5 Traits of a Disclosure Document for Private Lenders [Best Practices]

There are many ways to get started in real estate investing and flipping properties with no money. Anyone can start doing wholesale deals with no money down. There are also several other strategies like owner financing, lease options and joint ventures that can be executed with no money out of pocket.

Doing large flips, commercial deals, rental portfolios however can require capital to grow and scale. One myth about real estate investing is that this capital needs to be your capital. NOT TRUE! Real estate investing in rehabs and rental portfolios and commercial certainly requires money to begin. BUT it doesn’t have to be your money.

You may go to your network of business contacts, family, friends and people you have already established relationships with. You may have a rich Uncle Bob, borrow $100,000 and promise to pay it back when the deal closes.

According to the SEC and state regulators, no matter who funds the deals and puts up the capital there should be an adequate disclosure document that discloses in writing all the material facts, of how you intend to invest money, use the proceeds, your background and experience before you actually borrow it;

Disclosing all the material facts in writing is private lending best practices. In my conversations with my attorneys and specifically my securities attorneys we’ve compiled the 6 keys to complying with SEC regulations and making sure your private lenders, partners and capital providers receive full fair and adequate disclosure.

4 Keys to Complying with SEC Regulations on Private Lending

1. Security

Once you make an offer to someone to take their money for a return of principle or interest, you offer that person a security. It can be a mortgage, note, debt or even equity. The SEC does not recognize mere IOUs but recognizes security. Generally, anytime you offer to take someone’s money and offer them a return or interest in exchange for that capital, with them being passive and the results of the deal based on your efforts, you’ve offered them a security.

2. Sale of securities

After giving your offer to several investors and getting them to agree to invest their money, you now start selling securities to them. When you sell securities, you have two fundamental choices:

  • Register with the SEC (going public) -it’s complex, difficult and generally discouraged.
  • Obtain an exemption from registration (A.K.A. private placement) This is the easiest way to go about compliance. You simply have to fill a form (rule 501 regulation D) with the SEC which we’ll discuss below shortly. This exemption from registration allows businesses to raise capital for their deals or for equipment without becoming a registered broker dealer.

3. Full, fair, and adequate disclosures

When dealing securities, anti fraud rules apply to the sale and purchase of any. It’s your affirmative duty to the investor and government not to:

  • Make a false/misleading statements
  • Omit a material fact that could render your statement false/misleading

Failure to do this equals non-compliance and therefore no registration/exemptions.

4. Know your target investor

You generally have to come up with your own means of validating an investors’ status. Your target investor could be:

Regulation D rule 506 (B)

Under Regulation D rule 506 (B) a real estate business can raise capital from both Accredited or non-accredited investors, in a private placement arrangement, you can do real estate investing with an unlimited number of accredited investors but only 35 non-accredited ones.

  • You could raise capital in your state or across states
  • An Intrastate offering is not recommended as it is complex and will require you to abide by the state laws of each of your investors.
  • A public investor or private (someone you have a previous relationship with)

Rule 506 B applies to private placement solicitation where you only solicit from private investors who you know personally whether accredited or non-accredited. It is flexible in that simple mistakes will not deny you an exemption from SEC.

Regulation D rule 506 (C)

You can still solicit from the general public and still be exempted but:

  • Investors must all be accredited
  • You must take reasonable steps to verify accreditation

Real Estate Investing Disclosure Documents for a Private Placement

A.K.A. a Private placement memorandum (PPM)

This is the document you send to your private investor when soliciting. It includes:

  • Investor name (yours)
  • Amount being offered, Example $100,000 units or $5 Million total
  • Offering terms
    • Are the passive investors accredited (must be a sophisticated investor) or non-accredited investors
  • Risk factors
    • What risks are there that the passive investor may loose some or all of their money
  • Your company and its management description
  • Intended use of the proceeds
    • How exactly will you use the fund they give you?
  • Securities description- rights, restrictions, and class
  • Subscription procedures
    • These are the investing instructions. How do they wire the money and receive proof of ownership.
  • Exhibits- supplementary documents and information upon request by the target investor

Also included in a PPM are:

  • Securities subscription agreement
    • This is also known as the investor questionnaire?

It’s an acknowledgement that the investor received, read, and agreed to everything in the PPM. It offers you protection in case the investor wants to leave later and how they will get their funds and interest.

  • Investor self-accrediting document
    • An investor fills out this document themselves and is not fact checked by anyone. The investor indicates where he falls depending on what you provide.

Winding up

Real estate investing is not hard when you comply with laid down, long standing rules and regulations. It is best to register your company as one that deals with real estate investing securities. If you don’t do so and solicit as well as invest wrongly, SEC will be at your doorstep any minute.

We're going to be doing a deep, deep dive on everything you need to know to stay compliant and "avoid the orange jump-suit" at our upcoming Flip and Fund Summit, the nations leading Real Estate Investing Training & Mastermind Event.  Tickets are about to go up, so if you act now you can get in at a huge discount.  Click right here or on the banner below if you want to supercharge your investing career.


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