How to physically collect money from private investors?
Denver, CO · Member since 2016 · 23 posts · 9 votes
Hi BP,
My brother and I just made our first offer on a property we have been looking at.
Though we have the cash needed, we are also considering bringing in equity investor(s).
Now that we're at this point, we realize we don't know how we would go about actually collecting the money from them. I read that most syndication deals use escrow accounts, but am wondering if this is also typical for smaller deals. If so, how can I set up an escrow account for this purpose? Clearly most financial institutions offer escrow services as part of their mortgage services, but can these institutions also just set up an independent escrow account? I Googled around a bit and everything just directs me to mortgage related information.
If it is relevant, we plan to deed the property to an LLC after closing. We have not yet created this LLC, because its structure would be dependent upon how many partners we have/how much money we raise.
Any insight is appreciated!
Sounds like a syndication to me...
@Tristan Cottarel you mentioned a lot in your post and I will try to address some things separately as best I can:
I don't want to sounds alarming here but these are all pretty fundamental items that would need to be discussed BEFORE you make an offer on a property. Some of the items above have serious repercussions to your private investors. If this does turn out to be a single family home that you need to close in 10 days or something then it will be likely that you don't have any time to do any of the items listed above and you should purchase with cash. Certainly willing to answer any questions here and if you know the answers to the items above would provide direction based on those answers.
Thanks for your response.
Type of Property: Duplex
Closing: 30 days
Exit Strategy: Hold for 3-5 years and then refi or sell.
LLC and Members: Our plan was to take out a residential loan in our own names. Then after closing we would deed it to the LLC. The potential investor(s) would be non-managing members in the LLC with a % ownership stake.
Syndication: I've done fairly extensive research on syndication and from what I understand this would not be considered syndication. Correct me if I am wrong.
Please let me know if there's more info I can provide. I hope this helps. Thanks again!!
@Andrew Postell Following. May PM you later of that would be okay. Waiting to see your next reply.
@Tristan Cottarel Ok, those help considerably. First, yes, this is not syndication. That is something else entirely.
Now, if you ALREADY have money, I would encourage you to NOT partner with people. Partnering means you give away your ownership rights in some way. The alternative, is just to raise money....or get a "loan" from someone. Private Lending if you want to do some research on that subject. You pay them their interest and you keep 100% of your property. They still make money, you can file their lien on the property, etc. You keep your property and all control to it and all decisions of the money too. Having partners makes things complicated quickly. >SPECIALLY if the residential loan is going in your name, then you carry the burden of the debt, but partners get off scott free. Just a thought but that's the route I would suggest.
30 days might be enough time to fundraise....but it depends on if you have a regular job and normal life. if you do, then 30 days likely won't be enough time but plant seeds now and tell your potential investors about this deal so you can come back to them on the next one and tell them about the success story here.
Also, if you are buying with cash and looking to get a residential loan after you purchase it then I would highly recommend reading this post HERE
Hope this helps!
Thanks again for your response. I appreciate the input. My brother and I have discussed all these options in length and are comfortable with giving away some ownership for various reasons. We have also been "planting seeds" for some time now and have a few individuals ready to invest.
Regarding my original question of collecting money once we agree on terms with an investor, do you have any insight on this? We've gotten this far and then kind of paused and thought "huh, now how do we do this?". Is it as simple as walking into a local bank branch and setting up an escrow account? We have strong enough prior relationships with most of these investors that we probably could just have them write us a check, but we'd like to go about it professionally.
Why is this structure not syndication?
@Tristan Cottarel many investors that have partnerships just have partnership bank accounts. You can call it an "escrow" account but a simple "business" bank account will be sufficient.
Why is this structure not syndication?
Relevant question. From what has been described so far this would require syndication paperwork to be prepared, and the rules and regs to be followed. You may be better taking out private money loans from these folks, based on the deal size that has been implied.
As some here have questioned, @Tristan Cottarel, pooling money from others, with the expectation of paying them a profit, when you do all the work, would almost certainly be considered a security and require a syndication.
Partners should have bona fide, legitimate, job descriptions. If not, and you can replace “equity investor“ with “silent partner,” as seems to be your case, it’s usually a security requiring a syndication of some sort. From doghouse to duplex to a large commercial building, the size and type of the property doesn’t matter.
Syndications are expensive and can be restrictive. It’s possible your friends would have to be accredited investors and might not qualify. You might be better off simply borrowing the money from them, as @Taylor L. mentioned.
If this is a CA property, and in a few other states, you could have 10 or fewer investors loan through one first position fractionalized note. These are legal in CA if originated by a licensed CA real estate broker. The restriction here is that they could not invest more than 10% of their net worth in any one loan. Other states will be different.
Good luck, Tristan.
Hi all,
Thank you for the input.
From Raising Private Capital by Matt Faircloth from BiggerPockets Publishing, a deal is considered syndication if it satisfies the following four requirements:
Clearly the first 3 are met. However, Matt writes that #4 is the key element for disqualifying your deal from being a security. He notes that discussing business decisions such as major maintenance and expense reduction. "As long as all members are contributing in some way to the goals of the business, it's not a security" (p. 159).
@Andrew Postell is this the same reason you agreed that it was not in fact a syndication deal?
@Jeff S. if define a role in the contract something along the lines of (for example), "Partner" shall approve of all capital expenditures exceeding $X and approve of all new tenants being placed", is that sufficient to exclude this from being considered syndication?
We also had a paid consultation with an attorney in the market we are investing in, and he said setting up LLCs in this way is something he has done before. He did not note any concerns about the SEC.
@Tristan Cottarel you need to talk to a securities attorney. The attorney you talked with might only be familiar with corporate formations and not securities.
I think the big question is whether you really want to have these folks having such an active role in your business. For my syndications I'd hate to have to pass decisions through all of the investors before we could take action. It's worth spending the dough and setting it up properly as a syndication.
Tristan, Taylor highlights the practical issues of sharing the decisions. Do you really want the other people helping to run things or are you only letting them have a say so you can try and avoid the SEC regulations?
Second, if you are trying to avoid the SEC regulations, be very careful that in the heat of the moment, you do not make a short term decision which flips you from being 'safe' to over the line.
Amy is specialist who is SEC and tech aware. In other words, if she feels it is a securities offering, highly likely she is correct. Lawyers who are not SEC aware can easily not realize that they are overstepping the line when stating that they have set up LLCs and it was not an issue. Think of this analogy.
I am traveling on I-5. My highly accurate speedometer tells me I am traveling at 77 miles an hour. I am being passed by people traveling at what I estimate to be 80+. No one that day received a ticket from what I can see. Does that prove the speed limit is no longer 70mph? Or, could it only prove that you know of no one who received a ticket that day?
If you go down the route of not following the SEC and state regulations, any of the investors can turn you in later when they want to force you to buy them out. Assuming one was married, they might be getting a divorce and their soon to be ex wants cash. Or, the ex is being awarded the shares and they want no part of dealing with you. Why leave yourself exposed? Even if there is no SEC issue, think about who might become your 'partner' later.
One last point. Amy has a service where you book a small time slot for a reasonable fee. She will then provide advice based on what you want to know. Consider getting in touch with her and her law firm.
@Tristan Cottarel I am saying this is not a syndication deal because you are buying a duplex. Syndications are good for apartment building and commercial properties. You would need to register the syndication and validate your "accredited investor" to your other limited partners. Creating a syndicate is about a $10,000-$15,000 fee...depending on the size of the commercial property you are purchasing. Since you are buying a 2 unit, residential building there is no reason to create a syndicate for this type of property. Hope this helps.
Agreed with @Andrew Postell on your most recent post, if you're just doing a duplex you need to find a way to structure it so you do not need to syndicate. The deal is going to be too small to eat the legal costs.
Thank you @John Corey and everyone else for your response. @Amy Wan could you elaborate a bit on why it sounds like a security? I'd be happy to book a time slot with you as John mentioned if needed.
@Andrew Postell thanks again for your continued responses. I understand that it wouldn't make sense to create a syndication on a small deal like this, but what I am wondering is if the structure I proposed is or isn't a syndication, whether or not it is worth the money.
@everyone This makes me question all these BP books I've read about raising money from a passive investor to buy a SFH or other small residential property. They give countless examples of using a retired friend's SDIRA to fully fund a deal while taking a cut for themselves. How is that not syndication?
Thank you @John Corey and everyone else for your response. @Amy Wan could you elaborate a bit on why it sounds like a security? I'd be happy to book a time slot with you as John mentioned if needed.
@Andrew Postell thanks again for your continued responses. I understand that it wouldn't make sense to create a syndication on a small deal like this, but what I am wondering is if the structure I proposed is or isn't a syndication, whether or not it is worth the money.
@everyone This makes me question all these BP books I've read about raising money from a passive investor to buy a SFH or other small residential property. They give countless examples of using a retired friend's SDIRA to fully fund a deal while taking a cut for themselves. How is that not syndication?
Go to InvestorPedia and read up on the Howey test. https://www.investopedia.com/terms/h/howey-test.asp A simple way to see if a deal crosses the line. Not legal advice yet good enough for many conversations. And do book a call with Amy.
basically, you are offering a security when you have 2 or more passive investors. syndication just means "group investment"
Don't think I'm allow to post my own articles, but you can google "Why Private Money Investing in Real Estate Involves Securities Law" for a linked in article i wrote a while back. Not exactly on point but close enough.
basically, you are offering a security when you have 2 or more passive investors. syndication just means "group investment"
Don't think I'm allow to post my own articles, but you can google "Why Private Money Investing in Real Estate Involves Securities Law" for a linked in article i wrote a while back. Not exactly on point but close enough.
Amy,
I like what you share. Happy to post your link for you.
https://www.linkedin.com/pulse/why-private-money-investing-real-estate-involves-law-wan-cipp-us/
To others. If you good the title Amy provided without the quotes, you will land on a different article by another author. No idea what that one says. I just know it comes up first.
@Tristan Cottarel
I am new to investing and also considering raising money from friends and family possibly. I was under the impression that I would create a LLC. At that point, I'd go to a real state attorney and draft a contract with the specifics as far as investment amount and terms. Once I had the contract, I'd "close" at the title company making investors lien holders for respective amounts and money from investors would be wired in and disbursed after closing to a shared bank account for the LLC that would have money drawn through the attorney's office.
To summarize my current thought process on this:
1. Form LLC and bank acct.
2. Have lawyer draw contract
3. Title company holds funds until close
4. Moneys get disbursed and left over to bank account.
5. Draw money from bank through lawyer.
6. At sale or refi, investors get their portion of the investment.
7. Repeat 1000 times!
Maybe I’m way off now that I read this thread. I didn’t see where any one person specifically said how it’s normally done. I will keep researching this as well.
Just a follow up here. I ended up speaking to a syndication attorney. He told me:
If an investor is truly passive, it is a security, and therefore syndication. Simple as that.
Thanks again everyone for your input and I hope this is helpful to someone who might stumble upon this thread in the future.