Hi BP,

I'm in the process of raising some equity for a commercial deal and I've been reading about securities law. 

I'm still getting my operating agreement together, but the general structure will be an LLC of which I will be the managing member/ sponsor, receive an asset management fee/ acquisition fee, and a promote based on the performance of the asset.

I'm trying to determine whether I need to file a 506(b) exemption. 

My understanding of the "Howey Test" is that for an investment to be considered a security it has to meet the following criteria:

• It is an investment of money
• There is an expectation of profits from the investment
• The investment of money is in a common enterprise
• Any profit comes from the efforts of a promoter or third party

It's that last point that I'm struggling with. The operating agreement for the LLC between myself and my investors will look a lot like a GP/ LP relationship. I won't have majority ownership of the LLC, but will have control... and will be doing "most" of the work.

Under what circumstances would I not have to file a 506(b) exemption? It seems if my partners did some work on behalf of the LLC we'd be in the clear... is holding quarterly meetings with partners and having them vote on resolutions good enough? How material does their involvement have to be?

In addition to staying compliant, I'm also concerned about cost. I've read filing the exemption can be $10,000 and since this would be my first commercial deal (I'm planning on raising a couple hundred thousand dollars) the expense of filing is definitely a non-trivial sum...


Any perspective would be greatly appreciated!

Patrick 

I just listened to a podcast with the founder of bootstraplegal.com @Amy Wan , i haven't used it yet, but it sounds like a cheaper alternative to get some legal work done for smaller deals. 

I am curious to hear what kind of feedback you get on 506(b) details. I have been looking for more clarity here myself, particularly around raising money from friends and family. 

@Patrick Maney

If I'm understanding your question correctly, you're asking whether you have use JV structure and refrain from taking the syndication route. In JV each of the partners has some sort of role in the partnership even if it's minor. Syndication entails you will have passive investors that have no roles. Also, as a general rule of thumb if you have more than 5-6 partners, it doesn't sound like a JV. Note, this is my understanding and I'm not an attorney.

@Amy Wan is a securities attorney and can hopefully shed some light on your case. 

Thanks @Alina Trigub .

What you're doing sounds like a classic syndication, so you would need to comply with securities regulations. I always get questions where people ask stuff like "hey, if we meet once in a while to vote on paint and drink wine, is that enough to be an active investors?" While there is no bright line on what makes an active or passive investor (in order to differentiate between a securities offering versus a JV), someone who is active is first and foremost a business partner and is actively contributing a unique skill. They have veto power on decision-making and help drive the train--investors already have the right to meet every so often and vote on things.

Happy to chat off-line if you'd like.

I agree with @Amy Wan as it sounds like a syndication. 

@Jillian Sidoti has mentioned in the past that if you are raising $500k or more, its best you prepare those documents and stay compliant. 

Raising capital has its set of rules you have to be in accordance with. Having the right legal team in play will help you play by the rules. 

Just going to say that it doesn't matter how much you're raising--I get that under $500K the transactional cost often isnt worth it, but that doesn't mean its not a security at a <$500K raise...

Sounds like a syndication. With 506(b), you must have a substantive, pre-existing relationship with all LPs.

@Patrick Maney as long as your investors are partners in the deal and not just passive investors then you do not need to file an exemption.

Originally posted by @Amy Wan :

Thanks @Alina Trigub .

What you're doing sounds like a classic syndication, so you would need to comply with securities regulations. I always get questions where people ask stuff like "hey, if we meet once in a while to vote on paint and drink wine, is that enough to be an active investors?" While there is no bright line on what makes an active or passive investor (in order to differentiate between a securities offering versus a JV), someone who is active is first and foremost a business partner and is actively contributing a unique skill. They have veto power on decision-making and help drive the train--investors already have the right to meet every so often and vote on things.

Happy to chat off-line if you'd like.

Thanks very much @Amy Wan

What if my investors have veto power and can replace me as managing member? Is that enough active contribution for the partnership to be considered a JV as opposed to a securities offering? If not, and my goal was for the LLC to be considered a joint venture/ partnership, would I need to spell out specific roles/ responsibilities in the operating agreement? Would "Bob Smith is a consultant/ adviser" be good enough?

I appreciate your offer to chat off-line. This isn't all that pressing at the moment. I ended up finding a smaller commercial deal I could take down without 3rd party equity... but I certainly plan on raising money for my next deal, and I absolutely don't mind paying a high hourly rate for premium advice!

When it comes to securities laws, I say that if it quacks like a duck and walks like a duck, its probably a duck. It doesnt matter how you structure things like veto power or say that so-and-so is a consultant/advisor. The U.S. Supreme Court's Howey case and subsequent case law have found that an "investment contract" (aka securities offering) exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. There is decades of case law that analyzes what exactly this all means. It sounds to me like the true intent is to allow third party investors an investment opportunity and there's a lot of thought in figuring out how to structure it so that it doesn't look like a security. For what its worth, I've seen an entire industry of folks put up fights with the SEC on arguing that something isn't a security--many of them have since spent a lot more time and 10x more on defense attorneys than if they'd just... acquiesced to regulatory jurisdiction. Sorry--I know this probably isnt the answer you were looking for.

Look for my post on this thread:

https://www.biggerpockets.com/forums/67/topics/710162-when-is-it-syndication