Profit-Sharing, Participating and Convertible Financing for Real Estate Deals
How participating loans, profit-sharing agreements and convertible notes work in property deals, what to negotiate, and the securities and interest-rate rules.
Updated & fact-checked Figures are linked to their sources at the end of the article.
Some property deals do not fit neatly into “debt” or “equity.” A building that a bank will only part-finance, a hotel conversion with uncertain income, or a sponsor who does not want to give away ownership can all lead to a middle path: the funder lends money but also takes a share of the profits, or lends now with the right to become an owner later.
This article explains the main versions of that idea, participating loans, profit-sharing agreements and convertible notes, for sponsors negotiating with a capital partner and for investors being offered one. It also covers the two legal points that catch people out in Canada: securities law and the criminal interest rate. It is general information, not legal or tax advice.
The main structures
| Structure | What the funder gets | What the sponsor gives up | Typical use |
|---|---|---|---|
| Participating loan (participating mortgage) | Interest, plus a share of cash flow and/or sale or refinancing proceeds | Part of the upside; less than with full equity | Lender accepts a lower fixed rate in exchange for upside |
| Profit-sharing agreement | A contractual share of defined profits, with or without a return of capital first | A share of profits; control depends on the agreement | Smaller deals with a single capital partner |
| Convertible note | Interest, plus the right to convert the balance into shares or units at an agreed price | Potential future dilution of ownership | Early-stage projects where value is hard to set today |
| Joint venture equity with a promote | Ownership, with profits split by a waterfall | Ownership and some control | Covered in our joint venture guides |
For full equity partnerships and how profit waterfalls work, see our guides to joint ventures for hotel and apartment projects and structuring a joint venture agreement.
Participating loans
A participating loan is a mortgage on which the lender receives a fixed interest rate plus a share of the property’s performance, such as a percentage of net cash flow above a threshold, or of the gain when the property is sold or refinanced. In exchange, the fixed rate is lower than the lender would otherwise charge, which helps a property whose current income cannot cover full interest.
| Item | Example assumption | Amount |
|---|---|---|
| Loan | Second mortgage | $1,000,000 |
| Fixed interest | 6% a year | $60,000 a year |
| Participation in cash flow | 20% of net cash flow after all debt service | On $150,000 of net cash flow: $30,000 |
| Participation on sale | 10% of the gain over the purchase price | On a $2,000,000 gain: $200,000 |
The details that decide the value of a participation are the definitions. “Net cash flow” and “gain” must be defined precisely: which expenses are deducted, whether capital spending and reserves come first, whether the sponsor’s fees are included, and how a refinancing is treated. Lenders will also ask for reporting and audit rights so they can check the figures.
Profit-sharing agreements
A profit-sharing agreement gives the funder a share of a project’s profits without making it a formal lender or shareholder. It can be flexible, which is why it appears in smaller deals with a single private investor. The flexibility is also the risk: the agreement has to say when profits are measured, whether the investor’s capital is returned before profits are split, what happens if there are losses, who controls decisions such as selling or refinancing, and how either side can exit.
If the sponsor can decide unilaterally when the property is sold, the investor’s profit share is only as good as the sponsor’s judgment and honesty. Investors should ask for consent rights over major decisions, regular financial reporting, and a deadline by which the property is sold or the investor bought out.
Convertible notes
A convertible note is a loan that can turn into ownership. The holder earns interest and, on a trigger such as a new equity raise, completion of construction or a fixed date, can convert the outstanding balance into shares or units of the property company at a price or valuation set in the note. Convertible notes are best known from start-up company financing. In real estate they suit projects whose value is hard to agree today, such as a development or a new hotel business.
The terms to negotiate are the conversion price or valuation cap, any discount to the price paid by later investors, the maturity date and what happens if the note has not converted by then, interest, and whether the holder or the company decides on conversion.
Income-share agreements
Income-share agreements, in which a funder receives a percentage of a person’s future income, are a student-finance product, not a real estate financing tool. U.S. regulators have treated them as credit: in 2021 the Consumer Financial Protection Bureau found that one provider had falsely represented that its income-share agreements were not loans and did not create debt.[1] We found no established use of them to finance property, and we do not suggest using one.
Two legal points that apply in Canada
These are usually securities. Nova Scotia’s Securities Act defines “security” to include any bond, debenture, note or other evidence of indebtedness, and any profit-sharing agreement or certificate.[2] Selling convertible notes or profit-sharing interests to investors therefore generally needs a prospectus or a prospectus exemption, such as the accredited-investor exemption. The U.S. approach is similar: offerings must be registered with the SEC or fit an exemption such as Regulation D.[3] One private investor and one sponsor negotiating face to face is a very different situation from marketing a note to a group of investors, but in either case ask a securities lawyer.
Profit shares can count as interest. The Criminal Code defines interest as the total of all charges and expenses paid for the advancing of credit, in whatever form, and sets the criminal rate at 35% a year.[4] A lender’s share of cash flow or sale proceeds may therefore be counted when testing a loan against that rate. The 2024 regulations exempt business loans to borrowers that are not individuals: loans of more than $500,000 are not capped, and loans of more than $10,000 up to $500,000 are exempt from the 35% rate provided the APR does not exceed 48%.[5] Smaller loans, and loans to individuals, need particular care.
What to settle in the term sheet
The base return
Fixed interest or preferred return, how often it is paid, and whether it accrues if cash flow is short.
The participation or conversion
The percentage, what it is a percentage of, any hurdle before it applies, and the conversion price or cap for a note.
Definitions
Net cash flow, gain, capital events, permitted expenses and sponsor fees.
Control and information
Consent rights over sale, refinancing, new debt and budgets; reporting and audit rights.
Ranking and security
Where the funder sits behind any bank loan, and what security it holds.
Exit
Maturity, buyout rights, what happens on default, and how the participation is valued if the property is not sold.
For an overview of other ways to fund a property banks will not fully finance, see financing hard-to-finance property.
Sources
- Better Future Forward, Inc. (enforcement action) — Consumer Financial Protection Bureau, September 7, 2021. Checked 2026-10-12.
- Securities Act, R.S.N.S. 1989, c. 418, section 2 (definition of “security”) — Nova Scotia House of Assembly, Office of the Legislative Counsel. Checked 2026-10-12.
- Exempt offerings — U.S. Securities and Exchange Commission. Checked 2026-10-12.
- Criminal Code, section 347: Criminal interest rate — Justice Laws Website, Government of Canada. Checked 2026-10-12.
- Criminal Interest Rate Regulations: SOR/2024-114 — Canada Gazette, Part II, June 19, 2024. Checked 2026-10-12.
