We get this question a LOT. What is the difference between a syndication and a joint venture?
It’s an important question, because the answer could help save your deal, your investors, and yourself!
When structuring a deal, the best way to tell if a syndication or if a joint venture will work is to use the Howey Test. This can help determine whether a deal should be classified as a joint venture or a syndication. But you have to be careful, because there are potential consequences of not following these rules.
We cannot emphasize enough the importance of being aware of the legal requirements in order to protect oneself and one’s investors in the event of any issues or disputes.
So, what is the difference between a syndication and a joint venture?
Find out on this week’s episode of Multifamily Investing Made Simple, In Under 10 Minutes.
Happy New Year! We hope everyone has a good holiday. Tune in next week to hear Dan and Anthony’s best plan to get started in real estate investing in 2023.
“As soon as the investment starts to falter, you don’t make the money that you thought you would… An investor can get upset and then they go to get litigious. Then you’re really in some hot water.”– Anthony Vicino
“When people are brand new, they’re usually doing deals that are a little bit on the smaller side. And what you’ll notice is there’s a pretty big difference in the cost for legal for a syndication versus just an operating agreement.” – Dan Krueger
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[00:00:00] Anthony: Hello and welcome to the podcast. I’m psyched to have you here. However, the guy sitting next to me is less sight. That is, why are you doling? I’m in the middle of something. He’s doo duling. This is a podcast. I know. This is like an audio only format, but at least like pretend like you’re present. Nope.
Okay. Well it’s good to have you here, listener. At least you are here present. Dan’s gonna be kind of phoning it in, but that’s okay because I am up to the task. I’m gonna carry the load. Are you ready yet? Yes. Okay, let’s do that. So today guys, we’re gonna talk about the difference between a joint venture and a syndication.
So, , you might already know this, you might not know this, but I got a call yesterday from a guy who’s, uh, I would say he’s pretty established in the, in the industry. He does short term Airbnb rentals. He runs a couple masterminds and he wanted to get on a call [00:01:00] cuz he was like, you know, I wanna start raising capital from my guys and this mastermind and start putting their capital into these Airbnbs with me.
And he’s like, do I need to do a syndication? It seems like I could probably just do an operating. And I was like, oh, it’s a really good thing you called me because yeah, no, you absolutely cannot do what you’re proposing. So I think this is actually a really good topic.
[00:01:21] Dan: It is. Because I think when people are brand new, they’re usually doing deals that are a little bit on the smaller side.
Mm-hmm. . And what you’ll notice if the, if this is at all interesting to you, is there’s a pretty big difference in the cost to legal. for a syndication versus just an operating agreement. Right. A 10 x, right. Like, yeah. I mean, to get just an operating agreement, you might spend one to 2000 depending on the attorney.
Um, that’s I think, an appropriate price point for a simple operating agreement. Uh, or even less. And the syndication, it’s easily 15, 20, maybe 25. Yeah. So a lot of people look at that and they’re like, man, that kills the, uh, economics of the deal. Lemme just whip this operating agreement [00:02:00] together. run with that.
Mm-hmm. . But that might be not the right move. It
[00:02:04] Anthony: might not be the right move. And full disclosure is a lot of people, even though that they know, they technically need to syndicate the deal because of what we’ll talk about here is called the Howie test. It has to pass this test, um, which is established like back at the forties maybe, something like
[00:02:19] Dan: that.
Yes. Sometime between the twenties and
[00:02:22] Anthony: a long time ago it had to do with citrus farmers. So that’s pretty interesting. But it has to pass the Howie test, which we’ll break down in detail. So you’ll. , should I go and make this a jv or can? Does it have to be a syndicate? But, uh, a lot of people will, will skirt the rules on this one because the real, real estate’s kind of the wild, wild west.
And on these smaller deals, when you’re like, I’m just gonna go raise a hundred thousand dollars for my friends and family, they’re gonna passively invest with me and we’re just gonna go buy like a couple duplexes, right? Like at that level, the chances of the s e c taking notice very, very low, like you’re probably not gonna get caught.
However, if things go wrong. Then you’re gonna be in a lot of deep [00:03:00] trouble. And when things are going well, never a problem. But as soon as, as soon as like the, the investment starts to falter, you don’t make the money that you thought you would. An investor gets upset and then they go to get litigious, like now you’re in some hot
[00:03:13] Dan: water.
And that’s really the big thing there because, uh, you know, like Anthony said, unless you’re operating at incredibly large scale, uh, the s e c or the irs, No one’s gonna be walking around just auditing this kind of stuff. What’s gonna happen is an investor’s going to get ticked off if something goes sideways in the deal, and that’s where you’re gonna run into trouble.
So tons of people have done it the incorrect way and are perfectly fine, but there’s that inherent risk that’s just gonna be out there if you do this the wrong way. So let’s, let’s get into it. Yeah.
[00:03:45] Anthony: So let’s break down the, the Howie test. Yeah. This is the, the litmus test to tell us, okay, is does this need to be a syndicate or can I go as a joint venture?
What, there’s four parts to it. Yeah.
[00:03:56] Dan: It’s really, the howi test is really trying to find out if you [00:04:00] are selling a security or not. Um, that’s really the, the basis or the, the thing you’re trying to find out. It’s are you partnering on a project with somebody where you guys are both doing things or are you effectively selling a security?
So you do this test to determine if something is a security, and there’s four questions to answer, and really only one of ’em matters. Number one, is there an investment of. , presumably yes. Yeah. In any joint venture or syndication, there’s gonna be an investment in of money. So that one, like I said, doesn’t really matter cuz there always is in a common enterprise, is there an investment of money in a common enterprise?
This is question number two. Um, answer almost always for everything that’s gonna be yes. So again, doesn’t really matter. Question number three, is there an expectation of profit? Yeah, probably always. Yeah. So again, it doesn’t really matter, but number four, here’s the guy that matters. , is this profit going to be derived from the efforts of others?
That’s the ticket. Yep. Are you going to sit back and do absolutely nothing while somebody else does the work and delivers you profits? [00:05:00] If the answer’s yes, and it is a security and you cannot just do a simple operating agreement and call it a day.
[00:05:06] Anthony: Okay, so let’s break this down like in actual terms. If you have five buddie.
and you are thinking you’re gonna go find the deal, you’re gonna asset manage it, and all you’re gonna do is have your buddies put like $25,000 in. Well, if they’re not gonna do anything else, if they’re not signing on the loan, they’re not putting earnest money, they’re not taking any risk, they’re not managing it, they’re not part of the property management.
Well, and if they’re, that means they’re p, they’re passive. If they’re not taking an active role, then it has to be a syndicate. It has to be because they are passively investing in a common enterprise with the expectation of returns. However, Those same four or five guys, if you could find ways to get them active.
Maybe you have Jim sign on the loan. Maybe you have Carla, uh, put up some earnest money. Maybe Dwayne does some property management and maybe, no, no, don’t have Dwayne do that. Okay. Dwayne, that’s a horrible idea. Dwayne, you are going to sit in on monthly [00:06:00] asset management meetings and, and, and you’re gonna take notes.
You’re gonna be our note taker, okay? So if you can find ways to get them actively involved, then you could do it as a joint. . Now, there’s a downside to this, which is they do actually need to have active roles, and then two, in this scenario, they’re not limited partners, so they are exposed to the same amount of risk as the general partners would be on a syndicate.
So if something goes wrong on the property, the bank is gonna maybe hold their feet to the fire, which. , depending on who they are and how cool they are with that, that that might be a
[00:06:29] Dan: problem. Yeah, I mean that piece really kind of depends on the bank and how the debt structure, but that I would have to say is one of the easier ways to get somebody actively involved is to get them co-signing on the loan with you.
Right. That’s a good way to have them actively participate. It’s still relatively passive. Mm-hmm. acting as a guarantor takes some of the risk, doesn’t really take the risk off of your plate, but it spreads a little bit over to them as well. Misery loves company. Yeah, and that’s a really. That’s, I’d say that’s some of the lowest hanging fruit, um, that earnest [00:07:00] money.
Um, what else? Asset management. That’s amazing. A lot of those you can, they’re not super active. Mm-hmm. ways of being active. Yeah. So
[00:07:08] Anthony: it’s global. So now, now the question is at what point are there too many people in this joint venture that you’ve, you’ve found active roles and I’m kinda using our quotes there, cuz.
They’re as passive as they can be. And you’ve found like the minimum amount of work that they could possibly do to qualify as active. At what point are we clearly just stuffing people in this into a deal? They can’t possibly all be active cuz there’s really not that many jobs to do. What’s your threshold before you start to look at it and be like, knowing nothing else about this deal, just based on the number of people in it?
This seems like you have a syndicate.
[00:07:44] Dan: Well, as with most legal things, there’s no like direct answer. There this number is where the cutoff is. It doesn’t exist. And I’ve talked to a couple lawyers about this to kind of ask them like, what are your thoughts? Because my thought has always been when you get towards 10 [00:08:00] and it starts to kind of get there above five, seven or eight is kind of where I’d say, let’s cut it off.
And if you’re 10 or above, uh, to double digits, that’s probably a tough sell. And that’s been confirmed by two different attorneys at this point that that’s a pretty decent ballpark to. to be looking at. Yeah. So, but there’s no exact answer.
[00:08:19] Anthony: Yeah. My gut tells me as soon as you start getting over seven, I’m looking at each new person, like with more and more skepticism.
Yeah. Like, come on, Dwayne, like what are you doing, Dwayne? You’re obviously not doing anything. , what are you even doing in this? Oh, he put in $50,000. Okay. Well he’s a passive investor. Yeah. Well we should have syndicated this .
[00:08:37] Dan: Yeah. So I know that’s probably not the answer that a lot of, um, newer people or just people who are doing a smaller project want to hear.
but, um, it’s the answer
[00:08:47] Anthony: you need to hear. It is the answer you need to hear. Now, one thing you could think about, uh, that I suggested to this guy that I was talking to, cuz he wants to raise capital on an ongoing basis. I was like, you could, you could look at doing a fund. Oh, you know, that’s gonna be a little bit more expensive than the syndication, [00:09:00] but if you set it up correctly, that thing can last you for a couple of years and then you can just keep raising capital through that vehicle, kind of amortize the expenses that, that might be a good option.
[00:09:10] Dan: unless you’re doing some like really high end, like massive Airbnb properties, like, you know, for us it, the, the, the point. makes economic sense to syndicate a deal. Aside from the how we test and all that other stuff we talked about, it’s when you’re raising about a million bucks or more that that, that bill from the syndication attorney doesn’t really impact the economics that much.
Yeah. So, you know, for the Airbnbs, I mean, unless he’s doing properties that cost a a few million bucks, that requires him to raise at least a million. Not that big. Yeah. So definitely do a fund, especially if they’re all gonna be pretty much the same kind of thing and just spend all. Take it down. 10, 15, 20 of them.
[00:09:48] Anthony: Yeah. And for us, I think you just said this, but this is a really good threshold, is typically if we’re raising less than a million dollars, we’re gonna try and do that thing as a joint venture and we’re gonna try and limit the number of investors coming into it [00:10:00] to like three or four. And we find ways to get them active.
Mm-hmm. , once we get over that million dollars of equity needed, then we start saying, okay, you know what? Like this is worth syndicating. The costs are amortized over enough space. We’re not gonna feel the economics aren’t gonna be
[00:10:13] Dan: negatively impacted. Yeah. So that’s a just partner with an attorney, give ’em a little cut, and then don’t have to get nickel and dime by all the syndication fees.
That’s good. You can do each JV or each, um, Airbnb is a syndication. You’re gonna have to find a
[00:10:27] Anthony: lawyer that’s willing to do that. Yeah. And if it’s your first deal, they’re probably not gonna be willing to do that. But it’s a
[00:10:33] Dan: stretch. It’s something, it’s, it’s still a way to kinda get creative. We’re trying to get creative here.
People we’re trying to.
[00:10:37] Anthony: All right. So that’s it. That’s, uh, the difference between a joint venture, a syndication. We’ve done this episode a bunch of times in the past, but it just keeps coming up all the time. And, uh, it’s, it’s an important one because it’s important that you do these things the correct way.
If you don’t, you know, it can work out for a really long time until it doesn’t. So. Yep. And it doesn’t work out really well at all. That’s it. That’s all we got, guys and gals. We’ll see you in the next episode. We, we appreciate you. [00:11:00] We love you. Um, Dan admires you. Happy to hear you. I am am impressed by you, um, and your mom says very nice things about you as well.
Wow. So good job. Keep being a good human and we’ll
[00:11:13] Dan: see you in the next
[00:11:13] Anthony: episode.