Learn the best ways of raising private money to invest in real estate while avoiding the pitfalls.
One of the first considerations when you’re trying to raise private capital is, do you want to advertise for private money or not? A lot of private lenders are going to have money in their retirement accounts. They may have quite a bit of money sitting in their 401Ks, old pension plans, and other places. But do you know the laws regarding how you are permitted to attract private lenders and work with them to access some of those funds? If not, read on to avoid falling into hot water with the SEC and other government entities.
The 80-Year Ban
Up until very recently there was an 80-year ban on advertising for private money lenders. Meaning you could not advertise for private money lenders unless you were a registered broker-dealer. You had to deal with people with whom you already had a relationship. You had to wait until you knew the lender for at least 30 days before you could have discussions with them about private money lending.
Even if they were an accredited lender, it didn’t matter. So the typical registration, up until 2012, was what’s called an Intra-state offering, where you, your private lenders, your investors, and your deals were all within your state, in which case you could raise up to $1Million in private money. Each state had a certain number of private lenders you could approach. But you couldn’t advertise for them. Then, some people wanted to go state-to-state. They wanted to go through what’s called an Inter-state offering, where they would cross state lines looking for private money.
Registering to Raise Private Money
But as soon as you cross state lines, you’re now regulated by the federal SEC. The federal SEC says you can’t raise money from private lenders unless you get registered. They came up with different types of offerings, which were the 504, 505, and 506-B Federal Registration. Those were known as Inter-state Reg D filings. Until the fall of 2013 it was the easiest to do. It allowed you to get money from accredited and non-accredited private lenders and raise an unlimited amount of money.
There are multi-billion dollar companies that use this strategy. There were no filing fees and there was a very small list of questions to get registered. You can register to raise private money for free. There is no federal expense for raising private money. There are no federal filing fees. You don’t have to pay to get registered. What you pay for is what’s called an executive summary and a private placement memorandum, which is your set of disclosures.
You should pay an attorney to create those disclosure documents, because if a private lender were ever lend money to you, and then sue you because you didn’t fulfill what you promised, they’re always going to take the side of the private lender. Unless you have some sort of “CYA” documents.
The 506-B was the most common of these. There was no waiting period. It was the most popular because there was no limit. But, you are not allowed to advertise for private money. You could only go to people that you already knew. It was perfect if you knew a lot of people and you could network well. If you were good at marketing and a good networker, good at speaking with people and getting to know people, and you were able to create these relationships with people and then pitch them on why they should invest with you. But you couldn’t take out any kind of marketing ad that said this is how much money we want to raise, this is how much interest we will pay, this is the property that we want you to invest in. Couldn’t do that. Very restrictive as far as what you could say.
The Jobs Act Changed the Game
Then in 2012 came the Jobs Act. This introduced the 506(c) registration. Now you’re allowed to advertise, so long as you’re advertising for accredited investors only.
You can use a 506-C and 506-D together. The 506-B offering allows you to advertise for accredited investors, and then the 506-D offering allows a separate company, a separate LLC with a separate registration allows you to take all your non-accredited investors, build a relationship with them, and then take their money into your B fund or B-company.
When you have those registrations, and you have people responding to your marketing to raise money, for sure you’re going to have a large number of those folks that are going to have money that are in retirement accounts.
This brings us to the issue of how to advise your private money lenders who have their funds in various kinds of retirement accounts. They might have 401Ks, pension plans, IRAs or whatever. The point is, they need to know how they can free up their funds so they can do their own investing without incurring any tax liability. This is where you, as a knowledgeable real estate investor and potential partner to your lender, come in and show them the next step – a Self-Directed IRA.