I am speaking with my attorney who is helping me setup the proper documentation for use with private investors. She is suggesting that I do not deal with non-accredited investors because if something should happen to them and they need their money back, they could sue me and claim that they should not have invested in the deal but did anyway because they didn't know any better. She feels that the disclosure documents that would be required for me to use a non-accredited investor would be too onerous for the type of financing I am seeking.
My strategy is to use private money for a one year term to acquire/rehab a rental property priced under $100k, then refinance to a conventional lender after that term.
I am kind of stuck here, as most of my potential private lenders have money sitting idle they want to invest, but do not meet the accredited investor threshold.
Has anyone had this sort of risk come up and how have you dealt with it? Is everyone who is using private money only using accredited investors?
Using a non-accredited investor adds an additional layer of risk. You have to mitigate that risk. Will the loan-to-value ratio be 70% or less? Will there be an appraisal? Lenders policy of title insurance? Does the investor have hard money lending or real estate experience?
If you do this deal with a non-accredited investor, you aren't heading straight to jail. If you make money, your investor makes money, and your investor gets their money back, you are fine. The $&!? hits the fan when the deal goes south and the investor loses money. Now it's game on, and you have to defend what you did. You need as many facts in your favor as possible. If you can answer yes to the questions in the previous paragraph, you still don't have a get-out-of-jail-free card, but you are defending your actions from a safer position.
Your securities attorney is giving you good advice if your objective is to minimize your own risk. Business is about taking calculated risks, and perhaps the additional risk of using non-accredited investors is acceptable to you in exchange for the opportunity of doing this deal. Only you have that answer.
Judging by the responses so far, all the money spent on legal advice would make for a pretty nice pool of funds to work with :) Only joking of course...
On a serious note (no pun intended), how can the laws for raising funds possibly be so vague? It seems like if you spoke to 100 different attorneys, you'd get 100 different answers as to what is or isn't legal. If 100 people ended up in court, you'd probably have just as many different outcomes.
Bill Gulley, using your partnership idea, it sounds like the goal would be to eliminate the investor from truly being considered "passive". Is that correct? If I'm understanding correctly, each investor keeps their funds in their own account, and when the time comes to purchase a property, the details are sent to be looked over by the investor, and upon approval, funds are moved as needed. In the eyes of the law, does this become a partnership rather than a security?
Never having done this before, it seems like the person that gets the short end of the stick is the medium sized organization. The mom and pop companies can find enough personal friends to fund the limited amount of deals. The big time organizations have the cash to pay attorneys to make everything legal. It's the person that has tapped out all their personal connections, but maybe doesn't have 50k to pay an attorney. Just a thought...
Good post Bryan. yes, the personal recourse is unlike that of securities, liquidating a firm for recovery.
Carl, yes, a JV/partnership is not a security issue, unless you mess it up. A passive investor throws money in and does nothing, just like those that buy corporate bonds.
Bryan's post better explains my points above, total agreement. :)
We obviously sit on the opposite sides of the table, @Sean H., but our goals are the same: to do deals safely, over and over, and to each make money. Education and knowledge are important, but you’ll make yourself crazy, and your business will become hamstrung, trying to figure out “What’s a security?” This is why you use an attorney.
We’ve found that the easiest way to find a good lending attorney is to talk to some local hard money lenders and ask who they use. It won’t take long before you start hearing the same few names over and over. These are the people you want to call. Ask if they personally lend or invest in notes. Sitting in the deal flow that they do, it’s likely they’re also investors. If you haven’t already, you’ll also want to form a relationship with those who are lending to you.
Before we loan a dime to anyone, we get to know them a bit by spending some time with them, visiting a few of their properties and perhaps having lunch once or twice. It doesn’t take long for us to understand whether they’re people we want to loan our hard earned money too. This also works in reverse.
You need to feel comfortable with the people you borrow from. Whether it's the largest HML in town or your dentist, you should are always be concerned about your lender's reliability, capability, and character. If you believe they are still nervous, hesitant, or financially incapable for any reason, obviously don't do the deal -- and never pressure anyone.
You can only do the best you can and get the best, most practical, available advice. It’s unfortunate that the laws are not clear and that you can be sued for being left handed. At some point however, you either have to pull the trigger or change your business model.
Hope this was practical.
Now, back to the Supreme Court…
Because there are millions of different ways to structure investments. How would a law-making body possibly codify every scenario? The best they can do is to set guidelines and leave it up to the courts to fill in the gaps as best as they can.
What makes matters worse is that each state has laws that have to be followed too. Good luck learning all of those laws. That is why you hire someone knowledgeable with these matters to keep you out of trouble.
The government is overprotective with regard to securities in my experience. I am sure they're well-meaning, but attorneys and legislators are not necessarily good investors. The laws are arcane and make it difficult for scrupulous entrepreneurs to access capital needed for growth. There are new laws that are meant to break down these nonsensical barriers, but the SEC has resisted them vigorously. Whether or not they're a good idea remains to be seen, but they certainly should make accessing capital easier over time. With today's technology the way capital is raised is completely inefficient and costly. This cost is bad for the economy at a time when we have job shortages.
As you study the securities laws more you'll become even less enthusiastic about them. People who need yield on their funds are "protected from participating" and people that are able to participate are generally too savvy to surrender funds to other managers. The savvy folks can generally generate similar returns on their own.
Thus the entrepreneur is left with a narrow sliver of the overall capital market to raise funds from. The alternative is to take on more risk and navigate the securities gauntlet. All of the advisers have the system designed to where you need to pay a securities attorney $600/hour to keep yourself safe or put your freedom at risk if you fail to pay these fees.