Sarah: So, with all the complexity… what due diligence needs to be taken, whether it’s on the person or on the documents before getting into a joint venture?
John: First, you look at the person and the history. It’s amazing how many people don’t look at IRA money as real money, which is ironic because it’s more precious than normal money, right? IRA money can be tax-free or tax deferred, unlike normal money. But some people – since they don’t have it in their hand – they don’t look at it as “real”, which is very dangerous. You have to actually take the time. If you’re going to invest real IRA money, do a search – not just a local search of the courthouse records or the search where they live. You want to get more.
Sarah: Are there any ways you suggest doing due diligence to get more information? Not just surface level?
John: Background checks nowadays are so cheap. Information wants to be free! You can get so much: every address they’ve lived or worked at, social security number, everyone they’re related to, and most importantly, a comprehensive list of both civil lawsuits and criminal issues across the country. At a minimum, ask around and search for the court records.
Sarah: I totally agree, and also look at the deal, I think.
John: Yes. How many times have they done the deal? I tell people, “You don’t experiment in your IRA”. If the person doing the deal is new to the deal and the terms sound great, or if they’re willing to offer the sun and the moon and the stars… Why? Well, they’ve never done it. I don’t think the IRA is the place to experiment. I would use your non-IRA money. I’m going to do a reference check, and if somebody gets offended, well fine. I say “You need to go get money somewhere else.”
Sarah: Exactly, I’m doing you this favor. You’re not doing me the favor. Yeah.
John: Also, have safeguards. Have access to the bank account. If you invest in something and you’re the capital investor, always have access to a live set of QuickBooks and a bank account that ties to the QuickBooks. It better be current… And your gut. When [you] get the sinking feeling something is going on, follow that feeling.
Sarah: At the very least, if you get the feeling, go out and do more due diligence! Any other things that you should be cautious about when doing joint ventures, when self-directed IRAs are involved?
John: What’s the exit plan? What happens if things don’t go according to plan? Obviously, the plan is not for things to go bad, but they could. Things could go wrong, so ask them, “Have you ever screwed up a deal?” List those bullet points. Now, if the answer is no, I get a little suspicious. If I hear, “I never screwed up,” my Spidey sense starts to tingle.
Sarah: Right. It’s so important to lay out your exit strategy. While we’re kind of talking a bit about structuring, in your opinion, what’s the best way to structure a joint venture?
John: The lawyer answer is “It depends.” Go for simplicity, like it was with a note. If it gets the job done as simpler, we’re going to do simple. If a note is not good enough, then LLC, because that’s my default. I can get out of an LLC much easier than is the case with a corporation (or LLC taxed as a corporation). Really, the entity choice is an LLC or a C corporation. Simplicity says we pick the LLC and it’s the right choice maybe 97% of the time. My default choice will be an LLC. The complexity of the operating agreement will be driven by the size of the deal. Size matters.
Sarah: You say your choice is an LLC or C corporation. Why is that?
John: Why do I prefer LLCs? They provide the asset protection shield. Unlike trusts, they’re way simpler and way cheaper. I’m only going to use a C-Corp if there’s a really good reason, which is usually UBIT, and I’m only going to use a trust if there’s a really good reason to justify the added complexity, because I can form, run, and exit out of an LLC easier. If you make a mistake in an LLC, unwinding it is much easier than unwinding a C-Corp or a trust.
Sarah: Makes sense. Now, I think we mentioned this, but let’s talk about disqualified persons. What if someone’s trying to do a joint venture with a disqualified person?
John: Be really, really careful. Let me tell you what people hear: “You can do a joint venture with a disqualified person, subject to the details.” And the details matter a lot. Who’s contributing money? I need to know precise details. Who’s going to be on the board of directors? Who’s going to be an officer? Who’s in charge? Who’s getting paid? Now we have 30 to 40 questions. The biggest danger of partnering with a disqualified person is that you have to show that the disqualified person did not need the IRA to do the deal. That’s a very simple example. The first thing we ask people is, “Is there a way to not do this deal with this partner?”
Sarah: How do people determine this?
John: So, we’ll show how each of your IRAs could have partnered with someone else on the same terms, because the deal was so sweet. Show how somebody else would have been willing to do the deal, and write it down and record it. It has to be real. Actually lay out the deal and show how real people would have done the deal.
Sarah: And it’s important to have that documented, like you said, in an email thread or something.
John: That’s better evidence.
Sarah: Okay, say somebody, hasn’t really done the appropriate due diligence or educated themselves on what’s allowed, and then they find themselves getting in trouble. How common is it to get in trouble? And what happens?
John: I don’t know that I have a good statistical sampling for that. By the nature of my practice, I’m kind of like a cop who sees a lot of crime, so I think there are more criminals. I know it’s frequent enough that a lot of really good people who put a big chunk of their life into their IRA, lost a big chunk. I know that there are a lot of predators and a lot of those predators are so good at appearing to be something other than sociopaths.
Sarah: I could definitely see that. I’m going to finish with just one follow-up question. What’s one piece of advice that you would give someone, a new investor or an experienced investor, who’s looking to do joint ventures with a self-directed IRA involved?
John: Be willing to pay the price. The price involves understanding IRAs. You guys do a lot of excellent education. Learn how to ask the narrow focus questions on the clock, while asking the big question as part of Quest’s educational presentations. There’s a lot of upside, but joint ventures are an expensive way of doing business. Loans are much cheaper. I’m not saying joint ventures are bad. I’m just saying it’s a more complex, expensive way to do things, so the upside really needs to be worth it. It comes back to your due diligence and making sure that the upside is there.
Sarah: Right. Don’t experiment with your life savings. Definitely not.
John: Yeah! Experiment with the drinking money!
Sarah: You’re so funny, John. Well, I really want to thank you for taking your time on a Friday. I really do appreciate it. You’ve been so fun to interview. I’ve interviewed quite a few people and I’ll just say, the banter has been really enjoyable!
Joint venture can be good investments if the details make sense, and we hope this article has given you a bit of insight into how these deals work! If you ever have questions about how to do join ventures with your IRA, you can give a Quest representative a call at 281.492.3232, and we’ll be happy to help! To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.