There’s a syndication myth out there that you need to know about. That myth is called the “Syndication LLC”. The “Syndication LLC” is not true; it is a pathway to an SEC securities violation and civil and criminal penalties. We’re going to talk about what that myth is, how to recognize it, and what’s exactly wrong with it.
Let’s talk about how the “Syndication LLC” is being described, and then we can go into the details about what’s wrong with it. The story goes something like this: you buy a piece of real estate, say 10 units. You identify it, and then you say to yourself, “Okay, off the top, I am going to take 20% of the equity. Maybe I’ll put down 5% of cash, and the rest of it is my syndication entity’s profit.” The rest of it comes in the form of equity from other investors, maybe in 10% increments. So you have essentially a bunch of pieces of the pie like that.
How it’s being described is that you find these investors, they come in, and on paper, you need to make sure that everybody has voting rights and some sort of control. The descriptions you hear about it also go on to say it doesn’t matter how you actually do it. This is the huge problem with it – it doesn’t matter how you actually do it, it just needs to be this way on paper.
I’ve heard it also described as complying with the Investment Company Act. As an aside, the Investment Company Act is not the right regulation for this, especially if this is real estate; it’s already not part of the Investment Company Act at all.
Where it is a problem is this part: you may be giving investors partial ownership shares, and you may be giving them voting rights. But what’s much more critical is not the fact that on paper they have these voting rights, but that there’s an understanding that you’re in control of the whole property. It’s not the on-paper part that’s critical. It is important that it’s correct and proper on paper, but it is also just as critical that your investors have control and ownership rights if you’re going to be complying with this.
In one of my other videos, we went through the difference between a joint venture and a syndication. A joint venture is where you’ve got partners coming together, where the decisions are really being made together. I emphasized in that video that it’s important that most all of the decision-makers, all of the people in that joint venture, have a very active part and be active participants.
Some of the myth that’s out there about the syndication LLC is that it doesn’t actually need to be active, that it can be passive, which is completely untrue. The courts have found time and time again that when something is set up as a syndication LLC, it’s not a syndication LLC – it’s a security, and a security requires there to be a PPM. It requires that it either be registered or it needs to fall into one of the exemptions.
It doesn’t matter what number of rights you give; it’s what number of rights the investor themselves feels like they have. If there is a tacit understanding that the investor isn’t participating and isn’t an active part of the decision-making, it is not a syndication LLC properly called a joint venture. It is a security which must be registered or fall under one of the exemptions.
The big takeaway here is: don’t fall prey to listening to people on the internet about how you should legally structure something with side understandings. There is not a shortcut around following the rules. Trying to make a shortcut is a long cut to getting what you want, but it’s a shortcut to ending up in jail or facing civil penalties.
Yes, it may not happen right away. But at some point, one of your investors is going to file a complaint, and all the holding up of your operating agreement in the world saying, “Oh, but it says here my investors have voting rights” isn’t going to help you worth a darn. It’s going to land you in big trouble because they didn’t actually feel like they have those rights. It may say that on paper, but if there was an understanding amongst all of your investors, and if one is making a complaint, the others are going to be right behind when they find out that they can get a piece of their pound of flesh as well.
If it’s a joint venture, however, and everything is good, then everything’s good. But what’s being described as a syndication LLC is completely and 100% wrong. So that is a joint venture, which requires active participation. Everything else must be either registered with the SEC or fall under one of the exemptions in order to be compliant.
Hope that helps. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. If we can help you stay in compliance and not fall victim to these kinds of nonsense that you see on the internet, please reach out.