I talked to a few different park owners who are looking for equity investors. Which works out for me since i would rather be a passive equity investor. They are presenting me with the following formula. Can someone educate me on this formula, and is it fair for both parties, or should i lean in a different direction?
$$,$$$ investment = 30% Equity / 9% after refinance.
Way too complicated. Limited Partners should get a preferred return on their investment (typically 5%-10%). After that hurdle has been hit the General Partner is entitled to a percentage of the excess. Lookout for folks promising high returns including a return of capital in a short period of time.
This sounds more like preferred equity than traditional equity (because you’re saying you get an ‘interest payment’ in year 1 and 2. You’re taking all the risk, but once you get your principal back, you’re getting ‘crammed’ down to 9% (if I’m understanding this properly). The way most people do this is for example, an 8% preferred return (based on IRR) and above that, the equity gets split (going more towards the sponsor’s favor as the returns go higher). These equity splits are know as hurdles. For instance, returns are pari pasu until an 8% IRR, from an 8%-12% IRR, you keep 70% of cash flow and the sponsor keeps 30%, and above a 12% IRR, cash flows are splits 50/50.
Ask if you can keep it simple - what happens in the above scenario if they don’t give you your principal back in 24 months? What happens if you have to put more equity in? If you base your preferred return and hurdles on an IRR, this all gets taken into account.
Other times you may see splits where cash flow and refi/sale are handled differently. For example, cash flow above an 8% cash on cash is split 50/50 and than all refi/sale proceeds go to pay the investor back their principal first. Once principal is repaid, the refi/sale proceeds are split 50/50.
The above structure to me seems like it’s trying to do a mix of the above, but it’s really confusing. I would ask for something much more simple. Also it just seems like you’re taking all the risk to buy the property but get crammed down relatively quickly.