What are the perils of drafting your own real estate syndication documents?
Improper Structure/Loss of Syndicator Compensation
A competent securities attorney will help you structure your offering with respect to how you and your investors get paid. You may overlook opportunities for syndicator compensation via acceptable fees and/or distributions if you don’t have competent securities advice.
Increased Liability for Failure to Follow Industry Standard
Your risk of personal liability will be increased if you prepare your own offering documents, as it is customary to hire securities counsel for group real estate investments/ syndications. Failure to follow the industry standard could subject you to personal liability for negligence.
Required Filings
The offering documents aren’t the only thing required of a securities offering. Notice of your offering must be filed with federal and/or state agencies within specific time frames (usually 14 days from an offer or sale of a security to an investor), or else any exemptions that would otherwise be applicable could be lost, and you could be accused of selling unregistered securities by either the SEC, the state securities agencies, or both. Yikes!
Selecting the Wrong Exemption
There are a variety of federal and state securities exemptions that may be applicable to your offering, and without advice of counsel you may be selecting an exemption that is inappropriate, too restrictive or overly burdensome.
Each Exemption Has a Specific Set of Rules and Failure to Follow Them Could Result in Civil & Criminal Prosecution
In addition to the offering documents and notice filings, there are specific rules that must be followed for any exemption to be applicable, particularly with respect to solicitation of the opportunity and suitability standards for your investors, etc. Failure to follow the specific rules of the exemption you are claiming may allow the investors an extended right of rescission, which they or a regulatory agency could invoke at any time. In this event, you might have only have 30 days to give everyone their money back! Failure to comply could result in civil fines or possibly criminal penalties.
Selecting the Wrong Entity/Jurisdiction
Selection of jurisdiction for an offering is an important consideration, and doing this incorrectly could require revising your filing documents and/or registering your offering in multiple states with potentially burdensome legal compliance and tax consequences.
Tax Implications
There may be huge tax implications for you and your investors if you use the wrong entity or legal structure; i.e., member-managed versus manager-managed LLC; or using a corporation versus an LLC. The value of any ownership interest a syndicator takes in exchange for managing the syndication may be wholly taxable in the first year if you don’t set it up right!
Misleading or Conflicting Documents
You may inadvertently make statements about your offering or the property that are misleading, which could subject you to personal and perhaps criminal liability if such representations turn out to be false. An attorney should help you guard against making such statements.
Improper or Incomplete Disclosure
You may inadvertently fail to advise potential investors of risks associated with your offering, which could subject you to continuing liability for the duration of your offering. An attorney will help you identify all of the direct and indirect risks of your offering, including some of which you might overlook on your own.
Investor Confidence
Why would investors want to invest in an offering where the syndicator took “shortcuts” in order to save money, while putting the entire investment at risk from future litigation from disgruntled investors and/or regulatory agencies?
Legal Fees Are Reimbursable
Legal fees for formation of a syndication are reimbursable to the investor once the minimum offering amount has been raised. Consider your investment in competent securities counsel to be an insurance policy that will protect YOU and will be reimbursed by your investors.
Hiring The Wrong Attorney Can Cost You More Than Hiring The Right One
Make sure the attorney you’ve hired is experienced in real estate syndication. Ask how many offerings the firm has done in the recent past and whether it has the correct insurance to cover securities offerings, which is one of the highest premiums an attorney can pay. There’s a reason for that.
Practicing Law Without a License
The unauthorized practice of law is defined as drafting legal documents that define the rights and duties of people other than yourself. Just as you can sell your own house without a real estate license, you can draft your own will or represent yourself in court. But if others will be signing legal documents that you prepare, you are practicing law without a license and could be prosecuted. In many jurisdictions, the unauthorized practice of law is a criminal offense. Attorneys are prohibited from assisting non-attorneys with the unauthorized practice of law.
Litigation Costs Far Exceed the Costs of Proper Syndication
Undoing or fixing an incorrectly structured or noncompliant offering will cost you many times more in legal fees than it would have cost you to hire a competent securities attorney to help you do it right in the first place.
You Can’t Be Indemnified for Securities Violations
No limited liability entity can protect you from violations of the law. And as a matter of public policy, a syndicator cannot be indemnified by the syndication for securities violations.
Conclusion
Drafting your own syndication documents without an attorney is bound to cost more in the long run than hiring one to assist you with the proper structure and appropriate exemption in the first place. Failure to do so may place your personal assets at risk. Would YOU pack your own parachute without assistance of a qualified professional?
