This past week I received several questions along the lines of “what if I raise money from friends and family and my apartment building deal is smaller, do I still need to be compliant with SEC regulations and do the whole private placement memorandum (PPM) thing?”
First, let me say that I’m not an attorney and you should, of course, consult your legal professional regarding anything I say in this article to determine how it affects your specific situation. OK, now that’s out of the way -;)
The purpose of going through the trouble and expense of a PPM is that complying with SEC regulations protects you as the sponsor if things go badly. Let’s say you need to declare bankruptcy and your investors lose part or all of their principal. Those investors might not be vey happy with you and some of them might want to litigate to recover their investment, or, at a minimum, to inflict justice on you.
In that case, they might also contact the state or federal SEC to file a complaint against you. The SEC may initiate an investigation and discover that the required disclosures and forms were not filed. This may result in prosecution by the SEC, and who knows where that might lead.
On the other hand, if the SEC does have the required disclosures on file and find that you complied with securities laws, then at least you don’t have to worry about the SEC breathing down your neck. And chances are that the litigious investors may not have a strong case against you, either, since the risk of losing ALL of their capital is plainly stated in the disclosure documents.
So that’s why we try to comply with SEC regulations when syndicating apartment building deals.
The question is: do we need to do this for smaller deals with friends and family investors? The answer to this depends…
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3 Factors to Consider:
- How big is the deal, and how likely will the state or federal SEC launch an investigation against you? I don’t have the answer to this, but common sense tells us that if we lose millions of dollars of investor money, the SEC is more likely going to investigate than if we lose $50,000. But where is that threshold? I have no idea.
- What is the make-up of your investors? If your investors are friends and family, then they may be less likely to start suing you in court if the deal goes bad. How likely are your investors going to want to litigate if things don’t go as planned?
- What is your risk tolerance? As real estate entrepreneurs, we take risk every day. It’s not about avoiding risk, but managing risk. The question is, how much risk are you comfortable with in this regard?
One other data point for you: I invested some money with a real estate developer who succeeded in losing over a million dollars of investor money. Some of the investors sued, won, and got a judgment but never collected a dime because the developer was dead broke. Some contacted the state SEC and they did launch an investigation because the developer was not compliant with the regs. They fined him $6,000 and told him he couldn’t raise money in the Commonwealth of Virginia for the next 7 years.
In the scheme of things, not so bad perhaps!
My Rule of Thumb
If the deal will bear the additional $6,000+ expense to create the PPM and other required SEC filings, then do it. Larger deals will obviously support such an expense, the question really is for smaller ones. If it’s a smaller deal with friends and family investors, you may be comfortable with the level of risk.
I hope this provides you with some things to think about as you raise money for your apartment building investing deals!
I’d love to hear about your stories about deals with other investors that maybe didn’t go as planned! What happened?