I am making this post because I thought others interested in business/learning may find it interesting and other people who are more experienced/knowledgeable than me can offer advice that may help me with the entire process or point out things I may have been overlooking from a legal, financial, or strategic standpoint. If there is enough interest I suppose I could periodically update over time on how things are going.

I have a family member that is highly successful (worth 100s of M's) that I had been keeping in contact with asking for advice on business and investing since he knew that I played poker.
He recently contacted me with a few different ideas and offers, one of which being to invest with him in a new corporation he just started that is going to be building a chain of hotels in what he feels to be a great location/market. The hotel cost him $3m to build and is almost finished being built. He told me that the main risks involved with this project were just going to be ensuring that the $3m he spent on building a hotel actually generated him a hotel that could be valued at $3m.

He told me that he would allow me to join in on the investment now even though they are pretty much done building the hotel and the risks have already been taken since he knows that they are going to be staying within budget. He referred to it as allowing me to "bet on a game int he 4th quarter". The way that he structured the deal with the people he's working with is that he puts up the entire $3m to build the hotel first as a loan that must be paid back to him in it's entirety at 7% interest before any money generated from the hotel goes anywhere else.

Then once the loan has been paid back in full he receives 60% ownership as a result of financing the entire project himself. If the hotel doesn't generate enough profits to pay back his loan and defaults he receives 100% ownership of the hotel. Basically if the hotel doesn't turn a profit he gets to foreclose it and still own the $3m hotel and prevent himself from losing money. So he told me that if I invested $150k with him that I would receive back my $150k at 7% interest along with an overall ownership of 3% of the corporation (5% of his 60% ownership). The amortization schedule was sent to me which showed payments over the course of 5 years monthly, totaling to me being paid a total of ~32k interest on my $150k.

The promissory note that was sent to me basically details everything above, I can post this later with private information removed if it's recommended. What other documentation should I be asking for... is this document enough or will he probably be sending me documentation showing that I own a % of the corporation? I trust this family member a lot and since he has so much money and strong relationship to me I doubt he's doing anything ill-will.

He is projecting he says around 30% annual returns and since he's had so much success in the past and lots of experience in this I just assume he knows what he's talking about instead of pulling #s out of his ass. He's well connected with a lot of powerful political figures and businessmen so even though I can't validate on my own how accurate those projections are I do know he's not some newbie that's ignorantly optimistic. Even if it didn't show that kind of a profit though, if the value of the hotel remains at least at $3m then I wouldn't show a loss apparently.

One way I was thinking of it which I'm interested in knowing if it has any truth to it is... assuming the hotel does become a commodity and operates at a profit (obviously a big if), wouldn't that mean I now have a total unrealized gain of ~$120k? I would have an accounts receivable on my loan that has $32k equity (?) as well as 3% ownership of a $3m hotel which is $90k in equity. $90k + $32k = $122k in unrealized gains before taxes? Assuming the hotel operates at a profit that is. But if it does operate at a profit that he projects wouldn't it be even more because a hotel w/ 30% returns would appreciate in value to be worth a lot more than $3m, no?

Also, this could be a pretty silly question but, when the loan of my $150k is being paid back, do I owe taxes on the principal or just the interest? Seems illogical to pay taxes on the $150k again so I'm hoping you don't have to but I don't know for sure.

Also, fwiw, if I lost the $150k investment I'd be perfectly fine financially in the event it may be asked if I'm putting it all on the line.

Any input/advice/questions welcomed.

To be frank it seems you stepped out of your comfort zone a bit. That's not always a bad thing and certainly can be a good thing, but in this case it depends 99% on how much you trust this family member. I don't fully understand how you're putting up 5% of the initial costs for 3% of the business. That doesn't really sound all that family-memberish although him including your investment as part of the note holding side of things seems like a decent deal.... but he's not really letting you bet in the 4th quarter, he's charging you a premium for ownership.

In some parts of your post it seems you don't really understand the valuation of a hotel. The value of the hotel is expressly a function of the revenue similar to an apartment complex. The building itself is going to have nominal worth as the vast majority of people interested in purchasing the hotel in the future are going to be concerned with little else but the revenue. The building comes into the picture in terms of maintenance costs obviously... but just because you pay $3M to build it, doesn't mean it's worth $3M on day 1 when it's open for business. In a way it's kind of like a company going public. You build a business for $X and the investment banker firm will put a market price on your company that is not always near $X.

In my limited experience and gleaning from those who have a ton more experience than I do, these types of transactions are profitable/not-profitable based on the initial valuations. My fear for you is that you're banking too much on how well the hotel will do instead of understanding exactly how the hotel is valued, which is the key experience that will help you do well in the future. My father has been a corporate lawyer for 35 years and has said that those who understand valuation the best often make the smoothest transitions from the sidelines into the driver's seat.

I'm just rambling at this point as the RE deals I've been involved with have always been with other people's money. I wish you the best of luck and I hope I didn't come off too much as a naysayer.

You only pay taxes on the profit, not the original principle. AKA capital gains. GL.

Hope you're paying cents on the dollar with the hospitality industry in the shi**er right now. Note - didn't read.

He and his uncle are hard money lenders taking a 60% equity stake, so 3% is 1:1. I assume that they are not responsible for the day to day operations - and that those who are have the 40%.

OP, the real value here is in the lesson. You have the opportunity to learn from a successful family member. Don't blow off corporate meetings, learn how to review financials and operating reports, ask your uncle (or whoever) if you don't understand something. Soak it up like a sponge. It is a good opportunity, with a maximum cost to you of $150k, assuming that you are not subject to any capital calls.

Good learning and keep us posted.

Well, this is definitely a big investment for me but not something I can't swallow a loss on. Currently I could expect to make back this $150k in a short time playing poker. I'm getting 3% ownership after receiving back all my money entirely w/ 7% interest as the poster above me mentioned. You are right though in that a lot of my decision to do this came as a result of having a lot of trust in him. He has been a highly successful investor that I know to be worth a lot and I certainly trust him to not be intentionally screwing me over if that's what you meant None of this ensures he will be right this time though but I just use some poker logic in thinking that he's probably very +EV at least.

You raise good points on a topic I can't claim to be too familiar with. I know one of the things he was referring to was that he wanted the hotel to be worth $3m just in the price of the labor and parts involved with constructing the hotel. As in if someone wanted to build the same exact hotel it would cost them $3m as well. Are you basically saying that even though it can cost $3m to build the hotel that once it's done being built it can be worth $1.5m instead?

I do know he's planning on it being worth far more which was the reason for him building it to begin with due to the location/market but I'm going to specifically ask him about this to hear what he says and will post back.

No, this is the type of response I was looking for to give me more things to think about as part of the learning process so I appreciate the feedback.

Yeah, it's somewhat of a passive investment but I plan to be involved so I can learn as much as I can. One thing he said was that I sure ask a lot of good questions.

Yes.

This scenario doesn't come up too often with homes and what not, but it comes up quite a bit with Commercial RE. If you build a $10M strip mall and can only lease out 50% then there's a big chance that the price is going to be significantly under $10M if you went to sell. The value is related to the cap rate which is related to the success of the business. In the case of a strip mall it's only successful if leased out nearly completely at prices that make it pencil. In the case of your hotel it's similar... but you get the jist it's all related to revenue stream and hardly to the building and/or cost of materials to make the building.

Just for reference... I worked on a shopping center a few years back and it was the opposite. It was leased so fast that its $6M construction gained value quickly... and after 6 months it was easily valued between $10-$12M. It's unfortunate that my company was only doing fee development on the project, but it was basically a grand slam.

Yea because it makes more sense to do what everyone else is doing supply/demand wise..oh wait, that makes no sense as far as betting...
IMO the risk is you either trust your uncle or you dont...if you don't, then don't make the deal..if you do then who cares what anyone thinks here, ask your uncle.
From what you posted it sounds like your uncle is trying to cut you in to his business and show you the ropes...Especially if he has no kids then dive in head first, blood is thicker than water.

I'm a professional RE investor, but I have no knowledge of the hotel business at all. Some thing in general that you want to watch:

1) investing in businesses/industries you don't really understand.
2) investing on the basis of the net worth of the principle rather than that person's track record in the specific industry you're looking at
3) investing any significant portion of your net worth into a startup unless you are the principle. As a rule, people can't be relied upon.

I also wonder why on earth a man with a 100M+ net worth would a) get into a $3M deal at all, and b) come up with this strange (IMO) financing strategy. $3M is only 3% of his net worth at most. Why not just build the hotel and hire out management? I'm not saying it fishy or anything, I just don't understand this man's motivation to do a deal this small.

I also second whoever pointed out how hotels (and any other commercial RE) are valued. you want to look at the past performance to determine value. What makes building large commercial RE projects so risky is that unless things go as planned, you are screwed. The building wouldn't be worth much of anything if you can't use it to generate any money.

Lending is tight. I know a particularly successful developer that refuses to sign a personal guarantee. He has to do smaller deals than he did 3 years ago because banks see a principal with a high net worth and insta want a personal guarantee, even banks where he has a proven track record.

Also, 7% interest on a note secured by commercial RE plus 60% of equity is a sick good deal if the management has any proven skill at all.

what city/country is the hotel in? that is probably the biggest factor to determine if it's a good investment

I took you off igonre for this? First, you are going back on ignore. Second, this could not be more wrong. It does not matter if the hotel OP mentions is in the best market on earth if it is in a ****ty location, has bad management, over saturated market, etc...ad infinitum

This is a pretty classic sales technique.

QFT.

My instincts are screaming that this guy is not 100% what he appears to be. If I had more info, or actually met him, I might even double down.

A passive 3M with a speculative upside is not a bad investment. And as stated, its 3% of his net worth. Maybe the investor isn't interested in tying up 10 to 20 % of his assets in any 1 deal.

investment looks good. some main points to have your lawyer and cpa review:

1. make sure the contract specifies that you do get a full equity stake in all land/structures/physical property..not just the "business"

2. make sure you are not signing a personal gaurantee (hotel needs to borrow 1 million in first year to operate, you are on the line for 30k of that)...if you are signing a gaurantee that is typically NOT a big deal as businesses need paper occasionally to cash flow, just know that you are doing so.

3. there may be some regulatory issues involved (not a big deal), i assume this will be structured through your family member (you are not seen to the whole overall investment) if you are, i am certain you must be an accredited investor (1m net worth or 2 years of income greater than 200k) to participate in this type of partnership. (not a big deal, but things an auditor might look for in event project fails and lawsuits arrise).

4. passive income is good, you dont get rich workin for the man.

This is actually one of the things I was wondering as well that I never got around to asking. Maybe it's possible that I'm overestimating his networth? I just know he owns a bunch of sick houses, his own plane/jet, lots of commercial real estate, lots of businesses etc... and he's told me about previous deals he's done that generated $1B+ for investors that he was involved in. He also told me that his new goal that he's working towards is becoming a billionaire so I figured all those things made it seem likely that he was at least 10% of the way there although I could be wrong I guess? I'm going to try to find this out too though.

I see, this is an example of the kinds of things I had hoped would be brought to my attention when making this thread so I'm glad you bring it up. I'm going to research this some on my own and talk to him as well to see what he says. I do know though that if he's expecting 30% annual returns that he is certainly expecting it to be successful but that still wouldn't account for him mentioning one of the main risks was in constructing a hotel that could be valued at $3m. Maybe I misunderstood his strategy for that... I'll try to find out. What you're saying makes a lot of sense. Even if this is a risk though I think he's very confident it's a great location/market though to build the hotel which was his primary reason of course for choosing it. The plan isn't just one hotel though, he's planned out building at least 10 hotels if that matters any.

Based on a lot of the things we talked about I am pretty sure this is a prime reason for his investment to begin with and his expected returns.

Yeah, the guys that are getting 40% are the ones with the expertise in that aspect of it and they don't make any money at all unless the hotel is operating at a profit since he gets back all his money first before anyone gets anything. I would assume this gives them a high motivation to do well.

Well, as far as the things I've seen personally with my own eyes, I've seen his houses, some of his commercial real estate, his plane, pictures of him with Obama and other world figures, etc. So I can't know 100% but he's family and I certainly trust him. Doesn't guarantee anything but it feels +EV and I could stomach the loss as a worst case scenario.

One thing I recall him mentioning was that if the hotel weren't operating profitably he would then have to foreclose and explore other options such as turning it into an apartment building or something instead.

From the legal side of things I'm very new... a lot of this is based on trust between him as a close famliy member so it seems like it would be kind of awkward to go to a lawyer/cpa to have them review everything. Obviously that's the standard procedure but doing it in this instance seems as though it might be construed from his perspective of lacking trust in him. I know it probably should be done though. The only legal document that has been signed by both of us thus far is this promissory note/stock option. I'll post it here... is this enough or should I be expecting more? (Private info removed ofcourse)

"PROMISSORY NOTE AND STOCK OPTION

$150,000.00

[Family member's investment corporation], holds mortgages against and stock/shares of [Hotel corporation he created], which owns a hotel and property in [location of Hotel].

For and in consideration of One Hundred Fifty Thousand and No/100 Dollars ($150,000.00), [Family member's corporation] will pay from money it receives from [Hotel] to [Me], principal plus interest on the above sum at a rate of seven percent (7%), with the first installment being due [date], and continuing thereafter each month for sixty (60) consecutive months until paid in full. A copy of the Amortization Schedule is attached hereto.
In addition, said [Me] shall be issued, by [Family member corporation] five percent (5%) of its interest in [Hotel corporation], which will constitute three percent (3%) of the current total outstanding shares of [Hotel corporation].
[Me] shall receive a prorated basis an interest in the property with [Family member corporation] should [Hotel corporation] default in payment and [Family member corporation] shall take control and ownership of the hotel property. Specifically, should [Family member corporation] come to own through foreclosure one hundred percent (100%) of [Hotel corporation]'s properties, then [Me] shall have his interest protected by having a five percent (5%) interest in [Family member's corporation]. holding from [Hotel corporation]
AGREED TO:

____________________________________
[Me]


____________________________________
[Family member]"

Well, not sure why it's being posted that it's my Uncle since I just said a family member but I guess it makes sense since I'm referring to "him" and the closest male relative other than father would be Uncle. But yeah, this definitely is one of the largest factors involved in me deciding to do this deal... primarily due to the trust I have of him and his experience in business.

I think your family member spelled out the risk clearly, you just lacked the experience to pick up on what he was saying when he said "I just hope that this $3M hotel is worth $3M after construction..." which with your newfound knowledge from this thread, should make a lot more sense. He hopes that the business will be profitable and valued at $3M+ because it's certainly no guarantee.

Talk to a lawyer. If your family member gets offended by this, then don't invest with him.

One initial thought I had is that you should think more about your exit options. Minority ownership stakes in closely held companies are illiquid. I think it would be reasonable for you to demand that he gives you a put option exercisable after a couple of years at a pre-determined strike price. When negotiating the strike price, make him put his money where is mouth is. If he is so confident that he can get 30% annual returns, why shouldn't he be willing to give you a put option with a generous strike price? You should also ask for tag-along rights in the event that he sells his stake in the company.

More generally, I think it is bad that you have not seen any documents pertaining to the company in which you are getting an equity stake. At the very least you should have someone look at the charter, bylaws and shareholder rights plan (if there is one) and do a UCC and mortgage search. Since you have already signed a promissory note in which part of the consideration is receiving an equity stake in this company, you really should have already received the above info, and possibly a stock or membership certificate, without having to even ask for it. I know you trust your family member, but you need to be more assertive in getting information from him. For all you know he could be really rich because he is charismatic and is good at getting people to loan him money on unfavorable terms.

Trust but verify.

Ya, I know lending is tight and whatnot, and I understand the personal guarantee angle. But still, it seems to me like a lot of time to spend dicking around with a deal that is going to only make you very moderately richer. IMO, this deal doesn't seem like a wise use of time for a guy that has $100M+ net worth.

I'm not disputing that its a good deal from a ROI standpoint. Personally, if I had $100M net worth, I'd rather just do nothing than a $3M deal. Or maybe when you have $100M you just spread it out into a lot of smallish deals just to mess around. Who knows?

I would also be very careful with trusting people blindly like this when you don't really know much about the basics in what you're investing.

Especially in a time like this when people who had a lot of money have been injured by the financial crisis and might be desperate to get it back.

If you're really in for the lesson maybe you could ask if you could follow him through a deal/some deals just to learn before putting you're money in. Maybe you can offer him to just bring coffee's and stuff for free just to be there and pick up a thing or two about how this kind of stuff works.

Best Regards and good luck on whatever you decide

TimeTwister

alot of the way you describe your "family member" reminds me of Madoff. Or maybe Lenny Dykstra...

I think so much of this really goes down to your relationship with your "family member." Considering that you describe him as a "family member" suggests to me that he is not super close to you