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Avoiding Prison When Syndicating Real Estate Deals (Do YOU Know the Securities Laws?)

by Michael Blank on January 27, 2014 · 9 comments

  
Securities Laws when Syndicating Deals

I’ve been writing lately about syndicating your apartment building deals by raising money from private individuals.

As Ben Leybovich said in his post about this topic, syndicating your deals is a great way to add a “zero” to your deals.

We’ve skirted around the commonly-asked question and concern, which is “what about the SEC? Isn’t it illegal to take investor’s money?”.

Let’s talk about it.

I will outline some of the securities considerations but I don’t want to overwhelm you with technicalities. This isn’t necessary because your SEC attorney will handle all of the details. But it’s important that you are aware of the main points.

When you accept funds from others to buy an apartment building, you are effectively selling shares, or securities, in the LLC (or other entity) that will own the building. As such, they fall under federal and state securities laws.

These laws differ by state and by how complex the deal is. Typically you have to provide your investors with some kind of disclosure document, and you have to file some forms with the federal SEC and possibly with one or more states.

Most investments will fall under the SEC’s classification of “small” offerings, i.e., not exceeding $5,000,000. The most important are those under Rules 504 and 505 of Regulation D. Under these rules, you can’t raise more than $5M and have no more than 35 non-accredited investors.

The SEC defines “accredited” investors with a household net worth of at least $1,000,000 and an income of $300,000. There’s no limit with how many of these types of investors you can have.

This impacts your fundraising only in the sense that you shouldn’t have more than 35 non-accredited investors.

Under these rules, you also can’t solicit strangers with your offering. This means you can’t put up billboards, send out mail, or post newspaper ads. Well, you can, but you need to file under another Rule, and then some of the requirements change.

I’m trying to cover the most common case where you’re raising money with word of mouth (more effective anyway in my opinion).

The SEC requires you (or rather, your attorney) to complete a “Form D” (download the form from the sec.gov here) and give a disclosure document to each investor.

The Private Placement Memorandum

This disclosure document is usually referred to as a “Private Placement Memorandum” or PPM. This document is prepared by your SEC attorney and is a long, laborious document that has information about you, the proposed use of the money, possible tax consequences and risks. The document also repeats the terms of your operating agreement.

Your SEC attorney may also have to file some state forms. Some states require you to file, others don’t. The attorney must review the filing requirements for every state your investors live in.

Working with Your Attorney

The only other thing you have to know about this is that it will COST YOU MONEY to hire an attorney to draft these documents. I found an excellent SEC attorney who “retired” from a huge expensive law firm that normally charges $20,000 for all of this, he charges me $6,000 for the PPM. He charges me half up front, and the rest can be paid at closing.

Be sure that your attorney specializes in these kinds of deals and has done a ton of them.

Conclusion

The details of being compliant with SEC regulations are complicated, and you should have your SEC handle them. All you need to know is the basics as I’ve described them, and your attorney will educate you on the rest.

The other lesson here is, since the attorney almost always charges the same for the PPM regardless of deal size, why not go after bigger deals in the first place?

I look forward to hearing from you!
Photo Credit: Jesse Acosta

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{ 9 comments… read them below or add one }

Alison January 27, 2014 at 4:13 pm

Another great article by THE Michael Blank! Good work guy!

Reply

Michael Blank January 30, 2014 at 7:30 am

Thanks Alison …!

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Kirby January 30, 2014 at 10:10 am

I’d be interested in learning about that attorney you mentioned. “My guy” is about double what you quoted.

Reply

Michael Blank January 31, 2014 at 6:47 am

Let me check with him to see what his geographic reach is, I will get back with you.

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Kirby February 6, 2014 at 11:52 am

Looking forward to hearing from you, Michael. My guy is in CA, but conforms to the federal SEC rules and thus complies with state regs as well so it doesn’t really matter where he is relative to where the deal is. (this is all for 506-d exemption status.. PPMs that work for sophisticated as well as accredited…)

Kirby

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Jonathan Makovsky January 30, 2014 at 7:14 pm

Thanks for posting this Michael – great material.

Do you pay $6K to your attorney per deal, or once the attorney drafts the documents for one deal do you just apply some “paint and carpet” for future deals and pay a lesser rate?

Reply

Michael Blank January 31, 2014 at 6:46 am

This is an interesting question. For my apt building, the answer was “yes, you pay the same amount for each deal”. But for the two restaurants I syndicated, that deal was set up as a “series”, meaning that you could use that structure to add more investors and capital and buy more restaurants (in theory). I think I’m going to use that structure with my next apt deal also. It’s very flexible, and you don’t need to start from scratch each time. The structure is an LLLP at the top, and then each property would be a separate LLC. The operating agreement defines how new members and capital is added, and how people can be bought out as well. Pretty cool.

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Brian Burke January 31, 2014 at 9:51 pm

Great article, Michael. So often, new would-be syndicators get so caught up in the details that they never move forward. Having a working understanding of the basics and having competent legal counsel is the key to doing it right. There are no shortcuts or “no-cost” approaches to accepting money from others.

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Michael Blank February 1, 2014 at 7:56 am

Thanks Brian …!

Reply

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