Frequently Asked Questions
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Should I Only Include Accredited Investors in My Deals?
Some people say “yes,” but honestly, my clients usually don’t start looking for new accredited investors until they have tapped out their group of family and friends who aren’t accredited. You will meet a lot of non-accredited investors at networking events, and you should not discount them. If you do Rule 506(b) offerings, you can include them.
There is a lot of talk on the internet about how having non-accredited investors increases your liability and makes your documents much harder, but in practice, those are non-issues, and it’s the way most of our clients operate.
The best investors are the ones who invest with you. Accredited investors whom you may have met recently are unlikely to invest with you until you have a track record; non-accredited investors seem to be more interested in investing with newer syndicators. So, my advice is meet everyone you can and tell them about your business, whether they are accredited or not. Take time to get to know them and what they want in an investment and then pick your exemption based on the qualifications of your investors.
What’s a Subscription Agreement?
A Subscription Agreement is a legal document in a securities offering package that contains an investor’s representation and warrantees that they meet the financial qualifications to invest, understand the risks, have read all of the documents, have asked all of their questions and sought appropriate financial advice from their own advisers, and can afford to lose the money. It also contains their contact information and signatures.
What is a Consent Resolution?
A consent resolution is a specific document giving you authorization from the members/managers of each of your companies to proceed with the purchase and the loan and designating one or more of the members of the manager as the authorized signatories for the loan documents.
Your lender may require this prior to closing on a loan. Your securities attorney should draft this for you.
Why Shouldn’t I Look for Big Investors Instead of a Bunch of Smaller Investors?
Whale Investors Can Krill Your Offering…
Waiting for large investors (I call them “Whale Investors”) to fund your offering is a certain way to doom it to failure. Whale Investors are known for 3 things:
- Stringing syndicators along and then bailing when it comes time to cough up the funds, leaving you with an underfunded deal. This could cause you to lose the deal if you can’t replace their funds before your escrow runs out.
- Renegotiating terms at the 11th hour so you don’t make enough money to make the deal worth your risk.
- Treating you like you work for them or trying to take control of the deal – didn’t you become a syndicator so you could fire your boss? Additionally, it’s not fair for your smaller investors to have one large investor who thinks they have the right to call all the shots.
My advice to clients with potential Whale Investors is this:
“Don’t stop raising money until you have their funds in the bank. If you keep raising money $50k to $100k at a time, you may not need their funds (or so much of them) by the time you get closer to closing. This will take away their ability to renegotiate terms or take control of your offering.”
The only sure-fire way to make sure you control the raise and don’t get left high and dry at the closing table is to have a ready source of investors waiting to invest in your deals. Some of the ways you can get this is by networking and following up with potential investors; holding educational events and following up with attendees; and letting everyone you know about your new syndication business and following up with them to keep them informed of your progress. As you can see, follow-up is key to cultivating and maintaining relationships with potential investors so they are ready to invest when you get a deal.
How do you follow-up with your prospective investors? If you don’t have a plan (most people don’t), here are 3 things you can do right now to get started:
- Check out our Online Store where you can purchase the Investor Marketing Program Template for $250; or
- Better yet, become an Annual Retainer Client for $1,000 and get it for free, plus get access to our Clients-Only Facebook Page, live Clients-Only Training on developing investor relationships and up to 3 hours of legal consultation, or
- Click here to schedule an appointment to see how we can help you meet your syndication goals.
5 Steps To Choosing Your Branded Company Name
5 Steps To Choosing Your Branded Company Name
- Do a Google search to see if anyone is already using the name or something similar.
- Check GoDaddy or another domain provider to see if the domain is available.
- If both of those fly, then check the Secretary of State’s business search to see if anyone has registered a similar name in the state where you want to form it (usually where you live). If there are other companies using the same 2-3 words and your name could be confusing to the public, the state will reject it.
- If all of those are clear, buy the domain for 1 year only until you’re sure this is your long-term brand, and ask us to form your LLC and Viola, you have a new brand!
- Don’t form it yourself with talking to us – so you don’t make amateur mistakes that have to be amended (like putting your home address in the public record or naming the wrong person as the Manager or registered agent, or forming it in the wrong jurisdiction).
5 Rules of thumb:
- 2-3 words are good. Don’t get too lengthy.
- Try to use words that mean something to you.
- Don’t use words that are hard to spell or pronounce (no-one will remember them).
- Descriptive words are good, but they can’t be trademarked. Made-up words can be trademarked.
- If you are a real estate investor and plan to buy multiple properties, don’t blow your best name on a single property purchase. For real estate acquisitions, you may not even want to use your brand in the Company name, but you can say “Presented by YOUR BRAND” or “Sponsored by YOUR BRAND.” If you blow your brand on a single property acquisition, you’ll have to think of another one next time.
Is “Managing Partner” the Right Title for Me to Use in my LLC?
NO! Doing so will advertise your lack of knowledge about corporate structures to the world. While many of your peers may be equally uninformed (since they are all using that title and think it’s OK), you can elevate yourself above the crowd by knowing and correctly applying the right terminology to your LLC. Each state has its own LLC Act that provides definitions of the terms associated with LLCs in its jurisdiction. All are pretty standard and pretty much follow the same guidelines.
Here’s a primer:
There are two types of limited liability companies (LLCs): “Member-Managed” or “Manager-Managed.” Most states will require that you make this election when you form your LLC. You may use both types of LLCs in your syndication business, but each has a specific application.
There are different legal names for the participants in an LLC:
- “Manager” —This is the natural person or persons, or legal entity that will manage the business of your LLC. If you select Manager-Managed, the state will require that you provide the name and address of the Manager or Managers. The Manager may be one or more individuals, or it may be other legal entities. Managers do not need to be Members of the company, but they could also be Members in some instances. There may be tax reasons you don’t want them to become Members, as the Manager’s earnings may be taxed differently than the earnings of the Members.
- “Member” —These are the people who make capital contributions (cash investments) or non-capital contributions in the form of services. Members are present in both Member-Managed and Manager-Managed LLCs.
- If your LLC is Manager-Managed the Members will not have day-to-day control over operations, as those duties will be reserved to the Manager, but they may have limited voting rights over certain major decisions.
- If your LLC is Member-Managed, by law, all of the Members will be considered to be Managing Members, which means all of them are actively involved in the management of the LLC’s business, and each Member could, technically, use the title Managing Member. In practice, Member-Managed LLCs may designate one or more of the Members to act as the Managing Member.
Back to whether you can call yourself a “Managing Partner.” As you can see, there are no “Partners” in an LLC. The term “Partners” arises in two instances:
- When you form a “General Partnership” — Two individuals or legal entities (“Persons”) that join together to achieve a common goal may be called a General Partnership, and both are typically actively involved in promoting the common purpose. Legally, if two Persons created a “general partnership agreement,” each of them would remain liable for each other’s acts. To circumvent this, the Persons wishing to become general partners will typically form a Member-Managed LLC and each of them will become “members” of the LLC, as the members of an LLC each enjoys limited liability up to the extent of their investment in the LLC. But even this would not be an appropriate place to use the term Managing Partner as the correct name for the members of a Member-managed LLC.
- The other place the term Partner would be appropriate is if you formed a “Limited Partnership.” In a Limited Partnership, there is a “General Partner” and “Limited Partners.” Note that it would not be common to call a “General Partner” the Managing Partner, although that term could be used if there were more than one General Partner and one of them were to take the lead role in managing the entity.
So, what should you call yourself if you manage an LLC?
Admittedly, the term “Manager” is kind of boring. But the beauty of LLCs is that you get to write your own “Operating Agreement” or “Company Agreement” as defined by the state LLC Act where the company was formed. In your agreement, you can decide to use whatever titles you want. You could use a traditional officer or director name, such as President, Vice President, Treasurer, or Secretary, or CEO, CFO, COO, etc. Or you could follow the legal name prescribed by your LLC Act, which would either be Manager (if your LLC is Manager-Managed) or Member or Managing Member (if your LLC is Member-Managed).
Granted, none of these names is going to inspire anyone to ask “what do you do” if they see it on your business card. It’s time to think outside the box. You should think about branding yourself in all aspects of your business, starting with the name of your company, your title, and any taglines you put on your business card that help people remember what you do long after your first meeting. When choosing a title for yourself, instead of choosing something that is boring and perhaps legally incorrect, such as “Managing Partner,” why not pick something imaginative such as “Chief Acquisitions Officer,” “Director of Investor Relations,” “Real Estate Fund Manager”? My friend Susan Lassiter Lyons actually uses the title “Chief Fun Officer”! Now, there’s a new spin on the meaning of CFO.
Bottom line: Think of something more creative than “Managing Partner,” which is probably legally incorrect and not very imaginative, and instead give yourself a title that invites further inquiry when you hand someone your business card — preferably one that they will remember for a long time to come.
How Can You Set Yourself Up for Success In Syndication?
The best way to set yourself up for success in syndication is to have a ready source of potential investors so that when you have a deal, you have investors to call.
You do this by developing a marketing program that includes live networking to meet and create a list of potential investors, following up after the event to get to know them, and then periodically keeping in touch with them to let them know what you are doing. The follow-up can be in person, on the phone, or via an email drip system.
You can establish credibility by having a company, a business card, a compelling company name and title, a professionally designed corporate brochure and website.
Once you decide to be a syndicator, you are no longer just a real estate investor; you are also in the marketing business.
Where Do You Meet Syndicators Who Do 506(b) Offerings that Allow Sophisticated Investors in Their Deals?
The best place to meet them is at educational events that attract a lot of people and network with the people there who are doing deals — such as REMentor events (I do teaching for them, I must confess). The other people in the room may be Sophisticated simply by virtue of having been trained by the people who are hosting the event. People on crowdfunding platforms can only accept Accredited Investors, so that’s probably not the best place to look if you are wanting to meet sponsors who can accept non-accredited investors. Crowdfunding events are really geared toward sponsors and services related to crowdfunded (Rule 506(c) or Regulation A+ offerings), so they are likely not the best place to meet 506(b) sponsors either. Or you can ask Securities Attorneys for referrals to their clients who are doing such deals. Most of my clients do Regulation D, Rule 506(b) Offerings until they run out of Sophisticated Investors. By then, they have typically generated a sufficient track record that they can successfully crowdfund an advertised offering under Regulation D, Rule 506(c).
Is There a General Format or Template for Soliciting Investors?
The following is a blueprint for soliciting investors for a Rule 506(b) offering, but it will increase your fund-raising effectiveness if you use it for all securities offerings.
- Document the Relationship.The SEC says you need to have a pre-existing relationship with an investor prior to making an offer (not a sale).
- The relationship is three-part and depends more on qualitythan timing. Think of this like dating; it’s more about the quality of the contact, and not how many times you have seen or talked to someone that determines whether that individual is a long-term prospect.
- a) Pre-Qualification.The relationship begins after you have met someone and know the person well enough to determine whether he or she is accredited or sophisticated, as required for a Rule 506(b) offering. You can use the pre-qualification questionnaire that the person fills out, your notes from an interview with him or her [you fill out the pre-qual questionnaire], the individual’s financials, or other information that makes him or her obviously qualified (e.g., the potential investor is the president of Ford Motor Company, runs an investment club, has owned self-storage or other investment real estate [aside from a personal home] etc.).
- b) Determine Suitability.The initial meeting must be followed by contact (preferably a phone call or face-to-face meeting) from you to determine the person’s suitability to invest in the type of things you may have to offer in the future (this is not a place to pitch what you have available today). This conversation should be 70% about the potential investor and 30% about your company and what it does in general (see example dialogue below). It is possible to combine steps a and b.
- c) Passage of Time.Finally, there must also be a passage of time between when you first met and when you make the investment offer during which the relationship ripens. It would be ridiculous to meet someone in a bar, have a follow-up phone call three days later, wait 30 days and ask that person to get married, right? Something else has to happen in between to further the relationship. So put that person’s contact information in your investor database after the suitability call, send out a newsletter or “welcome email,” get the investor on a drip system so he or she gets information about the self-storage industry (as an example), invite him or her to a webinar or self-storage educational event, or wait a week or two and invite the person to the password-protected area of your website, etc. The idea is to do something to nurture the relationship that furthers the other person’s knowledge about who you are and why he or she might want to invest with you, before you start making offers.
- Make Offers.Your Investment Summary is an investment offer. Only after some passage of time during which the relationship ripens can you make offers (1 to 3 weeks or more would be ideal with several documented contacts). CAVEAT: DO NOT SEND OFFERS VIA EMAIL BLASTS, EVEN IF YOU HAVE ESTABLISHED RELATIONSHIPS WITH ALL RECIPIENTS. THE SEC CONSIDERS EMAIL BLASTS TO BE GENERAL SOLICITATION.
- Technically, for a Rule 506(b) Offering, you should not make offers to people you met after your offering was contemplated or active. Your offering is active when you have documents in hand and are actively raising money. This rule can be relaxed if you take time to go through the steps in Number 2 above and document every contact for every investor. Ideally, you should develop a written policy on how you will do this that everyone raising money in your group follows. Additionally, you should consider a Customer Relations Management (CRM) software system such as Insightly (cheapest), Constant Contact, Salesforce, Filemaker Pro, etc., to keep track of investor contact information and contacts with your company.
Here are some example questions/dialogue for your Suitability Conference (No. 2 above): About Them:
- Have you invested in real estate before?
- Have you invested in a small group before?
- Do you know anything about the self-storage industry?
- What is your investment experience?
- What kind of returns are you getting on your investments now?
- How long would you be comfortable having your funds invested?
- Have you ever had a bad experience with an investment? What went wrong?
- Do you have a self-directed IRA?
- How much are you looking to invest?
- How soon would you be interested in making an investment?
About You: “We are a small investment company that pools funds from private investors to buy real estate [INSERT TYPE]. We buy properties at a discount through our network of nationwide brokers and industry contacts and then turn them around with capital improvements and a professional (or affiliated) property management team. Once we get the properties stabilized, we refinance them to cash out our investors, usually within three to five years. We typically offer annualized returns of 12% to 15%, depending on the amount invested. Our minimum investment requirement is $25,000. Does this sound interesting to you?” If yes, then, “Great, with your permission I will put you in our investor database so we can let you know when we have an opportunity that meets your criteria.” (You get the gist – you probably need to memorize and practice something like this). When you are ready to make the offer, you would send an individual email that would say something like: “Dear Investor, you may recall our conversation about investing in self-storage facilities. We currently have an opportunity for an investor in our private placement offering that meets your criteria. Please see the Investment Highlights below. If you would like more information, please click on the link to see the entire offering package.” You could attach your Investment Summary, or provide a link to the entire offering package. Call the investor to follow up and talk to him or her about the opportunity. Live contact is always the most effective. Remember, people invest in you, not in your offering.
Can I Just Borrow Money From My Family And Friends Without Having To Comply With Securities Laws?
Be sure you consider the securities implications of obtaining money from family and friends for your syndication deals. Promissory notes are “securities” and so are selling interests in a company to passive investors. Those are called “investment contracts,” which are also securities. If you are selling securities, you must either “register” the securities with a regulatory agency (SEC or state securities regulators) or qualify for an exemption from registration. Each exemption has a specific set of rules. Unfortunately, there isn’t any such thing as a “less than five-person” rule or a “do-nothing” rule. Further, you can’t typically just use a Limited Partnership Agreement or LLC Agreement with passive investors, without further providing disclosures, securities notice filings, and making sure your investors have the appropriate financial qualifications before accepting their funds. For each exemption, the burden is on you to establish a record-keeping system to prove how you complied with the rules (just like claiming a tax deduction). To do that, you have to understand the rules of the exemption you are following. Depending on what state you live in, there may well be a state securities exemption that will allow you to issue promissory notes to investors in limited circumstances, but it behooves you to figure out the rules before you do it. Because if you do it wrong, there can be dire consequences if the deal fails or someone wants his or her money back early.
What is the Difference Between Rules 506(b) and 506(c)?
Often, in social forum discussions concerning offerings under Rules 506(b) and 506(c) you only find good partial explanations. Here are the complete rules: 506(b) allows you to raise an unlimited amount of money from an unlimited number of Accredited Investors and up to 35 Sophisticated Investors. Investors can self-certify by attesting that they meet the definitions. However, you cannot use any means of general advertising or solicitation to promote the offering. To prove this, you must be able to demonstrate that you have a substantive, pre-existing relationship with every investor before you make any of them an offer to invest. The pre-existing relationship has been further defined as knowing whether the investor is Sophisticated or Accredited before you make the offer. That means you must have already had a conversation about the investor’s finances and his or her business, finance, or investing experience to know if that person is Sophisticated or meets the qualifications as an Accredited Investor (for individuals: $1 million net worth or $200,000 income if single; $300,000 income if married). 506(c) allows you to raise an unlimited amount of money from an unlimited number of verified Accredited Investors. You can freely advertise your offering to everyone (including on a crowdfunding platform), but you must be reasonably assured that all investors are Accredited before accepting their funds. The SEC has suggested that someone with a license (CPA, Registered Investment Advisor, Attorney, Broker-Dealer, etc.) or you can review the investor’s financial records (within 90 days of the investment) to determine if that person is Accredited and provide you with a certification letter. The investor must provide further assurance that he or she is accredited, which is usually done through a Subscription Agreement where the individual certifies that he or she meets the definition of an Accredited Investor.
What Should be Included on a Business Card You Use for a Real Estate Investment Company?
If your company is an LLC, your cards need to say “LLC” after the company name, either in the logo or elsewhere on the card.
Also, you should consider using a title that invites conversation, such as “Acquisition Manager” or “Acquisition Director” – or “Investment Manager” or “Investor Relations Director.”
Don’t use “Managing Partner” as your title. There are technically no partners in an LLC; there are only Managers, Members or Managing Members, none of which invites conversation.
Additionally, you should consider saying something on your card that describes what you do, such as “Commercial Property Acquisitions and Investments.”
What are the Rules Regarding 506(b) Solicitation and Mass Communication?
A reader writes:
“I am a member of a group of several hundred people who are interested in investing in commercial real estate. Many of them are not Accredited so I want to do a Regulation D, Rule 506(b) Offering. Can I email my deal to the group or invite them to attend a webinar where we discuss the deal as a means of finding potential investors?”
If you want to use mass communications for your offerings, you need to do rule 506(c) Offerings that allow advertising and general solicitation, but then you will be restricted to only having verified, Accredited investors. The Rule 506(c) exemption was designed for internet communications. Rule 506(b) — the original Rule 506 — has been around since before the internet existed. The Rule 506(b) exemption is reserved for one-on-one, word-of-mouth offerings to people the issuer already knows and not for mass communication to people they don’t know.
Here are the rules for soliciting for a Regulation D, Rule 506(b) Offering, as I see them:
1) You must have a substantive, pre-existing relationship before you make offers.
2) The pre-existing relationship is defined as already knowing an investor’s financial qualifications before making an offer.
3) You can’t create new relationships and invite them to invest in a current or contemplated offering.
4) A Letter of Intent would not be current or contemplated, and a purchase agreement might still not be. But the offering is surely current or contemplated at the time you hire securities counsel to draft your offering documents and have completed substantive due diligence.
5) You shouldn’t email-blast offering documents or details to groups of investors if you have a Rule 506(b) exemption. The SEC has stated that email blasts to several hundred people, even if you have a pre-existing relationship, is a general solicitation.
6) The safest (and most effective) way to solicit investors is to communicate individually with each potential investor, starting with a phone call to the prospect who meets the requirements of steps 1 and 2 above, followed by an email with the offering documents, and then a subsequent followup by phone to see if they have questions.
Can I Include in My Syndication an Investor Who Wants to do a 1031 Exchange?
No, an investor who wants to do a 1031 exchange cannot take partial ownership interests in a company that takes title to real estate (the typical syndicate structure). Such interests are considered partnership interests by the IRS and are specifically ineligible for 1031 exchange.
The 1031 investor would have to take direct title to his or her proportionate share of the real estate. Your syndicate could own the rest. Unfortunately for syndicators, profits get split amongst the TIC owners at the property level, so you can’t earn any distributions from the portion of the property owned by the other party, except perhaps an asset management fee. Additionally, you would have higher legal fees, as this structure would require all of the usual syndication documents plus a tenant-in-common agreement and an asset management agreement.
Unless the 1031 investor is bringing a substantial amount of money (e.g., 50%) that you don’t think you can raise from other passive investors, it’s not really worth it for you to coordinate the exchange, as you could be giving up a substantial portion of your earnings.
How Do I Structure a Small Multifamily Deal With Investors?
From a securities legal standpoint, you could do a joint venture (JV) or member-managed LLC, where the investors are actively involved and stay in control of their own money, if you don’t want to have to comply with securities laws. The mistake most people make is that they call something a JV but then treat it like a passive investment. It’s not what you say, it’s what you do that will determine whether you have sold securities.
To ensure that everyone stays active, they need more than just a voting right. You can either give them a title and a job, or simply don’t take control of their money (i.e., you could ask them to contribute money when you need it and they write a check).
The downside is that if you want to do bigger deals that you will syndicate down the road, the JV structure will hold you back and it won’t necessarily count toward your syndication track record, which will become important for subsequent deals. If you plan to stay with small deals with just a few high-net-worth investors in each deal, it can work for you.
A loan from a private lender is fine unless you have an institutional loan in first position that won’t allow subordinate debt. But notes are securities, too. If you do an isolated transaction with an accredited investor, you may not need to do anything else, but if you are pooling funds from non-accredited investors, or your business starts to depend on repeated borrowing from private investors, you are in the business of selling notes as securities and you still need to comply with securities laws.
If your concern is regarding the costs of syndication, you can keep them low by only using a small number of accredited investors, as a PPM won’t be required (although it is still advised) if everyone is accredited.
Using private money for real estate is a business where it is easier to go big than it is to stay small, as the securities compliance requirements may be the same for a small or big deal. But in a bigger deal, the costs are not as disproportionate.
As always, it is best to talk to a securities attorney when dealing with private money so you understand all of the options available to you, and some may vary on a state-by-state basis.
How Can I Write a Personal Biography for my Investment Company that Inspires Confidence in my Investors?
This isn’t a resume, so do this in paragraph format (not bullets). It doesn’t have to be long, just two to three paragraphs at most.
Here are some other tips and guidelines:
- Use a professional photo or headshot (it shouldn’t be more than two years old)
- List your name and title for this company. The title should be compelling enough to invite conversation, so don’t use President or CEO (boring!!!)
- Describe your role in the company you’re promoting (all the different hats you wear, etc.)
- Describe related experience, training or education
- Describe unrelated, professional experience and training. (Note: Leave the personal stuff for your singles ad!)
Can I Still Invest in a Securities Offering if I am Not Accredited?
For most securities offerings that allow unaccredited investors, you must have a pre-existing relationship with the “issuer” (syndicator) before it can offer you an investment opportunity. Your best option if you don’t meet the accredited definition is to reach out to some syndicators directly and develop a pre-existing relationship so they can invite you into a future Rule 506(b) deal.
Some ways to do this are to:
1) Ask securities attorneys to introduce you to some of their clients who do 506(b) offerings;
2) Reach out to some of the syndicators on Bigger Pockets or other forums and get to know them offline; or
3) Reach out to some of the crowdfunding platforms (like Crowdstreet.com) that can introduce you to some of their clients who do 506(b) offerings.
What Might Happen if I Lie About My Financial Qualifications to Get Into a Deal?
Some securities exemptions, such as the Regulation D, Rule 506(b) exemption (and some state securities exemptions) allow investments by a limited number of unaccredited but financially sophisticated investors whom the syndicator personally knows. Although the exemption allows this, some syndicators may still restrict their offerings to accredited investors only in order to reduce their liability.
The financial qualifications for investors will be spelled out in the “suitability” section of the Private Placement Memorandum (required if unaccredited investors are allowed), so prospective investors should always read this section of the offering documents carefully to make sure they are qualified before investing.
Accredited Investors should beware of “fudging” their qualifications. It’s surprising how many people say they’re accredited to get into a deal (when they are not) and then complain later that they weren’t qualified and shouldn’t have been allowed to invest when the deal fails. Syndication offering documents often require the investor to indemnify the Syndicator if they lie about their qualifications and it causes liability for the Syndicator later, so there could be repercussions against investors in those cases. I know of legal actions involving syndicators where this very thing was one of the issues.
Bottom line, investors need to be as truthful about their qualifications as they expect the syndicator to be about the deal, and don’t invest if you can’t afford to lose the money.
How Do I Structure a Deal with Investors?
There is no “right” answer on how to split money with investors. The answer depends on the deal and your investors. You may not need any track record if you have friends and family who believe in you and what you are doing. At Syndication Attorneys, PLLC we help plenty of new syndicators do their first deal without an experienced syndicator on their team. If you are trying to crowdfund (advertise) your offering, you will need an experienced syndicator with a significant track record on your team.
A typical syndicate uses a limited liability company (LLC). Although some may use limited partnerships, LLCs are more common. The syndicator “carves out” a portion of the ownership interests for himself/herself (20%-40%, depending on how good the overall returns look in your projections) and sell the rest to investors in exchange for their “capital contributions.” Ideally, you want to find a deal that yields a 12% cash on cash return during operations from the beginning or within a couple of years, and you can do something to add value or decrease expenses so that the property can increase in value in 3-7 years, giving you equity to share with investors on resale.
The sweet spot for multifamily investors in today’s market seems to be 8% annualized cumulative preferred return from cash flow (calculated quarterly) before the syndicator takes his/her cut. Additionally, for multifamily deals, investors typically get a share of excess cash flow or equity on resale based on their “percentage interests.”
Investors like to see projected overall returns in the high teens to low 20% range, after applying the amount of equity they realize on sale, spreading it out over the years the property has been held and adding it to the cash they received from operations.
As for who signs on the loan, if you don’t have strong enough financials to do it yourself, you will probably need a “sponsor” (or experienced syndicator) who can help you qualify, even for non-recourse loans. In exchange, you might offer a piece of the syndicator’s carve-out. It is not typical for every investor to be underwritten, unless you have a very small number of investors.
In any case, if you are selling passive interests (where profits are not derived from the investor’s own efforts) you are selling Securities and will need to comply with Securities laws, so be sure to seek advice from a syndication attorney prior to offering interests to investors.
Also, see our article entitled “How to Structure a Real Estate Syndicate.”
How Does Cash Flow in a Syndicate?
Here is how cash flows in a Syndicate (as drafted by Syndication Attorneys):
- Investor funds are collected in the Investor LLC Operating Account.
- When it is time to close on the Property, the Manager LLC (Manager) – Note: this is not the Property Manager; it’s the Syndicate Manager – wires only the funds needed for closing. There should be excess cash remaining the Investor LLC bank account that will be used to pay the Manager LLC for its Acquisition Fees and to reimburse the Manager (or its members) for any out-of-pocket expenses.
- The Property earns money.
- Either the Property Manager or the Investor LLC Manager writes checks for Property Operating Expenses and Debt Service.
- Excess cash is swept to the Investor LLC Operating Account.
- The Manager writes checks from this account to itself for any Asset Management Fees that are due at that time. Manager’s Fees are described in your Operating Agreement. The Manager LLC distributes its earnings to its members as described in the Manager LLC’s Operating Agreement.
- The Manager decides how much to retain in the Investor LLC operating account as Working Capital and Reserves and how much, if any, is Distributable Cash.
- If there is to be a Distribution, the Manager follows the Waterfall in the Investor LLC Operating Agreement, depending on the phase of the Company (operations or a capital transaction [re-fi or sale]).
- The Manager uses the list of Members from the Investor LLC Operating Agreement to determine who will receive checks, and how much each Member is entitled to receive from the Distribution. The checks are written from the Investor LLC to the Members – using the exact Member names listed in those tables (which should match their Subscription Agreements).
Also, see our article entitled “How to Structure a Real Estate Syndicate.”
How Long Does it Take to Set up a Real Estate Syndication?
For a specified Offering, you should plan on 3-4 weeks from the time you engage us to the time you receive your completed documents.
For a blind pool Offering, you should plan on 3-4 weeks from the time you provide a draft Business Plan/Investment Summary outlining your investment program. If you plan to draft this yourself, you should do it prior to engaging us (you can refer to our article, “How to Write a Blind Pool Investment Summary,” for instructions on how to do this). If you are having us draft it, you should plan on 2-3 weeks from engagement to completed Investment Summary. Thus, your total time for a Blind Pool could be as long as 6-8 weeks.
For a specified offering, you should hire us when you have a purchase agreement on a property, someone from your team has been to the site, and you have reviewed the last 2-3 years of financial statements.
Unfortunately, many clients wait too long to hire us and incur 20% Rush Fees, as well as needless stress for themselves and for their Investors (not to mention their Attorneys).
If you want to be a successful syndicator, it pays to plan ahead.
Are Rule 506 Offerings Exempt from Blue Sky Laws?
Rule 506 offerings are exempt from further regulation at the state level, except that issuers must:
- Be able to demonstrate to state regulators how they followed the applicable 506 rules,
- Not pay any fees to unlicensed brokers (most states have this requirement that basically eliminates finders fees), and
- File state securities notices (giving the state jurisdiction over the issuer) and pay the required notice filing fees, usually within 15 days of when an investor’s funds become “irrevocably contractually committed.”
Rule 506 offerings (b or c) are exempt from following additional state requirements, such as limiting the amount of an investment to a portion of the investor’s net worth, etc., as long as they comply with the above rules.
Should I Become an 'Accredited' Investor?
Newbie investors who encounter opportunities that are open only to Accredited Investors sometimes wonder, “Should I become an Accredited Investor?”
The fact of the matter is that “Accredited” is not something one “becomes;” you either meet the definition or you don’t.
You meet the definition of an accredited investor if you have:
- Over $1 million net worth, excluding any equity in your primary residence, or
- Make over $200,000 per year if you are single*, or
- Make over $300,000 a year if you are a married couple*.
*The income classification requires that you have met the qualifications for the past 2 years with an expectation that it will continue indefinitely into the future. There are other definitions for legal entities, but generally, the entity must have >$5M in equity or all of their members/beneficiaries/shareholders must meet the accredited definition above. Sponsors/managers of their own securities offerings also fall within the definition of an Accredited Investor.
The confusion seems to stem around whether one should get “verified” as an Accredited Investor, which entails getting a certification letter from your own CPA, Attorney, or Registered Investment Advisor, or from a third-party verification company, which reviews the investor’s financial information and then “verifies” whether the investor meets the definition above.
An investor’s Accredited status must be verified to invest in a securities offering that has chosen the Regulation D, Rule 506(c) exemption (which allows the issuer to advertise or crowdfund the investment opportunity). The burden is on the issuer of a Rule 506(c) securities offering to have a reasonable assurance that all investors are accredited, prior to accepting their funds. However, the SEC requires that the verification is dated within 90 days of the investment. So it won’t help you to get “verified” now unless you will be making an investment in a Rule 506(c) offering within the next 90 days.
Note: The Regulation D, Rule 506(b) securities exemption does not have the same verification requirement. In a Rule 506(b) exempt securities offering, the investors can self-certify that they meet the requirements. But investors must have a pre-existing relationship with the sponsor of the offering before being allowed to invest, so if you don’t want to go through the third-party verification process, you should develop pre-existing relationships with sponsors of Rule 506(b) offerings, who will let you personally know if they have an opportunity. They are still required to ask if you meet the qualifications and you do have an obligation to be truthful, but you may not need to cough up financial or income statements to be allowed to invest, and you won’t have to get re-certified within 90 days of making the investment.
How Should I Structure a Small Multifamily Deal With Investors?
There are lots of ways you can structure a small deal with investors. Some are cumbersome: Full-blown securities offering with Private Placement Memorandum, Operating Agreement, Subscription Agreement and Securities Notice filings. Others are not as cumbersome, such as a Member-managed LLC with all investors responsible for making their own profit.
Your legal compliance requirements will largely depend on whether your investors are:
- active (easiest legal documents) or passive (more complex legal documents)
- accredited (easiest legal documents – No PPM required) or non-accredited (PPM/disclosure document required)
- everything is in one state – you, investors and the property (may be an easy intrastate offering exemption you could follow), or crossing state lines (usually means you have to follow the federal exemption rules, which can be costly)
- people with whom you have a pre-existing relationship (easiest way to raise money) or want to advertise (harder to raise money, probably need a track record with similar properties and investors)
Some of the questions relate to legal compliance, but others are more logistical, such as “Who do know who might invest with you?”
A consultation with an experienced syndication attorney can usually place you on the right track and help you figure out what will work for your deal, while containing costs to the extent possible.
You should also consider getting some formal training in multifamily investing, as it’s easy to make $100,000 mistakes when you are first starting out. Better to learn from others’ mistakes versus your own.
How Can I Establish a Relationship With Investors to Invest in my Deals?
Generally, you can say you are planning to form some group investments for future multifamily acquisitions and would like to get to know others who might be interested in learning more about group real estate investing.
Then, you need an established plan of how you will follow up (and start the “dating process”) with people who express interest.
First date should be to get to know them (their goals; their financial qualifications, etc.) and general information about what you are doing. It should NOT be a sales pitch.
Subsequent contacts should be to provide educational information (not offers to invest) about the type of investments you are planning to do.
After a period of time has elapsed, you can contact investors one by one and talk to them about specific deals.
You must keep records of each contact and what was discussed or provided.
Here is the order in which to do things:
- Meet and get contact info.
- Interview and prequalify.
- Follow up/educate.
- Then. make offers.
This all has to happen over a minimum period of time (30-45 days) during which no direct offers are made, and should NOT happen after you have a current or contemplated offering.
What to do if You Want to Invest in a Rule 506(c) Offering?
In order to claim the Rule 506(c) exemption, the issuer of the securities you want to purchase must be able to demonstrate that it took “reasonable steps” to ensure that all investors are Accredited within 90 days of the investment.
The SEC, in its final rule regarding requirements for compliance with Rule 506(c), offered some non-exclusive methods that issuers could use to verify Accredited status for natural persons, which include such things as:
- Verifying income from the past two years’ tax returns and written assertions that the income is expected to continue;
- Verification of assets by reviewing statement balances from brokerage houses or banks, reviewing tax assessments/third-party appraisals of real estate holdings and verification of liabilities through an investor’s credit report; or
- Obtaining a written confirmation from a securities broker-dealer, registered investment adviser, licensed attorney or CPA, who attests to have taken reasonable steps to verify the investor’s Accredited status within the past 90 days and that the person is, in fact, Accredited; and
- There is an exemption for investors who previously invested with an issuer as an Accredited investor.
Bottom line, this isn’t simply the issuer trying to dig into your private affairs; they are required to receive this information or refuse your investment.
Simply stated: If you want to invest, you have to pass the test.
How Can I Develop A Relationship With a Syndicator So That I Can Invest With Them As An Unaccredited Investor?
Technically, the relationship begins when the syndicator knows enough about you to know whether you are accredited, or unaccredited but sophisticated. That’s why a lot of syndicators might ask you to complete a pre-qualification questionnaire early in their relationship with you (or should). Additionally, the syndicator should follow up and take time to get to know you, and for you to get to know them. The SEC says it’s more about the quality of the relationship than the quantity of time; but there should be a passage of time between when you first met and when they made you an offer to invest (more than hours or days); and they shouldn’t be offering you “current or contemplated deals” that were in play at the time you first met – they should only be offering you future investment opportunities. Think of this like a dating relationship – the first meeting is to exchange contact info; followed up by a phone call or meeting to establish rapport and gauge common interests; followed up by further contact and/or education to ripen the relationship – all before the “marriage”/investment offer is made.
Where Can I Meet Syndicators Who Allow Unaccredited Investors?
Go to as many networking and “guru” events as possible where people are learning to buy the same thing you want to buy. For instance, if you want to invest in multifamily, find multifamily trainers and go to their events. You’ll learn how to buy your own, what to look for in a syndicate, as well as meet others who are doing Rule 506(b) offerings that allow unaccredited investors. ReMentor’s Ultimate Partnering is the biggest one I know of (full disclosure, I sponsor this event and do training for them), but there are other trainers as well for multifamily. It will pay off to get exposed to as many trainers (and their students) as you can.
Also, even though someone has a 506(c) offering currently, they may do a 506(b) offering later on if they get contacted by enough people who are unaccredited to make it worth their while. Many current 506(c) Syndicators have simply exhausted their current database of unaccredited investors in previous deals and now have to do 506(c) offerings in order to fill their current deals. Bottom line, reach out to 506(c) syndicators and ask if they ever do 506(b) deals and if so, get to know them.
Are All Group Investments Syndicates That Require Compliance With Securities Laws?
There is a distinction between a joint venture, where all members are responsible for generating their own profits and where securities compliance is not required, and a passive investment (otherwise known as an “Investment Contract”), where investors are relying on you to make a profit on their behalf. The latter is a “security” and compliance with securities laws is required.
If you are selling securities, you either need to register your offering (i.e., go public — a long and expensive process) or find an exemption from registration, such as Regulation D, Rule 506, or another applicable exemption that will allow passive investors to legally invest with you without registration. There are several choices and there are securities exemptions that will allow unaccredited investors to invest with you.
So, in answer to your question, both scenarios could be group investments, but both are not securities. A securities attorney can help you determine the appropriate structure (JV or Syndicate) based on your facts and circumstances and then draft the appropriate legal documents.
Can A Syndicator Use SCOR And Rule 147 To Allow Non-Accredited Investors To Invest In A Deal?
Rule 147 is a federal rule that basically says that as long as you, all investors and usually 80% of the assets owned by the company are all contained within one state, then the SEC will allow states to regulate the sale of securities. The securities will usually be registered under Regulation D, Rule 504, which limits the issuer to raising $1 million in a 12-month period. Registered offerings under Rule 504 are approved by state regulatory agencies under the Small Company Offering Registration (SCOR) program
State registrations can be challenging and may take a long time to get approved, but once approved, you can raise money from non-accredited and accredited investors, and some states may allow you to advertise.
These types of offerings are generally more suited for syndicators who only need to raise $1 million or less (e.g., to start a business) versus buying real estate where $1 million might not go as far as you need it to. But, if everything is contained in one state and you don’t have a short timeframe to close on a property you have under contract, it could be a viable option for you.
The reason Rule 506 is so popular is that it pre-empts state laws (except for securities notice filings) and allows you to raise an unlimited amount of money from investors in multiple states without getting pre-approval from federal or state regulators, so you can raise money as soon as the offering documents are complete.
Is a 'Prequalification Questionnaire' all I need to have completed by an investor before I can ask them to invest in my Rule 506(b) Offering?
QUESTION: “I have a pre-qualification questionnaire that lists the qualifications for an Accredited Investor. Is this all I need to have completed by an investor before I can ask them to invest in my Rule 506(b) Offering? “
Most of our clients start out doing Regulation D, Rule 506(b) Offerings that allow them to bring in an unlimited number of Accredited and up to 35 Non-Accredited investors, all of whom must be Sophisticated. For your first few deals, you are much more likely to raise money from people you know, and many of your family and friends who will invest in your first few deals may not be Accredited. You will need to develop a track record before you can successfully do a Regulation D, Rule 506(c) offering that can be advertised to strangers – and advertising will preclude admitting any Non-Accredited investors. For a pre-qualification questionnaire that includes accredited and non-accredited investors, click here.
But in addition to getting this form filled out, there is more that you must do to establish the substantive, pre-existing relationship and to determine suitability such that an investor can be solicited for an investment. Read the articles entitled “Soliciting Investors for a Rule 506(b) Private Placement Offering” and “Determining Investor Suitability for 506(b) Offerings” for a deeper understanding of this topic. Both articles can be found under the “Free Info” tab on our website and the dropdown heading “Articles.” We also have two Teleseminar recordings about developing investor relationships: “Dating for Dollars” and “Determining Investor Suitability and Establishing Pre-Existing Relationships.” Those and other teleseminar recordings can also be found under the “Free Info” tab, and the dropdown heading “Teleseminars.”
Is This Ad Legal?
An advertisement containing the following language was forwarded to me, with the question, “Is this ad legal?”
12+% AVERAGE CASHFLOW!!
The ad went on to show photos of a multifamily property, discussing the status of due diligence and loan approval, and included several references to a respected real estate trainer – including a quote from one of his
This type of advertising could be legal for a Regulation D, Rule 506(c) Offering (that allows free solicitation but is limited to verified accredited investors). But it would NOT be legal for a Rule 506(b) Offering, as it is a general solicitation and that exemption does not allow general solicitation or advertising. For more information on what constitutes
There are additional troubling aspects to this advertisement. For one, the
Further, the reference to the real estate trainer is a clear attempt to add credibility to this team by dropping the name of a well-known real estate trainer as if that person were a team member. Investors could misinterpret this to mean that the trainer is somehow involved in this deal, which doesn’t appear to be the case. Without the trainer’s permission (and even with it), this is inappropriate and a potential misrepresentation. Misrepresentations violate the anti-fraud provisions of securities laws regardless of whether the selected exemption allows advertising.
Bottom line: Make sure you have your securities counsel review all advertising you plan to send to investors before you send it and blow your exemption!