea to the group that really set our team into high gear. Chet’s concept (a genius inspiration, in my opinion) was that we dissect a typical transaction into some very basic functions, then, as a group, agree on a value for each of those functions, or roles, in order to provide a financial incentive for each of us to seek out those functions and receive the associated reward for doing so. Chet went on to suggest that after the persons have been rewarded for their specific roles, that the remaining profits (if any) would then be divided based the traditional share-and-share-alike arrangement. That way, those who performed the most important functions in any given project would be paid first and in greater measure than those who contributed in a more minor role to the success of the project.

The idea led to several lengthy meetings with round after round of lively discussion. The basic thought behind the reward system was simply, “Let’s make the reward for each role first based on logic, but also make the reward so attractive that each of us will want to play each role.” Each project would stand on it own, with a separate written agreement for each new project. Once the sharing arrangement was set, it would remain unchanged for the duration of that particular project, even if subsequent events led to changes in future financial structures.

It was at this time we also decided to incorporate and the company, G5 Enterprises, Inc. (G5), was created. We also agreed that each project would be structured as a newly created limited liability company (LLC), with G5 Enterprises, Inc. serving as the Manager of each new LLC.

Since we anticipated that the bulk of the investment capital would come from a cadre of investors, we agreed that each LLC would be based on the classic “safety first” formula, where the cash investors would receive all of their capital and all of their profit before G5, as Manager, would receive any compensation.

For our purposes, we defined the following basic roles, or functions, for a real estate investment:

1. Finder, the person who locates the property and presents the opportunity to the group and then oversees the acquisition through the close of the purchase escrow.
2. Funder, the person who contributes capital to the project, or who brings in other investor’s cash to fund the required capital.
3. Coordinator, the person who manages the day-to-day details of the investment and sees the idea through to completion and serves as the primary contact person for all activity once the project is underway.
4. Administrator, the behind-the-scene person who is responsible for the ongoing administrative work, written reports to investors and the bank, bookkeeping, and tax preparation functions.
5. Loan Guarantor, the person with sufficient financial strength who puts his financial statement at risk to guaranty any loans that require a personal guaranty.

In any given project, one person may play more than one role. Likewise, one role may involve more than one partner. There may be occasions where not all roles are required for a project. For example, a Loan Guarantor would not be required if a project involves a non-recourse loan, or in a cash transaction where there is no loan.

G5 Profit Distribution:

Based on our discussions, we came up with the following formulas for rewarding the five major role players. Each of the following references to “profit” is based on the profit remaining after the investors have been paid 100% of their capital as well as their entire return on capital. We refer to the profit remaining after paying the cash investors in full as the “G5 Profit.” Those fees listed below based on other than the G5 Profit are also paid only after the cash investors are paid in full.

Finder, an amount equal to 3% of the acquisition price, or 6% of G5 Profits, whichever amount is greater.

1. Funder, an amount equal to 10% of the capital raised from third party investors or contributed by the partner.
2. Coordinator, fee will vary from 5% of G5 Profits for a simple purchase and resale, to 10% of G5 Profits for a construction project or condo conversion.
3. Administrator, an amount equal to 5% of G5 Profits.
4. Loan Guarantor, an amount equal to 7% of the original principal amount of any loan guaranteed.

Shared Profit Distribution:

Once the investors are paid in full and each of the above special fees has been paid, then the remaining profit (the “Shared Profit”) is distributed equally to all partners.

We have just completed our first project and the results are very satisfactory. The rewards for the partners in the special roles were very significant and the pro rata share of the Shared Profit was in the six figures, with all six figures to the left of the decimal point.

The G5 distribution method based on first rewarding a person’s contribution to a specific project works exceedingly well. This is evidenced by the fact that all five partners are fully engaged in concerted efforts to be role players in each of the five new projects now on line