Raising Your Own Real Estate Capital – Sure You Want to do That?

by | BiggerPockets.com

Securities & Exchange Commission HQ

I often see forum postings from real estate investors looking to raise their own investment funds. These are often newcomers that are frustrated by their inability to obtain financing for what they’re sure are smoking hot deals. The banks have told them ‘no,’ hard money lenders laughed in their face, private lenders turned them down, and friends and family members have told them they’re crazy. There has to be some easy way to raise capital. Right?

Thinking that they’re being creative, resourceful, and acting like a true entrepreneur, they set out to find people to back them. They spend hours, if not days, crafting a perfect pitch to attract investment funds. They post internet and newspaper ads promising investors a great return secured by real estate. They’ll advertise a rate that is significantly better than the paltry yields offered by banks. Brilliant idea – or is it?

Big Brother is Watching

The moment that wanna-be tycoon placed that ad where it can be seen by others he or she violated a major securities law. By posting a solicitation for money and promising a return that individual just made a public offering. That offering now falls under the jurisdiction of the Securities and Exchange Commission and is regulated by the Securities Act of 1933. That offering must be registered and a number of requirements must be met regardless of how small the amount of money involved.

I know this from first-hand experience. I too had that brilliant idea as a new investor. I had a great investment opportunity and was determined to raise the required capital. I was fortunate in that I worked in the financial services industry at the time and had access to people who actually understood how to do this. I had the investment opportunity and I had access to people with money so I took the steps to do it right.

Exceptions to Regulations

The regulations do allow for certain exemptions from the onerous and extremely costly filing requirements. These exemptions do not mean that you can just proceed with your plans; they must meet some very stringent requirements that are best left to professionals. This is not a job for do-it-yourselfers and there is no fill-in-the-blank legal form you can buy. With that in mind, I retained the services of a competent  attorney and created a limited partnership. Because I was soliciting high net worth individuals that would be considered accredited investors, we created a private placement offering. Since it involved fewer than thirty-five investors and sought to raise less than $1,000,000, this was a filing that fell under the Regulation D exemption of the Securities Act of 1933.

Ultimately the investment got off the ground and it was somewhat successful. I say somewhat because it earned a profit. However, that profit was not commensurate with the amount of effort involved. The greatest return was actually earned by the attorney that drew up the agreements. The total fee involved was just short of five-figures and more than any of the investors earned on their investment.

So if you’re thinking that it would be easy to just raise your own money by placing an internet ad somewhere – think again. That ad may result in a letter from your local SEC office that begins with ‘Greetings’ and ends with you wishing you never thought of that ‘brilliant’ idea.

The government solution to a problem is usually as bad as the problem.Milton Friedman, Economist

Photo Credit: Scott S.

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  1. michael meyer on

    Your absolutely right, OPM can be a tricky business if you don’t have legal counsel that specifically practices in the area of Security and Exchange rules and regulations. I was recently handed a business card from a unknown new investor that solicited private money and had the word “guarantee” at the end of the sentence. You simply cannot solicit money from strangers. To stay within most exemptions you should only solicit from friends, family, and associates. Associates are typically considered someone you’ve known for over 30 days and have met at least three times personally. And please never ever use the word “guarantee”. Only certain Financial Brokers can use that word. Good luck and happy investing.
    ~Michael Meyer – Oceans Financial Group

  2. Brian McCloud on

    Great article and actually the last part was pretty funny, except if your the one getting the letter but this is something that I have been very interested in finding more about the last month or so..

    I come across great deals that I would love to buy myself but just don’t have the funds, … can’t go conventional, hard money lenders are too expensive so I would like to learn how to raise private money and do it correctly.. Was wondering if you could maybe point me in the right direction, maybe a website, book, etc..

    • Richard Warren on

      Raising private money is no small feat. I’m not aware of any book that would give you enough information. As for websites – BiggerPockets is the best you can find for just about any real estate related topic.

      If you think you really have a deal the only recommendation I can make is that you consult with an attorney that has experience in this area. Be forewarned – it won’t be cheap.

  3. I am a brand new investor. What is the best way to find a good, experienced mentor? I am willing to bird dog, wholesale or do project management for a split of sales. The Greater Austin, Texas market is thriving.

    Larry Powell

  4. I thought that the SEC got involved only when it came to “across state lines” advertising. I had been taught that without the legalize mumbo-jumbo that Richard is talking about, you can NEVER advertise on the Internet. However, it is my understanding that advertising in a local paper or publication is exempt from the SEC filing….am I correct? Anyone? As a Real Estate Broker and a rehab investor, I have been very careful about how I have advertised in an effort to talk to other investors and thus far, I haven’t gotten an SEC letter. Other insight?

    • Richard Warren on

      Have you ever sought legal advice for this? I did when I wanted to raise capital. What I was told that anytime you solicit the general public for funds you fall under SEC rules whether or not you cross state lines. There are specific exemptions under Regulation D (http://www.sec.gov/answers/regd.htm) and each state has their own Blue Sky laws. So it doesn’t mean that it can’t be done, you just need to be sure you follow the rules.

      You say you are careful about how you talk to other investors, you may be managing to stay within the rules depending on who they are and how you are soliciting them. I would never do that without legal counsel though. Chances are that the SEC will never learn about it unless someone reports you. The person most likely to tell them is someone who invested with you and lost money.

  5. Hmmm, decent article, somewhat condescending and discouraging too any newbie without much of a solution stated. Granted, it states the ugly truth about “Raising Private Funds”. Most might say you can find out most info on “RPF” here on these forums, which you may, but I believe the subject and all the SEC legalities are too much and just too broad to search for correct info around blogs/forums. The experts I know of are Al Cowgill, Joel Block, Richard Roop, and hear that Lindahls in that game, too. I had went to see Joel Block who had some SEC lawyers and some actual syndicators there. I thought he provided some excellent info and another guy there attended Cowgill, whom he said was good, too. Most of the guys charge about or under $1000 (just putting it out there) for several days of info, so not outrageously priced. Too each its own as too whether you pay or scour the internet for info on the subject. I found it good to go listen to people in the game breakdown the complexities of “syndication”. I left a little disappointed, not because of bad info, but to know that in order to get “started”, YOU MUST BECOME AND EXPERT YOURSELF, “KNOW” THE PEOPLE YOU SOLICIT AND YOU WILL NEED ABOUT $10-15K (or someone with it in the investment) TO PAY YOUR SEC LAWYER TO DRAW UP THE PPO AND NOT GUARANTEED TO MAKE A LARGE PROFIT. Most money you will make is on fees to your investors. Sorry, to put it like that, but is a fair assessment. Thats why I’m looking to go about 20K of my own money before I even look at the area again.

    • Richard Warren on

      The intent is not to discourage but to urge extreme caution. Too many newbies jump in without knowing what they are doing and find themselves in hot water. There is a solution stated – consult an attorney or someone who understands this. There really isn’t a simple solution for a complex issue.

  6. What about applying for money from angels and VCs? If I already own a business entity, does that put me in violation of securities laws, or are there different statutes regulating private offerings?

    Please respond.

    • Richard Warren on

      I think you may be confusing two different things here. Angel investors and VC is generally private money. When you solicit the general public you are making a public offering and the SEC gets involved. Private money is fine in most cases. When in doubt ask an attorney.

      • I know the difference between a public and a private offering. I just don’t know the intricacies of law in regards to the latter, particularly if there’s a pre-existing business structure involved.

        Maybe I should clarify by asking some specific questions:

        1) Does a VC want to work with an entrepreneur in the corporate formation process, or do they only want to funnel money into existing structures? Is the latter even legal?

        2) Meyer says some things about not being able to solicit strangers. Is that a matter of law, or a matter of Mr. Meyer’s personal ethics? If it’s the former, how does that apply to question #1?

        3) If I buy an REI course on the internet, receive emails from the author for a month or so, and then solicit him, with or without a business structure in place, is that illegal? Would it be illegal either way, or just if I have an existing business structure I want him to invest in?

        4) If I form a private REI corporation with VC money, would it be classified as an REIT, or does that definition only apply to publicly traded REI corporations? Does such a classification somehow make an REIT different from other types of corporations? Is that what I’m aiming for? If so, where do I get legit and concise info on how to go about forming an REIT?

        5) Do I have to have an existing deal waiting in the wings before asking for money (i.e. a gaggle of wholesalers on speed-dial, contractors lined up for work) for a solicitation to be legal, or can it be a general idea of operations that I’ve established in my proposal?

        6) If I get a letter from the SEC, is that a “go directly to jail” card, or a warning? Could you please clarify, Richard? If I illegally solicited someone privately, would the SEC send me a letter of death for that, or would the sheriff just show up on my doorstep?

        The last book I read on business licensing and acquiring capital was way back in ’94, when I attempted to form a record label. I don’t know how much of that info was legit at the time, or how much is currently legal. From that experience, I’ve always assumed that a) it’s legal to solicit anyone privately, b) it’s not illegal to solicit angels and VC’s if you already have a business structure in place, and c) you don’t need a deal in the wings for it to be legit; all you need is a business proposal outlining how the money will be spent. Am I wrong in any of these assumptions? I’ll eventually get around to a sitdown with an attorney for this stuff, but it would be immensely helpful if I were straight on these things before spending any money on the little stuff.

        I have porphyria; I wouldn’t live through a jail experience. I can’t afford to make any mistakes. People imply things all the time on this site without bothering to explain themselves; being as impoverished as I am and as gun-shy as I have to be, it doesn’t help me much. I get the impression that lots of people get into REI by getting some general info off the internet or from some poorly written book, and ad libbing their way through the process. I can’t do that, and I need a clear vision of the path I’m going to take before I can commit anything to writing in a proposal or start doing the leg work.

        I know these and many other questions I have sound utterly stupid, but I have no time to sift through the internet for kernels of truth, no money for an attorney consultation, no idea what books to read for my particular strategy, no money to buy them with, and absolutely no trust of anything I read on the internet or in REI books. Every article I’ve ever read on REI and corporate business has been vague about something essential, because they’re not how-to manuals. Some REI authors I trust more than others, but they don’t make how-to books for creating a big-money REI corporation. (If I’m misinformed on that, someone please suggest some titles.)

        I’ve asked it before, and I’ll ask it again: if anyone here can help me sift through this stuff, please PM me. I don’t have time for little stuff; it’s go big or go dead for me. I need to figure out a way to make a big splash, because I’m running out of time, and I have an extremely limited budget. Stuff like wholesaling and DIY investing won’t work for me; I don’t have a job to fall back on or the health to get one if I fail at something small.

        Having porphyria is like being a vampire. I can’t get a job, and I need to hire minions to do my dirty work out in the daylight world. Has anyone here ever thought of how difficult that would be, or the cost of living for such a disability if one can’t get SSI? I don’t get any superpowers, I’m not part of some diabolical secret society with an endless supply of money and safe-houses, and I’m not above the law. One bad move, and I get to fry in a jail cell. But unlike the vampire, drinking my cellmate’s blood isn’t going to regenerate my sun-fried corpse; I’ll just die a horrific death. If even one of my parents die, I’m out of a controlled environment, and I’ll end up just as dead. Since that could happen any time soon, I’m living life on hourglass time. There is nothing even remotely fun or romantic about my life.

        As well as this, I’m frantically trying to finish 3 books, finish my music, and research more immediate small business options, none of which I can implement at this time. My plate is full just trying to save my life.

        I know there’s a mentor section here and I’ll check it out when I have more time, but any info in the meantime would be greatly appreciated.

        • Richard Warren on

          Your post is longer than my article.

          The idea of the original post was to caution new investors about posting solicitations or ads seeking money. It was not meant as a primer on raising capital.
          I am not a lawyer and many of your questions should be addressed to an attorney. You have Federal laws to contend with as well as the laws in any state in which you do business.

          To answer some of your questions:
          1 – Every VC has his or her own parameters. There are legal ways a VC can funnel money into a business.
          2- Soliciting strangers is where you have to follow SEC rules; it’s not a question of ethics per se.
          3- Ask an attorney if you aren’t sure about a particular instance.
          4- A REIT is a real estate investment trust. You need an attorney to discuss specifics.
          5- If you have an offering prospectus prepared you need not have specific investments lined up. The offering will spell out the types of investments you intend to pursue.
          6- Each case would be different but the first contact would probably be a warning to cease and desist. If money has changed hands you would probably have a bigger problem.

          Working deals privately with people is usually not a problem if you do everything legally. An offering generally occurs when you publicly solicit money and promise some sort of return. The article was not meant to scare you into thinking you’ll be hauled off to jail by SEC storm troopers, but to caution you to do things the right way. Find an attorney in your state that understands this stuff and see how much it would cost for a basic consult to find out what you can and can’t do.

        • Richard: you’re right; my bad. I’m drawing outside the lines here. I’ll put my crayons away.

          I figured I understood the basics; I already knew the answers to my questions. It’s just frustrating when I come here and see so much stuff, and so many people implying so many different things that force me to question my knowledge in unnecessary ways. It has set me back 6 months in my research; I’ve become so paranoid about what I’ve presumed I don’t know that I’ve given up any active interest. It turns out that I know more than I think I know, but I’m so busy trying to dodge bullets that I forget where I am sometimes.

          I know I’ll need an attorney at some point, but all this compartmentalized information is paralyzing. I can see now why so many people learn about REI, and then sit on their hands and do nothing; it’s like public school all over again. However, this situation has forced me to deal with my fear, and resume the good fight.

          Anyways, I guess I was just trying to make a point, but got out of hand with it. Sorry to talk your ear off again. No animosity intended towards you, Richard. Your article was informative, and I learned what I needed from it. It’s not something that really concerns me (I’m one of the newbies that knows better than to publicly ask for money), but it did answer some of my questions.

  7. Yes, Angels and VC’s are most likely interested in traditional business and maybe new ideas/inventions outside of REI. REIT’s are probably more set up for “individuals/groups” of investors that want to invest. Angels and VC’s will be knee deep in most aspects of your business, but they should since they have placed a high capital risk in your ideas and or business. My whole point of “Raising Capital” is that it can be done, but what I’m saying is you can not even start to talk to folks until you have a deal in place, not just “Hey, do you have some money you can lend me so I can invest in R/E”, is not gonna cut it. Then all your filings must be in place (to be legitimate), which will cost you, THOUSANDS of $$$ and thats what I want others to know. There’s really “No Money Down” situations in Raising Capital. Unless, they have that kind of capital of their own or someone to put it up for them they will be kicking rocks for a while.

  8. @Michael — getting stuck in all the info is nothing new. It happens to all of us.
    Find yourself someone that is successful and make them push you! Give them 75% of the deal just to get Real Life Experience.
    I’m telling you — it’s Priceless.
    You said, “I’m one of the newbies that knows better than to publicly ask for money”
    To be honest, I didn’t have a clue about this!
    But that hasn’t stopped me from doing 25+ transactions.
    It’s not like a go prospecting everyone for money, as I believe that private money is a relationship based business anyway — but at least I know to at least wait about 30 days to solicit even if I’m comfortable with a person much sooner than that.

    • Thanks for the pep talk.

      As for the public offering, I didn’t know about the SEC thing either, but I figured it was most likely illegal. Now that I think about it, that makes me wonder about the legality of posting solicitations on sites like Go Big. Sort of a grey area, I guess….

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