How To Do Crowdfunding Legally

The first question to ask yourself is:

“Can I raise money for other people?”

The answer is:

“Absolutely.”

However, the legality of it all can make it difficult and there is, of course, the question of how exactly you make money when raising it for others. Let’s ponder a basic hypothetical, imagine one of your friends is raising $2 million to buy some multifamily projects and you know a few investors who might contribute $500,000 of it, You say to your friend:

“I’m happy to bring these people into the deal. Obviously, I would like to be compensated for it in fashion.”

There is a legal issue around that arrangement, the legal issue of broker-dealers. In the Securities Laws, under the Exchange Act of 1934 in particular, anybody who is acting as a broker or a dealer has to be registered as such with the SEC. Being registered as a broker-dealer is a big deal. There are not many broker-dealers out there, it’s an expensive and time-consuming process to get licensed as such.

When your friend in the aforementioned scenario is raising money from these investors, he’s selling securities, everyone in the syndication business understands that from a technical and legal perspective. The definition of a broker in Section 15 of the Securities and Exchange Act is anybody who deals with securities for the account of another as part of the business. Therefore, If you are compensated, even for that little transaction with your friend, you are, in technicality, acting as a broker. If you are acting as a broker without a license, which, depending on the type of brokerage you are conducting can be serious.

Real estate agents can go out and sell your house, they may receive a 6% commission.

However, if you decided one day that you wished to assist someone in selling their house for a 6% commission and you’re not licensed as a real estate broker, then, you can get in trouble. You can get in much more trouble for acting as a securities broker without a license. If that happens, whether it occurs from ignorance or just because one day you decided:

“I want to do this, no matter what the law says.”

There are two different consequences that you could face. One, which the one that everyone thinks about yet is very unlikely to happen, and that is that the SEC knocks on your door and sends you to jail. It’s very unlikely because the SEC has very limited manpower. They’re probably not going to come after you on the basis of a $2 million real estate transaction. What is more plausible is that after you bring your friends in and your friend pays you a 5% commission for bringing in $500,000. You take away $25,000. All of a sudden the deal goes south. If any of the investors in the deal gets wind of what happened and happens to have a brother-in-law who is at a cocktail party one day and they speak with someone like me when describing the situation and I say:

“That’s interesting, if they used an unlicensed broker in that transaction, then that was an illegal offering and everybody has the right to get their money back.”

The brother-in-law’s ears would perk up and before you know it. Someone will be filing a lawsuit against you, the unlicensed broker and your buddy, the guy who used an unlicensed broker. Everyone is really unhappy and you’re very sorry you took that $25,000. That is, in the big picture, what the law is and what can go wrong when it is not abided by.

The primary reason that all of this is very unsatisfying is a result of the fact that these transactions happen all the time as everyone in the real estate industry knows. Lots of private real estate deals are funded in this way with compensation going back and forth and nothing ever happens. It is funny that the SEC knows this is going on. Every now and again they announce that they are aware that this is going on and don’t like it, so, they shake their fist and say:

“There will be dire consequences if anyone continues to do this!”

But, nothing happens. It is rarely enforced. The industry just toils on with all these finders out there taking commissions and lawyers pontificating:

“You can’t do that!”

Yet, the shoe never drops. It can be very frustrating.

On the next level. It is possible, in some situations to construct an arrangement that is legal. Let me give you two examples of arrangements that are legal:

The first is a promote, but, this is a very gray area. You could take a promote for bringing people into the deal. Let’s say your friend is taking a 30% typical promote and he says to you:

“If you bring in $500,000, I will give you 5% of my promote.”

A promote on one hand is okay, it’s an immediate cash commission, on the other hand, it is not okay. That’s one pretty thing you can do.

The other thing you can do is construct a legal finder’s agreement. For example, if you’ve never done this before and you’re not in this business, this is not how you make your income generally but you’re talking to your friend and he says:

“I have this multifamily thing. Do you know anybody?”

And you respond:

“I do know somebody. I went to college with so and so and he’s made $1 trillion selling some pharmaceutical company or something like that. I’ll introduce you to him. If he makes an investment, you pay me.”

If that is done properly and your role is limited to a one-time introduction, and you don’t try to sell the deal, you don’t make an investor presentation to your friends. You’re just making it an introduction, then, that arrangement can be legal.

Check the full episode here: https://lifebridgecapital.com/2019/04/ws188-how-to-do-crowdfunding-legally-with-mark-roderick/