Compensation for risk on investment

[FuriousGeorge]

If three people are investing on a project, a house flip for example. All three put in the same amount of cash to pay for the renovation but two of the people take the risk via the mortgage that is repaid upon sale. How would you divide up the return on investment? 

[Sahil Pandit]

@FuriousGeorge

@Average Investor hmm... 

[JustThinkingAloud]

3 hours ago, FuriousGeorge said:

If three people are investing on a project, a house flip for example. All three put in the same amount of cash to pay for the renovation but two of the people take the risk via the mortgage that is repaid upon sale. How would you divide up the return on investment? 

The return on investment is still divided by three. The costs of financing each personal share is a private cost and not related to the investment.

[FuriousGeorge]

@JustThinkingAloud for easy math, let’s say the purchase price of the home is 300,000 and the renovation cost is 30,000. 2 of the people co-sign on a mortgage and each invest 10,000 for the Reno’s. Would you still split the income by 3? Perhaps the two splitting the mortgage should get a little extra for taking in the risk?

[JustThinkingAloud]

32 minutes ago, FuriousGeorge said:

@JustThinkingAloud for easy math, let’s say the purchase price of the home is 300,000 and the renovation cost is 30,000. 2 of the people co-sign on a mortgage and each invest 10,000 for the Reno’s. Would you still split the income by 3? Perhaps the two splitting the mortgage should get a little extra for taking in the risk?

If you make a special agreement to do that (and everyone agrees) then it's fine but based on accounting principles you would split it equally by 3 based on the contribution, not on the cost of funding the contribution. It would be unfair to the 3rd person as that person is missing out on profit just because the other two don't have savings and have to borrow.

Have a look at it this way. Imagine that you buy stocks in a company together with thousands of other people. Does you dividend depend on whether you borrowed the money to buy the stock with? No, everyone still gets the same dividend based on the size of the investment whether they borrowed money to buy it or not.

[Average Investor]

I've never invested with a partner in something or real estate yet. Ideally you would want to be getting the mortgage through an LLC  to minimize your exposure if something happens with the property. Same with placing all the needed insurances on the investment. 

Ideally you would want to have an agreement formed between all parties and I would use a lawyer for ANYTHING involving high sums of money or multiple parties. You could actually have a corporation formed between all parties with percent ownership that would make it really easy to limit the risk. It would require you to have meetings with them documented and an operating agreement for who does what and who is contributing what money. 

Getting the amount of funding lent to the corporation might be the issue. I'm not very game on money lending yet, so I can't really say much there. But if it worked well and you could get the funding with enough contributions to it, then the risk would be potentially evened up and if not the amount of profit can be adjust to each party in the operating agreement. 

If the above does not work that is something you will personally have to account for. But I would not touch something like that without being behind a corporation to mitigate the risk. 

[FuriousGeorge]

@JustThinkingAloud @Average Investor thanks guys, good advice, setting up an LLC sounds like the best method

[Average Investor]

@FuriousGeorge Yes, thank you for taking that advice. It could save you thousands of dollars. I would seriously suggest you have a lawyer set it up. Might cost like $1,500, but at $500 a piece that is well worth it. Good luck with your investment. I hope it provides a great profit.