Legal Investment Structures
Doing business without any help, assistance, or collaboration is virtually impossible. There will inevitably be someone else involved in some part of the endeavour. Think about it: whether it’s just getting advice, bouncing an idea off your spouse, getting financing from a lender, paying someone to manage a property, finding someone who has expertise or someone who has investment funds, or just having someone involved who can hammer a nail; most real estate investors use a variety of ‘partnership’ structures to accomplish their business goals. As Spielberg observes, its usually more fun, less burdensome, mutually beneficial, and the overall business is better for it.
So what are your options if you don’t want to go solo? To keep things relatively simple, there are three major structures for most real estate investors: corporate, partnership, or joint venture.
From a legal perspective, there are benefits and draw-backs to each that should be carefully considered in consultation with your legal advisor in light of your goals and objectives. Since we have already posted about Joint Ventures in a bit of detail (see HERE and HERE) we’ll highlight only the first two here.
A corporation is a legal entity or ‘person’, created by statute (such as the Alberta Business Corporations Act), which permits a group of people (called shareholders), to own and operate (through appointed Directors) a business that pursues set objectives. Since it’s very existence is a creation of statute, its powers are derived from statute: it can sue and be sued, own property, hire employees or loan and borrow money. There are no ‘inalienable rights’ like individuals have - but corporations are for all intents and purposes a true legal ‘person’ under the law.
A Corporation is great for multiple real estate investors/participants. Through the issuance of shares it’s easy to allocate relative ownership. And shares do not initially have to be allocated based on how much cash is invested - other considerations such as time committed or expertise can be considered. Through a unanimous shareholder agreement its fairly easy to regulate control and how funds will be distributed. And it comes with a very long history of accepted legal precedent and legislation that creates a high degree of certainty with respect to legal rights and obligations. It is also helpful that banks and lenders understand corporations and can be convinced to lend. There are also some potential tax benefits mostly as a result of further and multiple options as to how income is treated and distributed (and thus taxed).
A significant draw-back (ironically) is liability. Normally, for most business endeavours, conducting the operation through a corporation is specifically motivated by the goal of limiting liability. So what’ s different with a real estate business? Well, most of the liability that a real estate business is concerned about can be insured over (property insurance, general liability insurance, etc). And the biggest potential for other liability (contract and debt obligations) is in relation to bank financing. The corporation is the borrower of course - and is directly liable for any mortgage loan. But most banks will not lend to a corporation unless they get, in addition to mortgage security, personal guarantees from the corporation’s shareholders. So each shareholder is effectively exposing all of his or her personal assets should the corporation default on the loan.
The second option is a partnership. A standard partnership is defined as individuals bound together by contract to share profits of a business carried on by all or any of them on behalf of all of them. Unlike a corporation, it is not a legal entity and is not therefore separately taxed or treated like a legal ‘person’. The partners share in profits but also in the liabilities (as between them as per their respective partnership interest - and as between them and world, joint and severally). And each partner is responsible for the actions of the others in relation to that business. There are other forms of partnerships though.
Lawyers sometimes practice together as an ‘LLP’ - which stands for ‘limited liability partnership’. This won’t help most of you. But another creature of statute, called a limited partnership is an option in many Canadian jurisdictions (politicians are so creative with these names!). And this structure could be very helpful to real estate investors.
Essentially, limited partnerships have general partners and limited partners. General partners carry unlimited liability and are responsible for managing the partnership. The limited partners do not participate in managing or controlling the partnership and are liable only to the extent of the amount of capital they have contributed. So this gets around some the draw-backs to the corporate structure while still allowing for different ownership interests. A limited partnership is created by filing a certificate of limited partnership (or equivalent) with the relevant provincial registry. A limited partnership agreement (with terms reflected in the aforesaid certificate) must contain specific information as dictated by statute.
This structure is helpful where one party has the expertise and others just want to be completely silent participants. The draw-backs include some doe eyed mortgage brokers who may not understand how to lend to such a business, and some more complex bookkeeping (including the handling of GST and so forth).
If either of these structures sound interesting to you or you think they may fit your goals, contact your lawyer to discuss the details. It could be just the right solution for you.