Structuring a Deal for PROFIT

everybody's can sew again thank you guys so much for sending in your your questions I do look at all these I think they're phenomenal we have some super educated and people watching this stuff and and keep those things coming in on Instagram and Facebook and LinkedIn and all the social medias and emails please keep sending those questions and I love these I think that a lot of times you'd be very surprised we'll get multiple questions multiple questions that people ask the same things from all over the world and so it's it's really fun for me to see kind of what everybody's thinking and what they want to hear so today I'm gonna do a couple more questions as we always do and I really like this one which was how do you structure a big deal in terms of profits and ownership with investors and so you know as you guys know I've done some videos on this specific thing and we have over 200 different entities that we have at our company here at MC companies and you know from literally from office buildings to self storage to to billboards to ground-up construction on land to value as to condo deals you know I'm sure there's many many many more in addition to that we have a bunch of businesses and so they all have different ownership percentages they all have different investment needs they all have different waterfalls which are the structure and so this is a phenomenal question and you know I hate to do this but the the truth is is that you know people want to know very concrete answers but I'll tell you and I get this question from my accountant all the time is it it just depends so now I am gonna give you some specific things but it really does depend and let me tell you I kind of there's there's the dog and then there's a tail you know what I mean so you know is the tail wagging the dog there's a dog wagging wagging the tail generally the equity is the dog okay so if you have your own equity you are in a much better situation on structuring to benefit yourself if you have nothing then you're going to actually have to give up the majority of the equity so so if you're gonna go to New York and let's say you have a deal and you're gonna go to New York and you're gonna try to raise some money like I did back in when I first started from the Lehman Brothers now they're of course out of business and we don't know what happened there with a big short and all that they're gone but they were an incredible investment bank during the day so I was in their boardroom and you know for Harvard MBA guys walk in and they basically just beat the heck out of me you know what I mean they just negotiated the heck out of me but I ended up with a 90/10 deal which meant that I kept 10% and they put up a hundred percent of the money and I gave them 90 percent and then they're what we call waterfalls that were benchmarks based on internal rates of return or IRR s or a return of capital so I think the number was about a nine or ten million bucks that I got from them and so they're looking for a return on that money so they're looking for you know the obviously the equity appreciation and the cash flow and all that kind of stuff okay so that's a straight ninety ten deal you're gonna find that as your IRR gets better so maybe it starts around fourteen or fifteen gets up to sixteen seventeen eighteen nineteen twenty once you get to say over twenty percent IRR you're actually split could change to fifty fifty okay so your ownership structure might start at ten percent but you have upside just like in just like an NFL quarterback you know like they get a base pay and then as they perform and make the playoffs they get X if they make the Super Bowl they get Y if they you know have certain hurdles that they have to do I have a bunch of friends that have cut these deals and our quarterbacks in the NFL and they're all very very different their performance based this exact same thing where when you're getting money from Wall Street and okay so that's one scenario so in that particular case your internal rate of return it gets better than your percentage gets better cuz what they're looking at is their core number so Lehman Brothers was looking at their nine million bucks what am I going to get it back and then after that's what's called a waterfall so the way waterfalls work if you think about it is the first thing that gets paid is the equity okay so somebody gives me nine million bucks they want their nine million bucks back okay the second thing that gets paid is what's called the preferred return okay let's say just for argument purposes that preferred return is 10% which is high but they're gonna want the nine million plus nine hundred thousand a year okay so if you have the money for three years that's two point seven million so the first nine million goes that's the first step in the waterfall the second step in the waterfall is nine hundred thousand a year times three that's two point seven million that's the second thing that's kids paid so now Lehman Brothers has been paid eleven million seven hundred thousand dollars we've satisfied their equity we've satisfied their preferred return after that then there's another waterfall and that's where you start to participate and this is a very common deal the equity gets paid first preferred piece gets paid second and then that's when you start participating I'm a big fan of this model because it's put your money where your mouth is so you can go raise all your money you want but if the property doesn't perform you don't get paid so the incentive is on the promoter or the developer to go you know make sure that that that property performs and so that's generally how waterfalls instructions structures are done now let's go all the way down to friends and family money friends and family money would be you know like crowdfunding for example which is a lot of small amounts which we don't do or it could be accredited investors which is kind of where we spend our time so we raised money through accredited investors that deal could be significantly different so I might do a 75 25 deal or a 50/50 deal perhaps and so a lot of it depends on the equity so when the equity is less sophisticated like you know friends and family or doctors lawyers whatever and I that is Believe It or Not unsophisticated investors generally even though they're accredited and I know a lot of people are gonna be upset for me saying that but the truth is you know doctors are doctors they're very good at what they do and they don't generally understand real estate that's generally sometimes they do but generally they're just turning money over to people and so they're it's not like negotiating with the Lehman Brothers and so you're gonna get a little bit better splits obviously if you have the less sophisticated the money is and then there's everything in between so the structures is are super important I think that the one thing that I just wanted to point out here is as the deals perform that's when you actually get paid so so you can raise all the money you want like a ground-up construction raising money you know that you're not going to have any kind of equity or any kind of cash flow for years ok so that money is sitting there and it's and it's burning this preferred return every single month you know while the property isn't performing so if you sell the whole thing and you and you cash out in a mega way then you're probably gonna be into the money so so I think that the best way to raise capital on a is to is through a friends-and-family model through you know in a much much more organic smaller level and do something that's a win win and in my opinion the first person that should be paid back is always the investor and then there should be a return paid on their money and then after that you should participate and you should probably never be more than 50% if you're not using your own money and if you are using your own money then you have more leverage to be able to say listen my money sitting alongside of your money so therefore the split should be a little bit different but phenomenal question and keep them coming the that the second question I have here is is pulling the initial money that you put down in a refinance a safety net so in other words so let's say somebody puts a million bucks down or five million bucks down and then it says if they pull that out in a in a form of a refinance is that a safety net and then they go further to say because if you default after that you only lose the money given to the bank and not your initial cash investment the reason I picked this question because there's a lot to it believe it or not even though it's a very simple question so first let me assure you that when we're talking about debt not the equity if you have a non-recourse loan that means that that if you default on the property then yes then the bank takes back the equity plus the loan and the property so they get everything okay and and so but if you have a recourse loan like on a new-construction it's very hard to get a non-recourse loan on new construction then you're probably gonna come after you personally for the loan and the equity etc etc etc so I'll make it really simple let's say you're doing a ten million dollar deal you borrow seven million dollars from a bank and you raise another three million dollars in equity and that deal goes to eight million bucks well if the loans recourse the bank's gonna come after you for that seven million dollars if the bank if the loan is non-recourse then they're gonna take the property they have a non-recourse loan of seven and they have a million bucks of equity so that's how that works so now let's answer the question directly if you pull your initial money out and a refinance is out of safety net and the answer is yes so what you've done here if you think about it is you now are in this deal for zero it's what we call an infinite return so if you put up a million box and a couple years later you pull that back and a cash out refinance it's two things one you are now infinite on your return to its tax-free so the million bucks that you pull out in a refinance it's not taxable because it's a Delon you actually owe it but the one thing that was missed in this question and this is reason I picked it is keep in mind when you refinance the banks looking at the whole picture they're not looking at your equity they're looking at the entire picture so they're never gonna leverage themselves up on a refinance in other words the bank's never going to give you 80 90 hundred percent debt you know just so you can get your money back because now they're looking at what's called a debt coverage ratio they're looking at the actual equity that's left after the refinance they're looking at the net operating income the way it's trending so they're looking at a whole bunch of things and so when we're taking a look at whether or not we're gonna refinance or not we're looking at the whole picture because the last thing we actually want is to be so heavily levered to where they barely kicks out any cash flow so we want to win win we want we want to be able to pull our money out completely and be infinite and have a tax-free cash out refinance oh that means that there's equity in the deal and that there's cash flow and so the bank is never gonna eat through that because generally cash out reef is add more debt and in the event that in some particular cases your interest rates can go down now this has definitely happened to Ross and I we bought stuff in the 5 6% rate and our payment let's say our payment was 250 thousand dollars a month on something and then we got more debt but the rates went down to say four and a half and so our payment might still be 250 thousand a month because the rate went down but we were able to pull more cash out so our loan balance went up but our rate stayed the same so generally I think you should just get your mindset around especially now when rates are so low you should be using fixed rate debt as much as you can because in in my opinion these times are not gonna last and if you can reef to cash out refinance at you know three four percent we just had a mortgage company give us a price of 3.2 percent on a fixed-rate 40-year note on a property that we already own and so we're looking at that right now so if we could lock in and imagine imagine I get three point two percent for 40 years so that's beyond belief to me that means that I'm actually beating inflation with somebody else's money so so the interest rates are really really important so but sometimes they can be more so let's let's go out ten years what if rates are five and six percent and you have something at four now you're never going to be able to refinance or do a cash out refinance unless you've grown the value of the property significantly so it's a really really good question the goal is always to do a cash out refinance and then have the property support itself with lots of cushion because at that point any cash flow to the partnership is infinite and it's tax-free because you know you're also shoring it up with depreciation and other things that we talk about in a lot of the other videos so again thank you guys great questions keep them coming I love doing these it helps me it helps the rest of the people that are subscribers thank you

Channel: Ken McElroy

Views: 28,193

Keywords: Rich Dad, Entrepreneurship, Investing, Personal Development, Get Wealthy, Earn Wealth, Ken McElroy, Entrepreneur, Rich Dad Advisor, Success, Business, Self-Help, Coaching, Real Estate, Real Estate Entrepreneur, Real Estate Investing, Freedom, Lifestyle Business, Hustle

Id: hvZgFnuwHzg

Length: 15min 13sec (913 seconds)

Published: Mon Dec 30 2019