I was wondering if I could get some advice on how I should go about starting a company that raises capital from investors to buy properties. My idea was to somehow raise the money for a complete purchase or a downpayment then when I had equity built up, enough money saved from cash flow, or I sell the property I could repay my investors and move onto another property. I would really appreciate any help you can provide with business models, financing with debt or equity, and anything else I'm most likely forgetting. Thanks for the help.
It is more likely not what you think. Under the Securities Act of 1933, any offer to sell securities (equity in a company falls into this) must either be registered with the SEC or meet an exemption. A common way is through an IPO, which registers a company and sells its equity to the public in the open market. A private way to raise money is through a Regulation D, which provides exceptions to registration as a security and sell securities to private investors.
There is a mile of details here but I recommend you start by looking up some regulation D threads here on BP. From there you can come back and clarify your desires and get answers.
It is more likely not what you think. Under the Securities Act of 1933, any offer to sell securities (equity in a company falls into this) must either be registered with the SEC or meet an exemption. A common way is through an IPO, which registers a company and sells its equity to the public in the open market. A private way to raise money is through a Regulation D, which provides exceptions to registration as a security and sell securities to private investors.
There is a mile of details here but I recommend you start by looking up some regulation D threads here on BP. From there you can come back and clarify your desires and get answers.
I'm not sure if I'm not understanding you or you're not understanding me but i really don't want to start a public company through an ipo. My idea is to have a private company that locates the property we plan to purchase then my company will bring in investors to provide the capital for the purchase or at least the downpayment where the rest is financed. I know I sort of restated my original question but I just want to be clear. Thanks again.
Dion DePaoli understood you perfectly. We understand you don't want to start a public company. But any company that brings in investors is by definition selling a security. Public or private or whatever. That means it falls under the Securities Act of 1933 and there are severe penalties for failing to comply with the regulations. Even bring 2 unrelated parties into your company to "invest" falls under the act.
This is a case of you don't know what you don't know. So please do yourself a favor and do a lot more searches before you start doing this or start looking for "investors".
Also ask yourself: Gee, this must not be a new concept of bringing investors together to raise money to do deals. Why don't I see everyone advertising for investors? the reason is that even the advertising is highly regulated and restricted.
Even when you go to a REIA, and some guy stands up and says: "I'm looking for large multi family projects in emerging markets, and am seeking investors to work with on those projects." He's usually violating the SEC regulations too.
Austin, I understood you perfectly. Raising capital publicly and privately is governed by rules. Those rules come from SEC/FINRA. Raising capital is a form of security whether public or private. A security is any investment instrument besides insurance or annuity. So selling equity to raise money is a security. That is how you raise money. You would be selling shares of equity to investors in return for their cash. You would then leverage that cash with debt to purchase an asset. This process has rules and regulations which determine who you can raise from, how you can raise, what disclosure you have to make, how much money to each tier of regulation to capital you raise.
You want to raise private capital to help fund your deals. I suggest you read up on Regulation D. When you do so, you will start to walk into the clear field from the woods.
It might be when you read through Reg D, which there is some pretty short and easy to understand threads here on BP. That your initial start up plans do not yet bump up against Reg D. However, you have plans beyond stage 1, so go get an idea of what you long term plan is so you can plan how to get there.
This is one of those...."Trust Me" moments.
Thank you for the clarification. I'll make sure to do research so at least I can know what I don't know and go from there. I appreciate the help and will definitely learn more before I ask a seemingly obvious question. You two have been very helpful.
The others who have replied are correct, but I will offer some encouragement.
Educate yourself to the point where you know what all these terms mean:
Private placement
Limited partnership
LP-LLC as GP
Reg 500 to reg 504
Blue sky
Qualified investor
When you understand these terms you will at least be able to ask the right questions.
Austin,
Your company would most likely meet an exemption under Reg. D. What you need to remember is that you can only accept accreddited investors with private placement. With a new law that just passed this year, you will soon be able to advertise private placements on billboards, magazines, ect. I think it's a good idea but this will sadly be exploited by all the con artists out there in the business world.
Ann Bellamy Dion DePaoli I am a developer, and have used private money for construction financing in the past. I'm not up on all the SEC regulations, etc., and you two seem to be pretty knowledgable. If rather than going for a loan to finance a project, on a larger project, couldn't a developer get joint venture partners that would provide funding in exchange for partial ownership?
Karen M., there is a big difference in SEC world between forming partnerships and joint ventures with people you already know and do business with, and bringing people in who don't know you, or bringing together people who don't know each other.
For example, lets say you and I and Dion DePaoli already know each other in the course of our daily businesses. (just using the three of us for an example) Maybe Dion and I have done a transaction together, and we know you because we've met several times at networking events and discussed various business topics and strategies. Maybe we run into you monthly at the REIA's and share a glass of wine afterwards. We know and respect each other already. We get talking about this new venture you have, and decide to form a partnership, the three of us. That happens every day, and is not the same as raising money from people you don't already know.
Let me add to Ann Bellamy's statement. In most cases the above situation would pass for identification of investor sources. Selling equity in any company whether it is LLC, LP, C Corp, etc is a security, period.
Who complains when things go well and everyone makes money?? (Nobody)
When things or if things went bad and proper disclosure is not followed or improper investors are brought into the mix, you will find yourself in some very deep water.
I see what you describe all the time. I see real estate agents putting together packages to help their clients raise money. I see developers putting their packages together to do the same. As alluded to, there are likely more violations in general than we can count. Until those cause harm, nothing is really done. Unfortunately, I suppose.
@Dion Depaoli gets to the heart of this matter. Everything is great when your investors are making money and everyone's happy. Please heed the advice from Dion and @Ann Bellamy - take how you raise capital very seriously so that when, not if, something goes wrong, you will be in the best position possible.
I also want to challenge you to take an additional step. I would consult with an attorney who is well versed in securities law as it relates to real estate investments. The price for that advice and heeding that advice will far outweigh the cost of raising capital in a manner that is not in compliance with the law.
Dion DePaoli, this brings up an interesting distinction. I've had this conversation with my securities attorney several times, and it's seldom clear cut.
Examples:
A. Three people who already know each other and already do business decide to form a company together. Essentially a partnership, and let's say they form an LLC together. Three people forming a company together is not typically considered to be selling a security.
B. A person finds a project he wants to fund, and finds two people who don't know each other to fund the project. In order to facilitate the transaction, the 3 people form an LLC. Given that the partners don't all know each other, and are brought in soley for funding the project, this could be considered selling a security.
Recognizing that neither of us is an attorney, and this is just a conversation, at what point do you think it morphs into a security? What in your opinion triggers the difference?
IMO, the "knowing" is a past business transaction or related by blood or marriage, it's not that I know he is the owner of drug store.
If you have A & B & C, C & B have done business in the past and so have A & B, then before the three join in some entity, A & C should conduct some business transaction and complete it before they enter as the three partners.
The transaction that introduces the two should be 1. at arm's length, 2. significant in scope, amounts and risk and 3. successfully completed to the end.
Yes, you could do something knowing that you will or would likely do future business and you can do some transaction that introduces each party.
As to a significance of the transaction, that would not mean buying a pack of gum at the drug store. It's not a poker game in Vegas. It is some transaction that has similar risks, is similar in scope or related and realistically (staying with the risk) in an amount that a reasonable person would base the transaction upon.
So, if you need to borrow 100K, I'd say borrow at least 50K for 30 days and pay it back in full, with interest prior to the next transaction. That would be "knowing" the new partner.
Don't ask for a referrence or statute, I doubt it's there, but is my opinion. If I were an SEC Examiner, that's what I would want to see at the minimum to say all three parties were known to each other. Singing in the church choir with a general contractor might show that a personal relationship existed prior to the business transaction, but it's not sufficient IMO to be a known business aquaintence.
When does it become a security (?), when money is exchanged and a security interest in a business entity or collateral is given, that is a bond....it's also a note/mortgage but mortgages between two parties are specifically exempt from SEC. :)
I very much second Bill Worsley's recommendation to sit down with an experienced real estate attorney who also has previously put together syndications. I did so before forming the syndicate with which we bought an apartment last year and it is well worth the money. Also be sure you get the type of syndication that suits your needs. Some attorneys will try to set up a much more expensive and convoluted LLC than what you need. Be sure that if you need a Chevy you don't pay for a Mercedes.
Ann Bellamy let me address your examples from how I understand it from my experience with Regulation D and Securities (I am no lawyer as you mentioned):
A. The real distinction here is not so much the parties are familiar to each other but rather they enter the equity at the same moment which makes it hard to define "sale". They type of company they form is irrelevant, LLC, LP, etc. The general term for people joining together is a partnership which also has an implied difference than investor. A partner is sort of "in on it" and an investor is brought in after "it" is something.
Three people come together and decide to mutually join to form a non-existing company. While there is some inherent "sale" from one or two that have and develop the idea it is treated different. The situation highlights relation to a certain extent because if they didn't know each other they would not join at the same moment. Moreover, a "sale" would be necessary more to definition if they didn't have some relation. So they are not selling a security to each other as much as they are deciding to open a business with each other. There is a nuance to the assumed approach which creates something different than the classification of a 'sale'. In some different words, trying to articulate the concept, in order to sell something, I have to have it, implied or actual. When partners join to form a company the implied context of having something does not hold true. They come together to make it to sell, if you will.
If A&B sit and scope out the idea of the company and then B says, "Hey, I know C and he has money, let's go see if he is interested." There is an implied sense of having something and starts to qualify as a sale. The inclusion of C into the mix is for the purpose of raising capital and essentially A&B approach C in order to sell implied equity they have created even though the equity may not yet be realized or actual. In this example, C can be looked at as more of an investor rather than a partner as he entered in after the concept and A&B likely offered a barter for his capital that until he says yes, they retain, again implied or actual.
It is a little hairy, I know, and most of the time A&B inclusion of C is still not viewed in the same manner as it can be argued a sale was not conducted since A&B do not have actual equity into a company whereas the company is formed and then shares are actually sold to C in exchange for cash. That is also not to say law suits do not arise from this example, as they do.
B. In this scenario, it would be the order of events that scopes out the issue. If A finds a project and needs to raise capital to accomplish the project then A will actually solicit the idea. The relationship to parties being unknown implies a sale. If you do not know someone then in order for them to give you money it is likely you need to give them something in return. In order to accomplish this task, A needs to create benefits to such an event. In other words, if you approach a random person on the street and say, "hey give me 1 million bucks" they will run from you. It is only until a sense of barter enters the discussion that a sale starts to take place. "Hey give me a million dollars and I will give you 'this"". Where "this" is equity and usually implies some benefit. The opposite of that is charitable giving, for the record. Which is also governed by rules, a company can not take charitable givings unless they are a register charity. (whole other discussion)
So we see that the relationship of A, B & C does matter but I think folks misunderstand what the relationship means in the context of 'raising' money. A relation is either present or it is not. One of two options. The term of the relation is only slightly defined. In a Reg D offering, typically round 1 of fund raising is called "Friends & Family". Clearly you know your family, well, it is assumed you do. It is also assumed you know your friends. To what degree of separation you know either is sort of open for interpretation. Really what follows after this round is the need, depending on what Reg D rule applies, to identify and document the correct investor, accredited or non-accredited. If the party is neither friend or family they are then stranger. Reg D has an interest to protect those folks (strangers).
An investor into GE stock in the open market is a stranger. This is arm's length. A friend or family is not arm's length. You know them. This is not to say that acts of moral turpitude does not exist amongst friends and family but recognizes if anyone should know "John is shady" it should be his friends and family opposed to a stranger.
And there in lies the purpose of the rule that ALL sales of equity sold are considered a security by definition and what we then to is supply exception to the rule. Since all shares of equity are a security, it does not matter what the formal company structure is, LLC, LP, C Corp, they all qualify.
It is important to note, even in the event you sell equity to your friend or family without proper disclosure you have potential liability. Certainly when you sell equity to a stranger you have liability. Project success and liability are not the same thing. Investments loose money, you can't go to jail for that. However, failure to reasonably substantiate the risk to the investor gives the investor, friend/family or not, an open door to imply the risks and benefits were grossly misrepresented. Typically it is from that angle that your attorney will consult you.
To this I want to point out a major point. Prior to that a little justification. I have worked with private placements for years operating two blind pool investment funds. Been audited by FINRA a couple times and have several hours of my life spent in front of attorneys.
There is a difference between a real estate attorney and a corporate attorney. If your attorney is a real estate attorney that does not mean they will be as versed in the rules and regs of corporate law. Vice versa.
How someone, without the specific field of study and background, can make the decision of "what is needed" or in excess without being an expert could be trouble. Those are lessens learned after the fact and usually pretty costly. This is one of those things that you never want to have to put your protection to the test but if you do, you want to be protected.
Personally, we use both, a real estate attorney and corp/security attorney. For a syndication, both would be needed and consulted.
I do not have any particular reading that I would say is better than the next. There are books out there and articles galore. Lean more toward recent opposed to aged books and articles as regs are updated often.
Certainly one of the easiest places to start is with is read the SEC Rule here
I couldn't find it in the link, but I did read that "family" for exemptions was considered in the first degree, husband, wife, mother, father, sister, brother, son, daughter, so uncle Ben or your third cousin Clyde is not exempt. This same relationship is common in many aspects of rules, regulations and laws as well, not just for securities transactions.
There is some outstanding information in this thread. If you read through other BP threads you'll notice the Howey Case that defines securities pretty well:
1. investment of money due to
2. an expectation of profits arising from
3. a common enterprise
4. which depends solely on the efforts of a promoter or third party
I pretty much raise money (debt and equity...and hybrids) all day long now and the rules start to get very blurry in many scenarios. This is especially true for smaller investments where one cannot afford a reg. D placement to raise funds.
To me the big financial decisions are:
1. Does it make sense to spend the money for the private placement for your project(s)? This depends largely on the size of the project and how common one will be to the next
2. Do you intend to raise the money for a single project or ones that are common or will each one be different?
3. Do you have the track record and expertise to design in favorable equity splits for yourself by virtue of aggregating investors or would you be better-served by just forming a JV for a project? There are a lot of tradeoffs here and it really depends to a large degree on the project and your expertise. In JVs you'll have active partners with similar expertise to yours
This does not cover the risks, which is the primary motivation to set up a private placement. It is to protect the promoters; not the investors.
If you intend to raise money and invest it you are really in the money management business. Your agreements should spell out in detail what your expertise is and how you'll be a good steward for the investor's funds. Anything you use to sell the investment (emails, etc.) become part of the private placement.
There are literally hundreds of decisions you can make about setting up a placement and these are items an experienced securities attorney can help with and coach you through. Liquidation preferences is a big one that many people don't think about much. There are many, many more. This isn't a do-it-yourself project.
I could go on and on. I'm happy to send you some material on key decision points if you email me. I have a ton of material on this that I can distribute to you privately if you email me.