From the desk:Syndications: GP / Sponsor

Sponsor offered me a slice of the promote for bringing $500k of my friends' money. Something feels off.

An operator I've been following wants me on his next deal, after six months of research and nothing to show for it. 84 units, 7.8M, he's raising 2.6M. He's done five deals, two of them full cycle, and the reporting I've seen from an LP friend is clean and on time.

The offer: if I bring 500k of the raise, I get 10% of the GP entity, so 10% of a promote he expects to be 900k to 1.2M, plus he'd put my own 75k in on LP terms with the pref waived on my dollars because I'd be a GP member. No fee to me otherwise. He described it as "co-GP" and said several of his other GP members came in the same way.

What I have: his last two full cycle deals with actual distributions against the original projections, both of which beat the pref and one of which landed near the 70/30 tier. His T12 and rent roll for this deal. A draft GP operating agreement that lists me as a Class B member with no stated duties.

What bothers me. The compensation is tied entirely to the dollars I bring. My name would be in an offering document as part of the GP while I'd be doing nothing operational, and the four or five people I'd bring are friends who'd be investing because they trust me rather than because they've read a PPM. If the deal goes badly I'm the person they call, with no ability to do anything about it.

The decision in front of me this month is whether to take the GP slot, or to just put my own 75k in as an ordinary LP and tell my friends about the deal with no economics attached to whether they invest.

Answer

1renee_dubois Get yours

The part to stop on is that your pay is a function of dollars raised and nothing else. Compensation tied to raising capital can implicate broker-dealer registration, and there's a whole industry of "co-GP" arrangements built to look like something else, so that's a question for a securities attorney before you sign anything, not after. The fact that his other GP members came in the same way isn't comfort. It means he's been doing it this way for five deals and nobody has tested it yet.

Set the legal question aside for a second though, because your own paragraph already answered the practical one. You said the GP agreement lists you as a Class B member with no stated duties. So you'd carry the title, your friends would carry the risk, and you'd have no vote and no information right beyond what he chooses to send. I own small multifamily and the one thing I've learned is that the person who gets the 2am call should be the person who can do something about the problem.

If you like the deal, put your 75k in as an LP on the same terms as everyone else, keep your pref, and if a friend asks what you're invested in, tell them and hand them the sponsor's contact information with nothing riding on their answer. You keep the relationship and you learn the sponsor from the inside for one full cycle. Then go earn a real GP role by doing real work on a deal, which is the version that's actually worth something in two years.

3 replies

1aliyah_bAU2APRO6

The pref waiver on your own 75k is a bad trade on its own terms, separate from everything else. You'd be giving up 8% or whatever it is, cumulative, on your own money in exchange for promote you might never see. Run the number where the deal only clears the pref and returns capital. In that scenario your 75k earned nothing and your promote is zero, while the LPs you brought got their pref. I'd want that scenario written out before I looked at the rest.

1Rena Expert

Two mechanisms worth separating here.

The first is what a promote actually pays for. Carried interest exists to reward the party that sources the deal, underwrites it, arranges the debt and executes the business plan through to sale, and it's disproportionate on purpose because the risk is disproportionate. A GP slot with no stated duties has none of that on the other side of it. What you'd be holding is a payment for introductions dressed in the language of ownership, and how that's treated depends on securities law rather than on what the operating agreement calls you, which is why cairn is right that it goes to a securities attorney first.

The second is the underwriting you should be doing on him regardless of which path you pick. Two full cycle deals is a thin sample and both landed in a different rate environment than the one this deal will be financed and sold in, so ask what his exit cap assumption is relative to his entry cap, what the debt term and extension tests are, and what happened on the three deals that aren't full cycle yet. Ask specifically whether any deal of his has had a capital call, and if the answer is no, ask what would trigger one. Sponsors who answer that question precisely are usually the ones who've modeled it.

On the pref waiver, tally's scenario is the one that matters. Model the case where the deal returns capital plus pref and no more. That case is common, and in it your GP interest is worth zero while the pref you gave up was worth real money on your 75k.

What any of this is worth depends on the assumption you haven't stated: whether his year-one occupancy and expense numbers hold on an 84 unit asset you haven't walked.