Builders and Contractors Exchange
Weekly Bulletin: 9 March 2007
Exit Strategies In Real Estate Investments
Sooner or later your colleagues will approach you about investing in a development deal or similar venture, if they have not already done so. The investment vehicle for such a project will typically be in the form of a limited liability company (“LLC”). Before getting involved in a LLC investment in commercial real estate, you should carefully consider your exit strategies if the real estate venture (or the management thereof) does not meet your expectations. Being inextricably locked into an abysmally unsuccessful real estate venture can be ruinous. Many statutes are flexible and accommodate all sorts of exit arrangements. However, in the absence of an express agreement setting forth such mechanisms, statutes do impose a number of restrictions on a LLC member’s right to exit.
Some exits are planned by investors as a component of the original investment decision, while others are emergency exits for when things begin to unravel. It is generally better to expressly provide for exit rights rather than relying on restrictive statutory default provisions. If a particular investor wants to cash out of the project, exit mechanisms should be in place to enable him to do so, with minimum difficulty. Furthermore, if one of the investors dies or receives an offer to have their ownership interest purchased, the remaining investors may desire to have a right to purchase the exiting member’s ownership interest in the project.
Some of the standard exit mechanisms that investors may want to consider early on when reducing their agreement to written form include the following: (i) drag-along rights (whereby the initiating member can require the sale of an entire venture), (ii) tag-along rights (whereby the non-initiating member can insist on the sale of the entire venture), and (iii) buy-sell arrangements (whereby the right to sell or buy the others’ interests and the conditions pertaining to that right are predetermined).
Buy-sell arrangements, which tend to cause the least amount of disruption to other investors and any lenders financing the project, are generally the preferred exit mechanism for investors. Careful investors will typically craft the mechanisms by which investors may exercise their right to sell their own ownership interests or buy the ownership interests of others, including the (i) method and content of notice required, (ii) rights of first refusal, (iii) valuations and price calculations of ownership interests, and (iv) timing within which such transfers must occur. Such exit strategies will be critical (i) in the event of death, disability, or bankruptcy filing of one of the investors or (ii) if one investor simply desires to transfer its interest and/or disassociate itself from the project.
When you are just starting out, this part of the process may not seem important, but being organized and hammering out these exit mechanisms early on can save you a lot of complications and money down the road. If you are uncertain as to what to include in your agreement with the other investors, consulting your attorney prior to entering into a deal should be viewed as preventative maintenance that may address important issues before potential conflicts arise.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.