This millionaire divulges his insider secrets to create lucrative partnerships
From Mark Morgan Ford, editor, The Palm Beach Letter:
It was 1985. Our direct marketing business was growing rapidly. For the first time in my life, I was making much more money than I could spend.
Most of those extra dollars were invested in stocks and bonds. I was comfortable with the bonds but I was skeptical about the stock market. It felt dicey—sort of how it feels today.
I looked into precious metals and commodities (touted heavily by investment newsletters back then), but they scared me. And I had no time to start a side business.
So when an opportunity to invest outside of Wall Street arose, I was interested.
It happened in an elevator in Boca Raton, Fla. I was headed to the third floor of a bank building, on my way to close on a house I’d just bought. I was dressed in a new suit, feeling grown up. At the second floor, the elevator stopped and another young man in a new suit stepped inside. It was Jerry (not his real name), a buddy of mine from high school.
“Hey, Jerry,” I said. “What are you doing here?”
Turns out he had moved to South Florida several years before me.
“We’ve got a lot of catching up to do,” he said. “Are you free for lunch?”
“Sure,” I said, as I got off at the next floor. “I’ll meet you downstairs at one o’clock.”
Over lunch, Jerry told me that he was a real estate attorney. And he was now embarking on a new career as a property developer.
“This town is growing fast,” he told me. “There is big money to be made building houses for snowbirds.”
Jerry’s enthusiasm about what he was doing got me interested. So the next day, I asked my business partner what he thought about it. He agreed with Jerry. In fact, he was already invested in several developments in West Boca.
I called Jerry and asked if there was “any way” for me to get involved in his project. And, yes, there was. His project—an upscale community of 200 homes— was structured as a limited partnership. He explained that, as a general partner, he had to do all the work and take all the responsibility. But I could come in as a limited partner and make money doing nothing.
That sounded good to me. I had money, but I had no time. And I didn’t need any more responsibility. Jerry had a business plan. And permits. And projections. According to those projections, I could make between 25% and 35% on my money.
I knew little about property development and even less about financial projections. But I was impressed by how detailed the plan was. I knew Jerry well enough to know that he wasn’t falsifying the numbers. And the numbers looked good.
“Even if I don’t get a 25% return,” I remember thinking, “I’ll still be happy. I’ll be happy with 20%.”
So I wrote Jerry a check for $50,000.
My job with Creating Wealth is to tell you everything I’ve learned about creating extra income and building wealth. I’ve told you how, as an employee, I talked my boss into doubling my salary. I’ve told you how I gradually and timidly became an entrepreneur. And how I eventually started and developed dozens of multimillion-dollar businesses.
I’ve told you about how, after being burned with rental real estate, I got back into it and gradually built a large portfolio of properties.
I’ve told you about my decision to buy gold. And recently, I’ve told you about my experience as an art collector.
But I’ve never said a word about that first investment with Jerry—and dozens of similar investments I’ve made since then. By “similar investments,” I mean direct investments in small business ventures. And for our purposes today, I’m going to limit our discussion to investing in those ventures as a minor shareholder or “limited partner.”
As a limited partner, you’re not buying into a business with the intent of running its daily operations. You’re not going to wield significant control or be the go-to decision-maker. You’re just a “money guy.” You supply the business with cash in exchange for a small share of the profits.
All businesses of this type are structured in one of three ways: limited partnerships (LPs), limited liability partnerships (LLPs), or limited liability companies (LLCs).
We know from reading your letters that more than a few Palm Beach Letter subscribers are interested in this kind of investing. And with good reason: It can give you steady and substantial ongoing income plus equity growth. That amounts to a potentially big return on investment (ROI) with limited risk and virtually no work.
It is that last benefit—not having to do any work—that most appealed to me with that first investment with Jerry.
Since then, I’ve invested in more than a dozen real estate development projects. Also three natural resource companies, two start-up technology companies, a private lending company, a furniture factory, a movie, a dozen publishing ventures, a dozen direct marketing companies, and most recently, a local brewery.
In today’s essay, I am going to tell you what I’ve learned about this area of wealth building.
Pros and Cons of Being a Limited Partner
The main benefit of being a limited partner, as I said, is the potentially high ROIs. Higher than you can get with stocks and bonds… without having to do any work.
For example, when I invested $80,000 in a wood mill in Nicaragua five years ago, I did so because I knew there was a fast-growing demand for custom-made doors, windows, and furniture. I also knew that an experienced person was running the business. The other limited partners and I didn’t have to build the plant, hire and train the employees, produce the product, or sell it. Our only job was to write that first check and then cash profit-distribution checks when they arrived.
Another thing I like about being a limited partner is that, in most cases, your financial liability is limited to your initial investment. If the business fails completely, the general partner might have to dig into his pocket to bail it out. But not the limited partners. If, for example, the wood mill in Nicaragua had failed, my risk would have been limited to $80,000.
A third benefit of investing in an LP/LLP/LLC is that you can take advantage of certain tax benefits. As a limited partner you don’t have to pay self-employment taxes, as you would with your own business. And the profits are treated as pass-through income. So they are not subject to “double taxation,” as corporate profits are.
When you invest in an LP/LLP/LLC, the first cash you receive is usually return of capital, which is not taxable. Plus, any profits that follow are treated by the IRS as long-term capital gains. Long-term capital gains, as you know, have a lower tax rate than ordinary income (unless you’re in the lowest tax bracket).
And there is another—intangible—benefit. I’m talking about the fun of being involved in a business outside of your normal sphere of expertise. I like the idea of owning a wood mill. Every time I’m in Nicaragua, I stop by to watch the hundreds of men and women working the machinery. And admire the quality products they produce.
So those are the benefits. But there are drawbacks, as well. You do have a certain sum of money at risk. If you invest in the wrong business, you can lose all of it. And if you’re a worrier, you will worry about your investment without being able to do anything about it. As a limited partner, you have no obligation—but also no right—to get involved in management.
My Batting Average
That first project I invested in with Jerry was successful. But it was not nearly as successful as he thought it would be. Since he was new to the business, he didn’t anticipate a significant increase in the cost of building materials and labor. Those increases—plus some construction delays—reduced my profit even below the “worst case” 20% that I expected. Still, I made 15%. A very good return.
I continued to invest in just about every project Jerry brought to me. I doubled my money on one project in Aspen and made 15-25% on several more. But I lost my entire investment in a development in Miami. (They found Native American bones while digging the foundation!) And I lost a big chunk on a project that ran into Chinese drywall problems.
Overall, I’ve done well with Jerry. I’d say my average ROI has been about 12%.
My experience with other investments as a limited partner has been mixed.
I made 10-times my money on an overseas development project. The project was (and is) a great success. But the general partner has yet to get all his money out.
I made good money with two of my investments in natural resource companies. But I lost half my money in the third one. And I lost all of the money I invested in the movie and the first high-tech start up. (The second one could still be profitable.)
Along the way, I learned a few things.
The Lessons I Learned
Lesson 1: The best deals are in businesses you understand.
When I wrote Jerry that check for $50,000 nearly 30 years ago, neither one of us knew as much about property development as we should have. But as time passed, our knowledge increased. And as it did, so did our ability to pick good deals and walk away from bad ones.
My single worst investment was that first high-tech company I invested in. I knew absolutely nothing about the industry. I couldn’t even explain what they did, despite having heard the CEO explain it a dozen times. The goal of the business (and this is true for many businesses) was to make some noise in the market and then cash out big time in some leveraged deal. That is exactly the kind of thinking I inveighed against in all my essays and books about entrepreneurship.
Why did I do it? I liked the CEO. That is, he seemed like the kind of kid that could pull off a trick like that. And I gave into my greed. Something I promised myself I’d never do again.
Lesson 2: There are advantages to being a limited partner instead of a general partner.
As a limited partner, you can decide beforehand—based on how strongly you believe in a project—how much money you will invest. General partners do not have this option. Jerry, for example, had to back every deal with most of his net worth. The banks required it. And that hurt him in the end.
You see, for 20 years, Jerry made truckloads of money on property development deals. But as the real estate market topped in 2008, he had most of his net worth tied-up in that project with the Chinese drywall problems. (Between 2004 and 2008, many contractors had unwittingly imported drywall from China that was defective and toxic.) As a general partner, he was liable for the settlements on the Chinese drywall suits. He was also liable for the debt that accumulated as sales slowed.
Another advantage of being a limited partner is how quickly you can recover your initial investment. I didn’t know anything about natural resources when I invested in those businesses. I did it because the owners were people I had helped in the past. They felt obliged to make sure I did well. They couldn’t ultimately guarantee their success, of course. But they could (and did) structure their deals so that I got my capital investment out before they did.
Lesson 3: It’s important to go with general partners who are open to your ideas.
Because of my experience as a marketer and entrepreneur, I was able to help several of the general partners I invested with make smart business decisions. For example, I persuaded Jerry to use direct marketing techniques to sell the million-dollar homes we were building. At that time, developers used nothing but space ads in newspapers to bring in potential buyers. Sending out carefully crafted letters to high-income addresses proved to be much more effective.
Actually, my best deals were the limited positions I took in direct marketing and publishing businesses. I made out very well on almost every single one. In retrospect, this is not surprising. I had a deep understanding of these businesses. I didn’t manage the partnerships. I didn’t spend nights worrying about them. But I was able to provide useful suggestions.
Three Rules I Follow as a Limited Partner
There are just three rules. They are simple. They are easy to understand. And they should be very easy to follow unless you let greed blind you…
1. Invest in businesses you know something about.
The best opportunities are in the industry you have worked in all your life. You should know the marketing side of that business: What it costs to create products and what consumers are willing to pay for them. You should be aware of the bad ideas that have caused most of the failures in the past. You should also know enough to evaluate the competence of the general partners.
2. Invest with people you trust.
There are many ways for general partners to screw limited partners. You can protect yourself from many of them by having a good lawyer review any contracts or agreements before you sign. But paperwork can’t protect you completely. You should invest only in people that you know—from experience—have integrity.
3. Bring more than money to the table.
As a limited investor, you cannot control the business in any way. (If you do, you might be subject to general liability.) But you can influence the general partners if you think they are heading in the wrong direction. General partners will listen to you only if they think your suggestions have merit. And the only way your suggestions will have merit is if you have knowledge—either industry knowledge or general business knowledge—that they respect.
Crux note: Mark’s business partner, Palm Beach Letter publisher Tom Dyson, has found a place to store your money that allows you to safely compound your wealth (tax-free) outside the banking system and Wall Street. Tom says he’s so happy with the results, he’s investing more than $400,000 of his own money this way. Click here for more details.
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