Ep. 42 | Navigating SEC Regs on Syndication – Part 1 of 2

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On this episode of The Mobile Home Park Lawyer, Ferd talks about some SEC regulations regarding syndication. Ferd gets us in the know about what you can and can’t do when syndicating a property. Enjoy!

HIGHLIGHTS:

0:00 – Intro
1:14 – Ferd has seen a lot of offering memorandums which are pretty wonky, you need to know what you’re doing
2:59 – The Securities Act requires promoters to register with the SEC, with some exceptions
3:11 – Sophisticated investors and accredited investors are allowed to invest in private placement memorandums
4:32 – As a promoter, it’s safer to go with accredited only
4:48 – There are three exemptions: 506b – private placements, 506c – general solicitation and crowdfunding
5:00 – You can only raise just over a million in crowdfunding
5:23 – 506b – You’re not allowed to openly advertise the investment and you must have a pre-existing relationship with investors
6:27 – PPM tells you everything that can go wrong
7:26 – 506c – You can advertise the investment, but all investors must be accredited
7:44 – You’re required to file a Form D within 15 days of the first sale
9:55 – You cannot pay someone to raise money for you, but Ferd will go into detail on this in the next episode

 

FULL TRANSCRIPTION:

Welcome back mobile home park nation. Ferd Niemann here again today, with another episode of The Mobile Home Park Lawyer podcast. Today, I have been thinking about all the election stuff and all the drama going on in our country. And I thought, man, wouldn’t I love to talk about the government today. So today we’re going to talk about the government in the form of the securities and exchange commission, the SEC and specifically it’s going to be, as it pertains to syndication because there’s a lot of things you can do to break the law, like jaywalking, have you speeding by one mile an hour. And nobody really cares that much.

There are other things you can do to break the law and the government cares and rightfully so, and obviously criminal matters are some of those. But today we’re talking about SEC. I see a decent amount of offering memorandums and private placement memorandum and have been involved in those from a legal standpoint and as a promoter standpoint. And I’ve seen a lot of them that are pretty wonky, pretty aggressive if you will, I’m not going to call out certain guys were illegal in these processes, but they’re definitely out there.

So, if you’re investing as a limited partner, you want to know who your GP is and want to make sure they’re compliant. If you are the GP general partner/promoter/sponsor/syndicator, those are all the same thing. You need to make sure you know what you’re doing at least from a legal standpoint, if you don’t, you need to hire a legal counsel, okay. I’m obviously biased. I’m a lawyer here, but this stuff is super complex. I’ve done some complicated tax increment financing deals, real estate contracts, leases but some of the more complex legal docs I’ve ever worked on, at least private placement memorandum and the pretty verbose, you know, easily over a hundred pages by the time you add in and then my last one was like 200 pages. By the time you add in the operating agreement, you’ve got your business plan and there’s an exhibit. Your financials sometimes you’ll include like a zoning appraisal or phase one report, a property management agreement. You’re going to have things like your investor questionnaire, the certifies your investors are sophisticated, accredited. And then you get your subscription agreement where they commit to pay. You’ve got your signature pages for the operating agreement and BPM.

So pretty verbose documents. But today I’m going to hit high level. What are the regulations concerning raising capital for certifications? And I think by now, you know what indications are, and the SEC is the regulatory agency that essentially the promulgated guidelines and regulations, specifically pertinent to raising money for real estate. This came in about 1933 securities act. And basically, it requires promoters to register at the sec, unless there’s a valid exception. And that’s where the private placement memorandum is typically come in, is there an exception and the two types of investors that are really allowed to invest in these, are the sophisticated investors or accredited investors.

Sophisticated is a little more aggressive. It’s got to be somebody who has enough financial and business knowledge that he or she can evaluate the risks and rewards of the prospective investment. You can have no more than 35 sophisticated investors in an investment.

So, this may be, you know, like, you know, I’m both, I guess. I’m a credit investor, but I’m also, I would argue I’m a sophisticated investor because I have enough financial and business and legal acumens that I could invest as a limited partner. But somebody who has the same, you know education and intellect, but as a surgeon may not qualify as a sophisticated investor, as it pertains to real estate investor. Now those people may, the surgeon example may very well qualify as an accredited investor, which is someone who has a net worth of at least a million dollars, not including their primary residence or has a net income of $200,000, $300,000 if married, they typically a measure that based on the last two years and an expectation in the subsequent year. There are some other ancillary definitions for if you’re an IRA or a financial institution or some sort of corporation.

But for most of the individuals, I hear if you’re an accredited investor, you can invest in these deals. If you’re sophisticated, it’s a little grayer. And as a promoter, the safer, best practice to just go with accredited only. And if you mess this up and you have even one person in there, who’s not, you can screw up the whole exemption for your offering.
So, you don’t want to mess it up. And that the key exemptions really there’s three, there’s 506B private placements. There’s 506C general solicitation. And then there’s, there’s crowdfunding. And I’ll just say crowdfunding first. Cause it’s the simplest and I’ve never done a crowdfunding. It’s a smaller limit. Like you can only raise up to a $1,700,000 in a year. And basically, this happens typically through online portals with the SIC is kind of involved as it regulates this kind of intermediary.

I don’t see a lot of those, frankly, I’m sure they’re out there, but most of what we see are 506B private placements or 506C general solicitation. So, let’s go with 506B. And this one, the key thing here is you’re not allowed to openly advertise the investment. Basically, you have to have a preexisting relationship with prospective investors. Typically, you know, 90 days we recommended at least 30 days of a preexisting relationship, the more material and sub substantial that is the better for use to promoter and the whole purpose of these private placement, by the way, so you don’t have to register the sec and you can be valid and not get in trouble for raising capital. And with the 506B private placement, you can raise an unlimited amount of money and you can sell securities to an unlimited number of accredited investors. Again, sophisticated are maxed out at 35. If you have sophisticated, you have to make sure they get the documents that contain the information. I mentioned some of that kind of the prologue year business plan, financial statements, basically the PPM is also, it’s a disclosure document. It’s kind of like a prospectus, you know, and then you have to give the investors the same sort of information that would be in a regulated SEC perspective if you buy Coca-Cola stock, there’s a prospectus.

And these PPM says all the bad, scary stuff that can go wrong. Things like the market may change, our financials are not audited. We have not had these assumptions vetted by anybody else. We may be overpaying, even though we may lose our financing or not be able to raise enough capital or management may die, you know all these other things or your tax situation be different than mine. So, on and so on. It’s a big scare you away document, but it’s kind of a safe Harbor for the promoter. Like if you do this, this process, you’re safe.
And that if the deal goes South and you didn’t do anything fraudulent or misrepresentation or of that sort, you’re more immune from liability, you know, we all know what a limited liability company isn’t supposed to have limited liability. PPM, supposed to make the promoter have limited liability. There’s some exceptions for crime and stuff like that. For the most part, it gets the job done.

So again, the key is no general solicitation or advertisements under the 506B. Under 506C, general solicitation. I think you’ve probably figured it out by now, but the difference is you can publicly advertise, but again, that’s if all the purchasers are accredited and you take steps to verify the purchaser’s investor status. So, you cannot have sophisticated people who are only sophisticated, but not accredited in the 506C. And if you do a 506C, you’re required to file a form D with the SEC, within 15 days after the first sale of securities, basically this just lets the SEC know who’s out there doing this, who’s out there claiming to be exempt and they can regulate it. And by doing this you’re exempt from state registration, but however, some States still have the ability to require you to give them notice of the courtesy filings and frankly, to collect fees.

So 506B, 506C, they’re fairly complicated, but it’s kind of the name of the game. If you want to be a syndicator promoter, if you’re doing stuff like you’re trying to do it in just a plain old LLC, like, Oh, it’s, Ferd the promoter and I’m going to bring on a million dollars of private equity. I can’t just do that in an LLC. If it’s like me and my dad and we’re just sitting around and we’re partners, I’m like, Hey, let’s do this deal together. I can get a way of just an LLC, just me and dad. But basically, once one party starts to get paid or starts to have a disproportionate share as syndicators typically want, you know, some asset management fee, some property management fee, an acquisition fee. The promote I talked about in a prior episode and, you know, you get typically a limited partner gets a preferred return. And then there’s a hurdle, once that preferred return says 8% is met, the promoter gets 30%. The limited partner gets 70% and you can change those ratios. It’s negotiable. You can have different ratios for, you know, things from cashflow, from operations, from dissolution, from liquidation, from refinance, from disposition or sale all of those things. And then also you can even, you want to talk to your CPA on the cost segregation tax benefits, but you can even have some ability to monitor, modify the tax benefits, it gets more complicated with qualified non-recourse debt. And I’m not going to get into that today. And I can hear my CPA, look over my shoulder saying, don’t get into this stuff. You’re not the CPA I am. But I’ve paid enough CPA fees over the years that I feel like I’m almost there, but I’m not. So, don’t let those, there’s no accounting advice, frankly, no legal advice. I think I have to say that too has been offered in this podcast.

But ultimately that’s the high-level regulation on these three categories in general. Another question that I’ll cover in a subsequent podcast or in a minute is what if I have someone else raise money for me? How can I pay them? The short answer is you cannot pay someone to raise money for you, unless you are a licensed broker, dealer. This happens all the time. I’ve been offered this on, I don’t know, three or four occasions, Hey, you want to raise money for my deal? We’ll pay you 20 present. It’s like, no, that would be a felony for both of us. So, don’t do that. I’ll get into that more in the next podcast. Until next time, have fun, be smart. God bless.

 

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