Questions about raising Private Money

10 Replies

Hi All, 

As a new investor, I have a couple of questions regarding raising private money. My business partners and I are putting together a pitch and list of who we would like to start approaching to fund our deals. We have seen many properties and can actually make moves on a couple the only restriction is that we do not have the capital to do it ourselves. We came upon a couple questions that I thought the biggerpockets community members would be a perfect source for. Please review the list of questions below, any help and feedback from past experience is appreciated as I am sure we can learn from all of you. I know that some of these might be beginner questions but I wanted to get an understanding of the different type of scenarios that can arise during this process.

- If an investor wants to invest with us, how do we go about having the individuals contractually bind to the investment, if at all? 

- Should we wait till we have investment opportunities to start raising private money or do we go about pitching private money without opportunities yet? Being a beginner this is something that will be a huge obstacle for us, so I wanted to know how some of you overcame that obstacle? Property first then pitch, or pitch first and look for properties, or 50/50 etc.?

- Once a deal is found, who's funds out of the investment pool are used first, is there a priority based on the money raised. For example, if we raise 50K but only need 30K, how is that decided on who's funds we utilize first for the deal? Not wanting to leave anyone out of the deal who wants to participate, not sure how that step of the process works.

- When pitching for private money do we pitch from the angle of it being an investment pool, asking if the investor would be interested and then once we are finding deals we send those deals to all the investors we met with and see if they are willing to join in on it? or is it suggested that we come to the table with properties and/or pitch an individual property?

- If a deal were to go sour and multiple investors are in on it, how is the money divided up to pay them back, do they sell the property and divide the proceeds? or is the property foreclosed and upon sale the dividends are allocated between the investors?

Thanks again for your help and I look forward to hearing back all your feedback.

-Luke

You will be MUCH better off to get ONE loan from ONE investor for ONE property.  You talk about pooling.  If you're doing that, you're "selling securities" and you're right in the signs of the SEC and the state securities broad for the state(s) where your investors are located.  That is possible to do, but there's a lot of legal work to do it right.  And you're limited to either people you already know (no advertising allowed) or you're limited to accredited (if you advertise).   Much, much simpler to just get a loan from an investor for a specific property.

If you were to do a pool and, say, raise $50K from two investors who invest 25K each, and you use $30K of that to do a deal each would get half the returns.

A key to being successful at this is to have a track record.  If you have enough of your own cash to get started, do that.  Keep accurate records and then you can show these to new lenders.

Even with the loans you will want to have an attorney prepare the documents.  

@Jon Holdman  Thanks for the quick reply and information, it means a lot. Going back to what you said at the end, I find it will be an obstacle to raise money without having a track record.  We plan on investing our own money into these deals as well to show the investors that we are at risk too to make them feel more comfortable with believing in us. As we are doing our first deal/pitch, from your expierince is there anything else to keep in mind or any other ways that we can makes the investors feel more comfortable about investing with us?

Thanks again.

The laws have changed where you may advertise your pooled investments that are targeted to accredited investors, but you must be very careful that you follow the new law.  (See the JOBS Act of 2012, the part of which we're looking at was effective in September, 2013; the crowdfunding aspect is still waiting final rule approval by the SEC)  Jon was correct when he said you pool money, you sell securities and have all the duties and obligations that entails.  

If you get more than one investor for one property, consult an securities attorney to structure the deal.  Some times your investor will already know how they will structure the deal and may require their attorney handle it.  

In any case, you need to better understand raising private money before you get yourself under the radar of state and federal authorities.

Divina K. Westerfield, Esq.

@Divina Westerfield Thanks for the explanation! I now have a clearer picture of which route we should go down. Finding a deal and then marketing it to investors. This does bring up a question:

Should we be putting in offers and getting the house under contract even if we don't have investors for that particular property? 

The reason I ask is what if you want to move forward with the property but have no investors to do so yet. By the time you find an investor, even if it takes a few days or even hours, if its a good deal it might and most probably will be gone.

Thanks.

It's tough to borrow from people you don't know to do this stuff. They tend to be suspicious.

I do my own docs, but know my lenders well and use ones an attorney prepared. Best to have the closing atty do them. The layer of comfort for the lender is worth the few bucks it costs.

A private loan is just two documents here in Georgia. A note and a security deed.

Note spells out the terms of the loan, the deed secures it against the property.

My pitch is pretty simple. "It works just like the bank with your mortgage. You lend me money, I pay you 2% for doing that, then 1% for every month I have it. It's secured by this house worth way more than your loan, and I can't sell it without paying you off"

Little more to it than that, but that's the gist of it. If they are new (and don't just trust me with hundreds of thousands of dollars like my lenders do), I walk them through them sending the money to the closing atty, how he doesn't release the money until the house is encumbered and how when it sells the atty calls and gets the payoff amount just like they were the bank and fedEx's that amount straight to them.

That stuff snowballs. They start asking you instead of the other way around once you've done a few. Great investment, really, I lend myself when Im cash heavy.

Lukasz - My answers are inserted below in underlined bold...

Originally posted by @Lukasz Kukwa:

Hi All, 

As a new investor, I have a couple of questions regarding raising private money. My business partners and I are putting together a pitch and list of who we would like to start approaching to fund our deals. We have seen many properties and can actually make moves on a couple the only restriction is that we do not have the capital to do it ourselves. We came upon a couple questions that I thought the biggerpockets community members would be a perfect source for. Please review the list of questions below, any help and feedback from past experience is appreciated as I am sure we can learn from all of you. I know that some of these might be beginner questions but I wanted to get an understanding of the different type of scenarios that can arise during this process.

- If an investor wants to invest with us, how do we go about having the individuals contractually bind to the investment, if at all? 

This question is "the cart before the horse" since your title is raising Private Money but your questions revolve around a Private Placement. Answering from the perspective of a Private Placement - you will send your potential investors a subscription agreement, private placement memorandum and other investment docs prepared by your attorney. Typically when they sign the subscription agreement they are on the hook.

- Should we wait till we have investment opportunities to start raising private money or do we go about pitching private money without opportunities yet? Being a beginner this is something that will be a huge obstacle for us, so I wanted to know how some of you overcame that obstacle? Property first then pitch, or pitch first and look for properties, or 50/50 etc.? 

I would say you should have closer to 75% committed investors before you find your first deal. Keep in mind that once you put a real deal in front of people you will find that several will not go forward for various reasons. I would have an investor pool large enough to oversubscribe the deal by 125% (I recommend using all accredited investors), if you get more than the 100% needed your subscription agreement should give you authority to reject investors.

- Once a deal is found, who's funds out of the investment pool are used first, is there a priority based on the money raised. For example, if we raise 50K but only need 30K, how is that decided on who's funds we utilize first for the deal? Not wanting to leave anyone out of the deal who wants to participate, not sure how that step of the process works. 

See answer above.

- When pitching for private money do we pitch from the angle of it being an investment pool, asking if the investor would be interested and then once we are finding deals we send those deals to all the investors we met with and see if they are willing to join in on it? or is it suggested that we come to the table with properties and/or pitch an individual property?

You need to have your documents done first. A good attorney will run you $8-12k for the Private Placement documents, which you can generally re-use for future deals. Your first deal needs to be a really good deal and you must show large returns to investors (subjugating your fees and returns as necessary to make investors comfortable). Once you have a deal under contract with the longest attorney review period you can get (2-3 weeks), send out your investment docs to as many accredited folks as you know with a deadline to invest. Get your investors funds up front. If you don't have 100% of the equity you need before the atty review expires it is decision time.

- If a deal were to go sour and multiple investors are in on it, how is the money divided up to pay them back, do they sell the property and divide the proceeds? or is the property foreclosed and upon sale the dividends are allocated between the investors?

If the deal goes sour there may not be any money to pay investors. If it is foreclosed upon the investors will ALMOST DEFINITELY not get any money. Your investment documents will spell out how the returns are split. If you are invested you may set it up so that you don't receive any of your investment back until the other investors are made whole. In a worst case situation, you may need to pay investors from your own pocket to keep them for future deals, otherwise your business model won't sustain itself and this was a failed venture. It is wise to expect the best (happy repeat investors) but prepare for the worst. 

Thanks again for your help and I look forward to hearing back all your feedback.

-Luke

 I wish you luck in your endeavor.

Brian

Looks like the underline feature doesn't show up in the post. Luckily I broke out my responses in separate paragraphs so it can be followed reasonably well.

- If an investor wants to invest with us, how do we go about having the individuals contractually bind to the investment, if at all? 

With a subscription agreement and a trust account to take the money into.  You should take the money in as you receive subscriptions and the deal you structure will specify what conditions need to be made for the funds to be released to your controlling entity.  

- Should we wait till we have investment opportunities to start raising private money or do we go about pitching private money without opportunities yet? Being a beginner this is something that will be a huge obstacle for us, so I wanted to know how some of you overcame that obstacle? Property first then pitch, or pitch first and look for properties, or 50/50 etc.?

I hate for this to sound harsh, but you're wasting your time trying to pitch investors without a track record.  For the right deal you MAY be successful finding investors, but trying to sell them on anything without a deal is going to be tough.  I am not sure what you'd sell them on if you have no operating history to point to.  The money should always be nurtured and available before the deal flow opportunity presents itself unless you can get an unusually good buy-side contract.  

- Once a deal is found, who's funds out of the investment pool are used first, is there a priority based on the money raised. For example, if we raise 50K but only need 30K, how is that decided on who's funds we utilize first for the deal? Not wanting to leave anyone out of the deal who wants to participate, not sure how that step of the process works.

Generally the sponsor will front the up-front money, but if you wish to get folks committed it would not be uncommon for investors that participate passively to share in the funds at risk as well.  This is especially true for investors who you haven't worked with previously that are likely to back out if they don't have skin in the game.  

- When pitching for private money do we pitch from the angle of it being an investment pool, asking if the investor would be interested and then once we are finding deals we send those deals to all the investors we met with and see if they are willing to join in on it? or is it suggested that we come to the table with properties and/or pitch an individual property?

Pooling general funds is at least an order of magnitude harder than presenting single-purpose deals.  You are much more likely to be successful raising funds for a single deal given your circumstances.  Note additionally that whether or not private placements are required depends materially on how the deal is structured.  For a smaller project like what you're talking about it is quite possible that you may be able to structure it as a simple partnership provided it is considered de minimis and fits with securities laws.  A lot also depends on where you will be trying to raise money from.  Will this be intrastate or across state lines?  There are simply too many unknowns for anyone to answer many of your questions intelligently.  

@Brian Burke  and @Bryan Hancock  .Thank you for the detailed answers to my questions. @Bryan Hancock it doesn't sound harsh at all, thanks for your honesty as this is what I am looking for. 

In your opinion, what is the best way and/or some ways that you have used in the past or heard of to fund your first deals. I know some people on here are beginners and some are veterans who run a successful business. However, one thing we all have in common is that we all started somewhere, all of us had our first deal and at one point none of us had a track record. It would be nice to hear what was successful and what failed for some of you.

Based on your answers and what I have read and gathered from other on here and through networking is that partnering with someone on the first deal is our best option. 

Please let me know your thoughts.

-Luke

@Account Closed  Good question, I actually talked about some of that on podcast #3 and podcast #76.  In a nutshell, I started with people I worked with, which spread to people I knew (the ol' friends & family set...that's how most startups are funded), which spread to people that knew people that I knew. 

Over time your track record speaks for itself and people begin seeking you out.  At a certain point I started getting press coverage, and people who read articles in the newspaper were contacting me and eventually investing.  Then it grew to people that they knew, and so on. 

Word of mouth and referrals...that's how I grew from not having raised a single dollar to having raised many millions.  Word of mouth comes from track record, you don't get one without the other so the first stop is with folks that already believe in you.

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