Don’t Be Intimidated by Federal Laws Affecting How You Raise Private Capital for Real Estate Investments. Here’s a Look at What’s Involved.
Leave it to the federal government to beef up the red tape quotient. It seems no matter where you turn when trying to raise private capital for real estate investments, there is just one more form to fill out. Well, the reality isn’t quite that bad, but there are some things you should know. Here’s a quick look at what to be aware of as you begin to raise funding.
Federal SEC Registration
A federal registration doesn’t cost anything to file, but it allows you to raise an unlimited amount of money, it allows you to cross state lines, and it allows you to raise money from international investors. The registration is the easy part. The hard part is creating the proper documentation.
Creating proper disclosure documentation
If you’re going to do a federal registration you need to have a full set of proper disclosure documents. There is a potential risk when a private lender invests with you. You will need to have a good securities lawyer create the proper disclosure documents. The two most critical are called an Executive Summary and a Private Placement Memorandum. These will protect you in case any issues come up between you and your lender.
Why do you need an Executive Summary and Private Placement Memorandum?
If the private lender tells a judge that you promised them one thing and you’re saying something else, and there’s a dispute, that’s when the disclosure documents come in handy. If it ever comes down to a lawsuit and you’re facing a federal judge and jury, you will need to have supporting documentation. The documentation reveals what you said and what you offered to your lender. This will insure you have the ability to protect yourself should a problem arise.
If you’re the borrower, and you promised your lender you’d pay him 8%, but you don’t have it in writing, and the lender says you promised him 12%, the odds are that almost every single time the verdict will go to the lender. Shocking but true in federal court.
The Executive Summary is not everything; however, it does tell people the highlights of the deal. It describes the who, what, when, where, how and why. Meaning you’re just telling people a little bit of the story to give them a taste of what you’re doing. You do that because even though you might get money right away from people you already know, or from accredited investors who are allowed to invest immediately, most people want to get to know you and what you’re offering over time. So you want something to whet their whistle and to get them interested beyond what you’ve told them, and also to protect yourself. So that’s what an Executive Summary is for. As the name implies, it’s just a summary.
Private Placement Memorandum
There are two reasons for this document. There are several pages of disclaimers that you’re not likely to know. And even if you find someone else’s PPM on the Internet, it doesn’t really cover you because it may be something completely different.
The point is that the Executive Summary tells people just a little bit about what you’re doing, but the PPM is a full disclosure document that reveals what you are offering. When you talk about making an offering, that means you are asking for money. Your Executive Summary does not ask for money, but the Private Placement Memorandum does.
If you don’t have those documents, and especially if you don’t have any proof that you gave them to people and they had a chance to look at it, ask questions, and seek their own advisors. If you don’t have these important documents, every jury is going to assume that you did someone wrong. On the other hand, if you have the Executive Summary/PPM in hand and someone wants to go try to sue you, they will not have any success.
The point is, you want your private lenders to know what they’re getting into, and you want to cover your butt legally. Those are the two main reasons people do the Executive Summary and the PPM.
The summary documents don’t tell the whole story
The Executive Summary, the Summary of the PPM, and the Summary of the Disclosure, are not an offer. They don’t cover exactly how much money you are asking for, what kind of increments you’re looking for, the interest rate, the particular properties you want to get funded. It’s just a summary of your disclosures. It’s your background.
The Private Placement Memorandum is critical
It is the Private Placement Memorandum that real estate investors are paying an attorney to create when they do a federal filing. They don’t pay an attorney to actually do the filing. That part is free. What you’re paying for is the full Private Placement Memorandum document. The reason you are doing all this documentation is because it’s not a question of WILL the SEC come walking into your office, it’s WHEN. If you have all your proper documentation, you have nothing to fear from the SEC or from a lawsuit. It’s not something you want to scrimp on.
Steps of the process of raising private funding:
- Start with Intra-State Offerings and learn what the rules are within your state.
- Raise as much money as you can from people with whom you have a prior relationship.
- Do the notice filings and other small filings in your state if they’re required.
- Grow as many in-state private lenders as you can before going out of state.
- When you need more funding, it may be time to move to the federal registration.
To grow your business takes serious money
If you’re a serious real estate investor and you really want to make a significant amount of money, and you want to buy properties to hold, or buy commercial buildings, or flip properties, you will need more than $1 million if you want to expand your real estate investment business.
The Private Placement Memorandum and Executive Summary are Critical
You have to think to yourself, do I want to go before a judge and jury, or do I want to go in front of an auditor or regulator, and know that everything is tight and confident, or do you want to go worry that you’re just squeaking by simply so you could save a few bucks?
The truth is that when you’re looking for private capital you’re dealing in securities. Things need to be detailed and confidently buttoned up, or you could find yourself in some seriously hot water. Raising private money for your real estate deals is very highly regulated, so do the right thing and make sure you’ve got your document ducks lined up.