This is the first time we are seeking other people's money to acquire real estate and are interested to know what legal documents we need for private money partners who want to join us as debt or equity partners.
We spoke with our attorney and he was unfamiliar with the legal process of raising money and said we need to speak with a securities attorney as we are selling a security when raising money.
I just want to confirm with the BP community what we actually need. What I've heard others say in the past is when a private money partner is lending you money (debt financings) then we are able to sign an agreement such as a promissory note or mortgage with this individual listing the property, terms, etc.
With equity, we can create an LLC with them listed as equity partners. If they are just going to be the money partner, then we can give them whatever percentage of the LLC that we agree upon. We are not necessarily looking for a syndication unless the only way we can bring on equity partners in this way is through a syndication.
Is all this correct? What contracts do we need for debt and equity financing partners? Or do we need to actually bring in a securities attorney and create a syndication?
Thank you all in advance for your help! Have a great day!
@AJ H. In general terms, if you want someone to lend you money to buy an investment property and it is a one off situation then yes you can give them a note and mortgage secured on the property. If you are looking to form a partnership then typically you would create a llc where you both are contributing members and each has specific duties and both are active. If you want to get money from multiple people and pool money then that is a security and needs the proper documentation and SEC attorney, etc.
Thanks for the insight!
We are pooling multiple sources to acquire a property. Can we just sign notes with each debt investor if they want to lend money and be done with it?
I see equity will be a little more complex. We'll go the syndication route if needed but want to see what options we have on this side utilizing an LLC and profit split.
I've heard of other people lending money then getting a percentage of cash flow/profits. So are all these deals syndications? Even if it is a family member or single individual lending money to another individual for a percentage of cash flow/profits?
@AJ H. I am by no means an expert in this area, but have studied up on it quite a bit as we are starting to bring on equity partners too.
My *understanding* is that a lot of it depends on if those investors 'had a preexisting relationship with you" (Think friends, family, co-workers, people you network with etcc...) VS "people you seek out through marketing efforts to invest in a security".
So far we have only done one investor per property, and they are all people we knew ahead of time. We do have a couple of people, who are friends to each other, who are thinking about coming aboard. The one way I have heard can work well, and what they will be doing if they join us, is for *them* to form their *own* LLC, and then *that* LLC, which is one entity, would invest with us.
For details, see Real Estate Securities by Levine and Feigin. Your google terms are "investment contracts", "Howey test", "Reves test", and "Forman test".
The economic realities determine whether it is a security. Pooling money from others where profits are generated by efforts of others, and no control over major decisions = a security. The default rule is that all securities must be registered, unless the issuer (you), the security, or the investor qualifies for an exception or exemption.
Federal regulations cover the security side (PPM, syndication, issuing securities), but the state laws determine the local instruments (notes, deeds, lien instruments, entities).
Even the lightest capital raise starts, for me, at a $10,000 retainer and can climb to $50K+ depending on how involved I have to get. This is one area you don't want to go cheap. Investors have money, not only to invest, but sue if things go sideways and think they were defrauded.
@Daniel Dietz Thanks for the insight! Our current capital partners are people we have personal relationships with. We aren't seeking to expand it through marketing efforts yet.
@Jerel Ehlert Thank you very much for the legal insight! If these equity partners become more than capital partners and take on roles/responsibilities in the LLC, then it can just be a basic partnership, correct? If so, what is the legal threshold for active participation? These partners are willing to participate but would like to be passive, if possible.
Thank you all!
Hey @AJ H. you might want to have your lenders combined on a loan together in 1st position. Each contributor can put in 20% or 25% or whatever they contribute to the loan. Your mortgage and note would have all the people on the deed of trust or mortgage along with their fractional part of the loan. e.g. If they lend you 300k, Bob 40%(120k), Steve 5%(15k), Mary 35%(105k), Sue 20%(60k) would show up like that on the mortgage.
You could also have in your note that they get a certain percentage of profits in addition to the interest when you sell the property or refinance them out. Google 'participation loan'. They dont happen as much, but easier and WAY cheaper to set up over a syndication.
I have done the fractional part and I have done the loan participation, but somehow, never both together. I can usually negotiate a little higher interest rate instead of giving up a percentage of the deal. OR Give up a little part of the deal and borrow from 1 person.
@AJ H. An LLC would be great because it will give you the flexibility to specially allocate income depending on your profit split ratios between let's say 60% investor/10% sponsor/ 30% managing member. You can also set up a waterfall structure in which you provide preferred return, then return of capital to investors, then by member % up to their unreturned contribution, and then a 60/10/30 split between members.
You definitely want to get a lawyer involved quickly. There are many on BP that you can reach out to, so just search in the forums and there are a lot who are experts in this topic.
Good luck on the raise.