Top real estate pros point out some things to keep in mind when raising private money to fund your deals.
There are lots of ways to go about raising private funds for real estate deals, but it’s almost always a belly-to-belly endeavor. Meaning it’s usually an intense, one-on-one interaction as you try to convince people to loan you money. And like it or not, it’s a very closely regulated process. As usual, the government has its mitts on this as it does on all things. You can’t simply decide you want to ask people for money in return for giving them a nice interest rate or piece of the action. Goodness, no. There are state and federal laws and guidelines that must be very carefully followed in order to avoid ending up in the Graybar Hotel.
Should You Do a Federal Filing?
In most cases, yes. If you’re going to try to raise more than $1 million dollars, and/or if you’re going to advertise for money, and/or if you’re going to cross state lines – you should do a federal filing. This filing will allow you to go after large amounts of money and legally market to private lenders across state lines or on the internet, and run your business between one state and another. Remember, there is no fee to file, but if you are planning on doing deals in another state, or borrowing money from someone in another state, advertising on the internet, or running part of your business in another state, you MUST do a federal filing.
Federal 506(c) Registration – The Sky’s the Limit
The 506(c) registration allows you to market to the general public for funds and take private money from accredited investors. It allows you to solicit private lenders from your website or to those living outside your state, and it allows you to aggressively go after large sums of private money. Without the 506(c) you can’t do any of those things.
Private Placement Memorandum
There is no fee to file the 506(c); however, if you’re going to do a federal registration and raise money, you should also do a disclosure document, called a Private Placement Memorandum. The PPM spells out the details of your offering and will protect you in the event of a lawsuit. If there is ever a misunderstanding between you and your lender, the PPM will be your best friend. Why? Because without it federal judges almost always side with the lender in the event of a lawsuit. It’s a critically important legal document that can be a tad pricy to create, although it’s worth every penny. You should have a qualified securities lawyer draw it up for you.
Intra-State means staying within your own state for everything pertaining to your business. If you’re staying within your state and you, your business, your houses, and your private lenders are all within your state, then you are regulated by your state. In most cases you are able to raise up to $1 million dollars. However, there are 4 states where you can only raise up to $500k. But if you do not cross state lines, and you do not do general solicitation and advertising, then you do not have to register in most states.
Prior Relationships with Lenders
The state requires that you have a prior existing relationship with anyone from whom you raise money, if you are doing an intra-state offering. This means you must know someone for at least 30 days, and you must have had at least 3 “touches” – instances of contact – during your lifetime. If you meet these two requirements, then you can market to them and make an offer.
Can You Advertise on the Internet?
If you’re thinking of putting ads on Craigslist, or Facebook or on a website, those ads are considered to be a national / international presence. Meaning if you put up any kind of marketing that mentions specifically what your offer is, and/or what your interest rate or other compensation is for borrowing funds, and/or you are asking for money in return for an interest rate or piece of the action, you have just made an offer. To do that legally you must have a federal 506(c) registration. Otherwise you are breaking the law.
Start off with Intra-State Offerings
Most real estate investors just starting out should begin with Intra-state offerings. Again, this means that you, your business, your properties, and your private lenders are all within your state. In that case, you are regulated by your state. In most states your state will allow you to raise up to $1 million dollars.
If you do not cross state lines and don’t do general solicitations, then you don’t have to register in most states. But the state securities department requires that you have a prior existing relationship with anyone from whom you are trying to raise money. Meaning you must have known them for at least 30 days and you must have had at least 3 contacts prior with them. If that’s the case, you can market to them and make them an offer.
The Definition of an Offer
An offer is any time you discuss specific details of what you’re trying to do. For example, any time you discuss the amount of money you want to borrow, or the interest rate that you pay, or the equity you give, or the property that you want the lender to invest in. If you mention any of those things, it is considered an offer. If you’re doing any of that on the internet, and you are not registered, you are violating the law.
The beauty of having your company protected by a federal 506(c) registration is you can disclose to prospective lenders the amount of money you need, the interest rate or equity you’re offering, and a description of the project for which you are seeking funds. All of those things are legal to disclose under a 506(c) registration. Before you begin your marketing program make sure you know to whom and where you will be marketing for funds. If any of it involves out of state dealings, or trying to raise funds over $1 million dollars, you will need to do the 506(c) registration.