Yes, you are!
First, your obligation when selling securities is to provide the investors with all of the material facts they need to make informed consent. This has been interpreted to mean that you must tell prospective investors all the things that could go wrong that are outside of your control, so they can decide whether it’s worth the risk of investing for the return you are offering. Their alternative is to leave their money in the bank for a return that doesn’t keep pace with inflation, buy CDs and get lower returns, or take their chances on the traditional markets (stocks, bonds, crypto, etc.).
Second, it’s an amazing fact, but investors read about the risks of investing in private offerings all the time and still make the decision to invest. Additionally, we all invest in the stock market knowing that on any given day, something could happen, and our investment could be cut in half, right? If you’ve been active in the publicly traded markets since 2010, you have seen this happen at least once before. Yet, we all still invest.
If one of the risks you warn them about in the PPM happens, you won’t be held responsible for their losses. Their signature on your Subscription Agreement is their affirmation that they have read and understand the risks and are willing to “assume the risks” that you’ve warned them about. If something happens that you didn’t warn them about, you could be held responsible as investors will say: “I wouldn’t have invested if I’d known that could happen. I didn’t have all of the material facts I needed to make my investment decision.”
Investors need to understand that with any private placement offering, there are substantial risks that could cause them to lose all or part of their money. For instance, in a real estate PPM, syndicators or fund managers warn investors about a possible drop in real estate prices that could prevent a property from being sold at the time a loan matures — resulting in a possible foreclosure or short sale. And, in fact, a drop in real estate prices is what largely led to the last recession, where borrowers couldn’t sell their properties when their loans matured because the real estate prices were lower than their loan balances. This very situation led to many foreclosures and short sales, where the lenders suffered a loss, and investors were stripped of their equity, meaning they didn’t get their invested funds back, nor did they realize their anticipated returns on their investment.
The “Risks” section in a PPM may seem harsh — but that is precisely the purpose of the PPM as prescribed by the SEC. If you want to soften the risk language, you can state how you plan to mitigate each risk.
For instance, you could say, “To mitigate foreclosure risk due to real estate market price fluctuations, our policy is to keep our loan-to-value ratios at less than 65% and get loans with long maturity dates of 7-10 years. This should allow us to be able to refinance the property even if real estate prices are depressed by 35% on loan maturity. We believe these policies should allow us to ride out the market swing and pay the mortgage from cash flow until real estate prices recover.”
Over the past 100 years, statistics show that real estate prices rise and drop in a cyclical pattern, but the eventual recovery of the real estate markets have always led to increased market prices even greater than before the dip. History shows that investors who positioned themselves to hold on long enough (through long-term maturity dates on loans and low loan-to-value ratios) were able to profit by selling at a high point in the market that not only paid off the maturing loan balance, but also repaid their equity investors’ original investment plus a healthy return.
Welcome to the world of private placement offerings.
If you have any questions, please schedule a call with one of our staff. They can help you get answers to your questions about raising capital legally.
