How can you tell if your offering is viable? You must overcome two hurdles in order to have a viable offering:
- Is it legal?
- Is it marketable?
Hurdle 1: Is Your Offering Legal?
The first hurdle — “Is it legal” — is easily answered:
- If you are raising money from passive investors by selling interests in your company and they are relying on you to generate profits, you are selling “Investment Contracts.”
- Investment contracts are securities.
- If you are selling securities, you either have to “register” your offering (i.e., take it public), which is a long and expensive process, or you have to qualify for an exemption from registration.
- Each exemption has a specific set of rules, so you have to decide which exemption you are following. That means “providing all the material facts an investor needs to make informed consent,” which is usually done through a Private Placement Memorandum, as well as other documents that collectively comprise your “offering package.” This typically includes a limited liability company Operating Agreement, a Subscription Agreement, and then there are securities notice filings that must be filed with the SEC and/or state securities agencies — usually within 15 days of when investor funds become “irrevocably contractually committed.”
- Once you choose an exemption, you must document how you followed its rules. This means establishing a record-keeping system to ensure that all investors have completed the Subscription Agreement and have satisfactorily answered all questions in it to establish their financial qualifications to invest (i.e., are they accredited and, if not, are they sophisticated? If they are not accredited, does your exemption and the offering documents drafted for you allow you to accept non-accredited, but sophisticated investors?) This information could be required as part of your defense if you are ever investigated by state or federal securities regulators, or if an investor ever files a lawsuit in connection with your offering.
- And you must follow the rules of your exemption to the letter. This means becoming familiar with its requirements and keeping records to show how you complied. For instance, does your exemption require that you have a pre-existing, substantive relationship before offering it to an investor? If so, you have to document that relationship and show that it began before you made your offer (i.e, pre-existing). A “substantive” relationship means you had a financial suitability conversation with your investors prior to offering them the investment opportunity. During this meeting, you learned whether they are accredited, and if not, how they are sophisticated. You also learned about their past education and investing experience, and you discussed your proposed timeline and made sure it fit with their investing goals. Most importantly, you determined that they could afford to lose the money.
The easiest way to get make sure your offering is viable is to hire an experienced corporate securities attorney to help you correctly structure your offering, form your companies, draft your operating agreement (or promissory notes), draft your PPM and Subscription Agreement, and do the appropriate securities notice filings within the prescribed deadlines. Your securities counsel should be frank enough with you to tell you if what you want to offer is outside the norm such that it won’t be desirable to investors, and thus, doomed to fail or only be marginally successful.
Hurdle 2: Is your deal Marketable?
The second hurdle — “Is your offering marketable” — is also something you can run past an experienced corporate securities counsel. They are in tune with what investors are looking for and what will make them willing to invest with you.
Some attorneys might just take your money and draft the offering materials whether your deal is marketable to investors or not — we won’t. We’ll try to talk you out of doing an offering that is doomed to fail as failure is disheartening — mostly for you, but our mission is to help you succeed, so your failure is a disappointment for us, too.
Here are some things to consider when deciding whether your offering is viable:
- Specified offerings are the easiest way to raise money. Our statistics show that clients who do “specified offerings” to raise money for a specific, pre-identified project are 85% successful in raising the money and closing on the project. Get something under contract; show your projections for how it will perform; create a business plan to show what you will do to make it profitable and your planned exit strategy; show investors how and when you expect to pay them back their original investment and a return on their investment — and if your terms are within market parameters, investors will invest with you.
- A fund that has no pre-identified projects is the hardest way to raise money. While it sounds great to be able to raise money before you have an identified project, in reality, this only works if you have a long, proven track record of successful, similar prior projects. If you don’t have this, you are likely wasting your money and time by trying to create and launch a fund. I have talked to many investors who spent money on fund documents to the tune of $25,000-$50,000, and never raised a dime.
- An offering such as those described below is likely to fail:
- You are trying to invest in too many different things, like multiple asset classes of real estate, or combing crypto, other securities (stocks, bonds, mutual funds, startups, small businesses, etc.) with real estate. I call these “kitchen sink” offerings — and they rarely work. Targeted funds that invest only in a specific asset class in which you (and/or others in your management team) have a direct, prior and successful history are the most likely to succeed.
- You are trying to advertise for investors before you have a track record. Until you have a long, proven track record of successful, similar prior projects, no stranger is going to invest with you.
- You are trying to allow the wrong people to invest. Securities laws are designed to protect “retail investors.” That means people like you and me, your family, friends and acquaintances. If your family, friends and acquaintances are not sophisticated investors and they are not accredited, they may be prohibited — by the securities laws that are designed to protect them — from investing in your private securities offering. You can help make them sophisticated by embarking on a formal training program that makes them sophisticated in the types of assets your offering will invest in. The only other way to admit unsophisticated investors is to do a “registered” public offering that requires pre-approval from securities regulators. Until you have a long, proven track record of successful, similar projects, this will be an expensive and speculative venture, which could easily fail. A public offering requires an intense marketing strategy (ever hear of Grant Cardone?)
- You are spending your time chasing single-check writers when you should be developing relationships with $50k-$100k investors. Family offices, private equity funds and high net worth investors will only invest with you after you have a proven track record with similar investments. Your family and friends will invest in you early on, before you have a track record, because the believe in you. They are the people who can help you build a track record — so that later on, you can successfully consider creating a fund or joint venturing with family offices, private equity or high net worth investors.
- You are trying to get people to invest using too many investment vehicles. This could include trying to allow crypto, NFT sales, etc. to support your offering. It all has to be converted to cash in order for you to use it to buy real estate. Do you want to take on the responsibility of converting these investments to cash (and bear the risk of the fluctuating markets surrounding them), or do you want that to be your investors’ burden? Why are they using these investment vehicles? Are they trying to avoid taxes? The IRS is going to get the money one way or another. Do you want to be the one holding the bag if the IRS says you owe the money (because your investor is outside the United States and its jurisdiction but you’re here); or what if the crypto or NFT becomes worthless, but you still owe the investor their money back? Do you understand these things well enough that you can explain them to investors — and make a profit off them? Few people do.
- Your offering terms are not in line with market norms. For decades, investors have wanted 8% cash flow returns from private offerings, plus a share of profits on exit that will bump their annualized returns to the mid-teens or high 20s; for non-real estate offerings, investors look for a certain multiple (such as 2x the original investment) within 5-7 years. For real estate, a typical split with investors in the current market is 70/30 with an 8% preferred return. Anything that deviates too far from that is doomed to fail or only be marginally successful. You might get away with offering a slightly lower return than the norm if your project also has a social good component, but you still can’t get too far away from normal terms, or few people will invest.
- You have too many steps in your distribution waterfalls. If your distribution waterfalls are too complicated for investors to understand, they are likely to say “no.” Keep them simple.
- Your fees are too high. Investors expect that management of a private offering will earn certain fees, but there are normal fees, and there are abnormal fees. A property management fee of 20% is usually going to be too high and is likely going to turn off investors. Find out what the norm is by getting bids from multiple property managers in the area where your property is located and adjust your proposed fees accordingly. Ask your corporate securities attorney what the norm is for your offering type and stay within those norms.
Set yourself up for success by keeping your offerings simple and staying within industry standards for offerings like yours. If a deal doesn’t fit with industry norms (returns are too low, etc.), it simply may not be viable as a “for-profit” venture, so you might want to consider instead doing it as a “non-profit” company, or you might need to get out of that geographic market and look for deals that make sense in other markets. If your deal is not viable, don’t waste your time or money hiring corporate securities attorneys to set up an offering up for you — and then have it sit in a drawer because no one you talk to is interested in investing.
Go after your dreams, but get some coaching on which deals are viable and which are not, so you don’t spend your time chasing rainbows. Be sure to hire honest securities attorneys who will give you a frank and honest opinion about your chances of success, and listen if they tell you your deal is not marketable.