I am putting together a friends and family deal on an multi-family property and was considering the following structure.
My LLC essentially sells a number of loans for "X" dollars to fund the renovations and down payment of the property. After year one we pay an pre-determined interest payment to everyone, after years two three and four we pay another pre-determined rate and then after year five we pay all the principal back plus interest.
According to my research and in reading @Matt Faircloth 's book Raising Private Capital this would not violate SEC regulations because the money is not being invested into a common entity. The investors or debt holders do not have any equity in the deal. However, I want to give investors piece of mind and issue promissory notes, even if they are unsecured.
My attorney, has told me the issuance of promissory notes is in fact a security so then the SEC would need to be involved.
Has anyone had experience with a structure like this before? If so, what did you issue to the investors without violating any regulations?
I'm not sure how big your deal is, but I would just pay the $5-10k for a PPM. Especially with friends and family, where emotions likely get involved if a deal goes South. It'll help protect both sides.
@John Dennis your attorney is correct that the issuance of a promissory note is a security.
And in the eyes of the SEC, there isn't a "family or friends" exemption to raise private capital. My recommendation is to have a securities attorney draft the appropriate documents.
@John Dennis to be on the safe side, I would hire and SEC attorney to protect everyone's interest. It's better to be safe than sorry. Saving 10-15K by not going with an SEC attorney, may cost you triple or quadruple that if something was to go wrong. Just my thoughts
Investing with friends and family is the highest risk strategy discussed on BP. Money and close relationships are at stake.
Like many others have mentioned, its better to have peace of mind than worry through the night. Link up with a SEC attorney and get it ironed out. Good luck!
there's not enough info here to determine whether its a security. are the notes collateralized? fractionalized? guaranteed? need more info...
Have you considered just a multi member LLC where investors are members of the LLC etc
@Mike Dymski It is, but this deal is small enough that if the worst does happen I can still pay everyone what's promised with alternate cash flows. I am treating this as almost a "starter" deal with friends and family.
@Chris Seveney That was a consideration but the way the deal is structured, the investors are basically lenders. They receive no equity only very solid yearly returns on their investment. If I made them part of the LLC then they would become equity partners.
@Amy Wan They are unsecured promissory notes and cannot be sold.
If this deal is financed by a lender, they will want to know the source of your down-payment and closing costs. Fannie Mae, Freddie Mac and most commercial loans (with the exception of certain bridge loans) don't allow subordinate debt. They will likely require that the investors become members of your buying entity. Regardless of whether you offer investors a share of profits or fixed returns, it is still a common enterprise (everyone pooling money to acquire a single property) and if they are passively investing and relying on you to generate their profit - what you are offering will likely be considered an "investment contract" (which is a security), so you still have to comply with securities laws. A former SEC commissioner once said that when someone asks if something is a security, the SEC finds in 95% of the cases that the answer is "yes".
@John Dennis No doubt this is a security. Keep in mind that your "worst case" is not just having to pay all your investors back. There is a good chance you will be slapped on the wrist by the SEC or the State which may prevent you from raising money in the future since you would now be considered a "Bad Actor". Your risk/reward of trying to save a few bucks isn't worth it in my mind.
I think your a little confused about raising capital and where the securities regulations come in.
There are no tricks to make an investment to appear to be something it’s not. Under the expanded definition of a securities offering, ANY investment in which the investor is not actively involved in managing the investment is an offering of a securities. Period. Any other advise is based on older regulations and interpretations, and are no longer relevant.
Secondly, securities offerings must be REGISTERED with the SEC, unless they qualify for an exemption from registration. There are two major exemptions. One is an intra state offering. If everything occurs on one and only one state, then the SEC is not involved, and the offering must comply with the securities laws and regulations of that particular state. The second exemption from SEC registration is the exemption for private , or non public offerings, commonly called a private placement.
In terms of the private placement, there are two ways to go, one is relying on the general exemption for private offerings. Your offering is made only to investors with whom you have a pre existing relationship; you can have up to 35 “sophisticated” investors and an unlimited number of accredited investors. There are no specific requirements for disclosures, PPM, or anything else. The upside is cost and lack of need for any particular filings or compliance. The downside is many investors won’t invest in this kind of offering, and if you are sued you have no statutory or definitive defense. As a result lawyers are usually willing to represent investors suing you should the investors be dissatisfied.
An alternative is to utilize the safe harbor Reg D 506 securities offering exemption. This exemption requires a PPM and a filing (not registration) of the Offering with the SEC. securities attorneys typically offer to create a PPM, Operating Agreement, Subscription Agreement, and file the offering with the SEC for $10,000 - $20,000. The advantage of using the safe harbor Reg D is that it won’t be challenged by the SEC, and you have an affirmative defense in case of an investor lawsuit, which would be unlikely absence fraud.
Wait. How can this be? Everyone on my fb newsfeed is syndicating apartment deals...
@Don Konipol Thank you for the information. It was very helpful. I do not want to take any shortcuts in the process and want to make sure everything is done above board. It sounds like creating a PPM is the way to go but I will consult a securities attorney in the state the property is located in to ensure compliance.
@Corey Thompson that ax is going to fall... trust me.
As Warren Buffett said, be fearful when others are greedy, and greedy when others are fearful.
@Amy Wan I agree there will be a correction.
Warren Buffet is a very smart man but he also seizes opportunities when he sees them or he creates them. There are still some deals out there. If you can find a property for the right price, that cash flows without assuming rent increases, in a good location, plan to hold on to it long term, without over-leveraging then inaction would be the enemy.
I also agree with @Corey Thompson . They're a lot of people out there buying just to buy and they don't understand what they are doing. I'm ok with that though. Once they realize the property they bought isn't going to appreciate the 20% YOY they assumed and they can't cover their costs it'll be another good opportunity(as the quote says).
We picked up 57 units in two small towns. 16 in one town, 41 in the neighboring town. 800k. Gross rents were 18k per month, will be 35k once stabilized.
We bought these on hard money, 100% financed. (HML brought 600k, seller carried 200k in second lien postion)
These were apartment deals 3 & 4, for us. Everyone has been bought with hard money from a seller that bought them during the savings and loans crisis.
Deals are out there. Just have to find them.