If a joint venture offers you to act as a key principle, or KP, on a deal, should you do it?
In order to gain a commercial loan, the joint venture must show a certain amount of personal liquidity. The purpose of this is that in case the project goes wrong along the way, the lender knows that the joint venture has enough personal capital to keep the property afloat. So if the balance sheet does not meet the needed requirements for the loan then they may bring on an additional key principle to guarantee the loan.
Things to keep in mind
If you have the net worth and liquidity, then you are a shoo-in for the role of key principle. But what is the joint venture going to do for you? Will you get a piece of the profits? Are you getting additional equity in the project? You need to know what your reward will be by serving the role of KP. You also need to be confident in the risk involved, as you may be the one personally signing the loan.
Additionally, how well do you know the people that are asking you to sign? Do you have confidence in them and their project? Just like you wouldn’t sign on a loan for a distant cousin you have only talked to while waiting in the potluck line at the occasional family reunion, you shouldn’t sign on a loan for someone that you don’t know very well.
Depending on the structure of the joint venture, their project, and how they choose to include you, you may have a seat at the table similar to that of one of the general partners. However, as a key principle, that is not a guarantee of the role. So make sure that you understand what your exact position is with the people that are asking to work with you, and whether you have enough confidence in the project that you would be alright with potentially not have voting rights in the project.
What are the pros?
If a group offers attractive rewards for operating as an additional key principle, then there’s a good chance that you will receive due compensation for the risk that you would be taking. But make sure that you evaluate the risk to ensure that it will be worth it.
If you sign as a key principle then you will be able to add that experience to your portfolio, and that experience will allow you to be able to go and get other loans on other projects. So in terms of your long-term investing, there is an inherent value in having key principle experience. In comparison, putting in money as a limited partner through syndication may come with far less risk than acting as a key principle, but on the flip side, as a KP, you’ll get experience that you would not as a limited partner. Putting in money as an LP does not technically constitute experience.
What are the cons?
The biggest disadvantage to operating as a key principle is the potential risk that the project will not work out. And if that happens, then the joint venture and bank or lender will look to you to tide the project over with your promised liquidity and assets. After all, your signing off guaranteed that the lender would not lose any money on the project. This could be a problem if you had gone into the project too optimistically, thinking that you would get a certain amount out of the deal by signing off as a key principle.
Generally, the partners make the decisions on a joint venture deal so why would you act as a loan guarantor if you don’t have any operational input? There is downside risk in every investment regardless of what someone in investor relations may offer to you. Wouldn’t it be better to operate as one of the general partners (if you want to be active) and have total equity in the project? Or to put your money in as a limited partner (if you want to be passive) where you don’t have loan default exposure?
Keeping in mind potential risks and advantages in regards to joint ventures, acting as a key principle may not be ideal, but with due rewards, increased equity, and probable success, it could be a way to cash in on a deal, as well as add to your portfolio.
Investing in multifamily housing is a surefire way to create passive income, and Myers Development Group uses a combination of joint ventures and syndications to buy multifamily properties. I am walking the walk by investing my time and money in multi-family investing. Why? Because it creates the robust income streams that are allowing me to leave a legacy for my children. I am paying my experiences forward through my Myers Methods real estate investing coaching. It helps people steer clear of RE mentor scams so that they can succeed in real estate investing, expand their portfolios, and create their own financial legacies.