By Theodore Kinni. When the concept of limited liability corporations came to Michigan, Paul Robertson Jr. jumped on the bandwagon. Robertson, the CEO and president of Robertson Brothers Co., realized that the new business form offered the family-owned company a better way to structure its projects as well as manage outside and inside investors.
The Bloomfield Hills-based firm was founded by Robertson's father and uncle in 1945 to build single-family homes for returning soldiers and their burgeoning families. Now, Robertson Brothers is an $80 million company that is on track to produce 150 units this year — many in major mid-rise developments where the average price is a million dollars. Calling himself "an opportunistic builder," CEO Robertson says, "We find the right place and the right opportunity and put the deal together. And, if that means we have to design some new product, we do."
Exit the 'S' Corp.
The company has a history of reaching out to private investors to help raise the equity needed to finance land development. "When we didn't have enough money, Dad would go out and get his buddies to put up [some of] the dough," says Robertson.
Like most deals in those days, Robertson's were structured as Subchapter "S" corporations; everyone received a share of the profits equal to their investment. Robertson remembers that the investors' returns were highly attractive, often ranging from 50 percent to 100 percent.
The limited liability corporation came into the picture in 1993, after Michigan passed the LLC Act. First established in 1977 in Wyoming, LLCs exploded in popularity in 1988. That's when the IRS ruled that for tax purposes, LLCs could be classified as partnerships, thus creating a business structure that combines the liability protection of a corporation with the "pass-through" tax status of a partnership.
Los Angeles. In the "S" Corp., for instance, the number of investors in a project is limited to 75. This limitation raises the possibility that the deal might have to be restructured if, for example, several investors passed their shares to multiple parties. Further, explains Black, stock in an "S" Corp. is limited to one class of shares.Of course, the primary reason for structuring development projects as separate business entities is to protect the parent organization from the liability and disruption that can occur when a project turns bad. But the LLC offers additional advantages, according to real estate lawyer Randy Black, a partner in Cox, Castle & Nicholson, a law firm based in
LLCs, on the other hand, allow unlimited members and multiple classes of stock. Better yet, there are no disadvantages beyond those that exist in other business forms, such as additional tax reporting and the legal requirements of operating separate businesses.
"[The LLC] has swept across the country because it is a very useful entity," concludes Black. "It has most of the advantages of the competing entities as well as a few more in terms of limited liability, structural flexibility, flow-through taxation, and not having to keep up with corporate formalities."
For Robertson Brothers, it is the ability to issue multiple classes of stock in an LLC that has proved to be the cornerstone of the company's investment structure:
- Class "A" stock is reserved for outside investors and business partners. These stockholders no longer get an equal share of the profits. Outside investors receive an annual return based on market rates, recently eight percent to ten percent, paid quarterly. Then, at the conclusion of the development, they receive a pre-determined percentage of the profits. "That gives them a rate of return in the 20 [percent] to 25 percent range," says Robertson.
- Class "B" stock is earmarked for inside investors, that is, the company's employees. Participating employees must make a cash investment, they do not get a dividend, and their final profit is subordinate to outside investors. "But they get a percentage of the profits that gives them a yield in the 45 [percent] to 50 percent range," says Robertson. Almost one-third of the company's 60 full-time employees participate in LLCs.
- Class "C" stock goes to Robertson Brothers, which manages the projects and along with other internal investors, provides half of the development equity. After outside investors and employees are paid, the remaining profits go into the company and finance the development of new LLCs.
Since adopting the structure, Robertson Brothers has used it four or five times, sometimes combining several developments in a single LLC to expedite financing for the company and to level the risk for the investors. Robertson raises one to five million dollars in each LLC, and up to 30 investors usually participate. The class "A" outside investors typically contribute half of the equity needed; and the class "B" and "C" inside investors contribute the remaining half. When the project is complete, the profits are distributed and the LLC is dissolved.
So what's Robertson's best advice for getting into the LLC game?
First, learn to accurately forecast the returns, particularly the cash flow, on a project. Overestimate and you risk sinking the project and the investors. Underestimate and you pay out more than is necessary to raise the equity.
Second, start slow. Robertson recommends limiting the percentage of outside investment in early projects. Pony up most of the equity yourself and be sure that your investors receive the proper returns, even if you must take a small loss.
Third, build a pool of reliable investors. The simplest way to raise equity is in private placement memorandums; possible sources include land brokers, large and successful trade contractors, and employees.
Fourth, deliver what you promise. "You can only do this if you've really gotten a track record," says the second-generation builder noting that the company has turned a profit for every one of its 57 years.
The potential payoffs in ability to manage risk, raise capital, motivate employees, and energize business partners, says Robertson, make the LLC a business form worth considering.
—Theodore Kinni is based in Williamsburg, Va.
Published in BIG BUILDER Magazine, November 2002