So as we wrap up in this video, the seventh of our seven-part series on how to stay out of trouble and in compliance with the SEC and state regulators when you’re doing a private placement offering through Regulation D, Rule 506(b) or Rule 506(c). How do we do it? What are the best practices? We’ve gone through the things that I think are going to get you in the biggest amount of trouble if you do them. But most of my clients want to just stay out of trouble altogether. And so I think you’re probably in the same way: how do I stay out of trouble and just make sure that I am always in compliance, so I don’t have to worry about it? Well, this video is going to go through those. And since it’s been a seven-part series, we’re going to do the seven most important best practices to stay in compliance from the very beginning when you’re putting your Regulation D offering together.
When you’re putting your Regulation D offering together, the last thing that you want to think about is getting in trouble. But that’s the whole point of this set of videos: going through all those things that are most likely to get someone in trouble if they do them. So in this video, we’re going to go through the seven most important things that you can do, right now, to make sure that you’re on the good side with the SEC and the state regulators.
Remember, they’re just trying to do their job. They’re trying to protect the investing public; they have a mandate, a mission to fulfill, to protect that investing public, to make sure that unscrupulous people are not defrauding people out of their good hard-earned money. That’s why they’re there. Our job is to make sure our investors succeed. The more our investors make through us, the more investors keep investing with us. So it’s in our best interest to be in compliance and do the right thing by our investors.
So how do we do that? What are the best practices to stay in compliance? Well, number one is to start with a well-crafted private placement memorandum. The private placement memorandum’s job is to put all the pieces together so that the investor knows what’s coming their way. They know what they’re putting their money into, the terms of the offer, what they’re getting, what those distributions are going to look like, what conflicts of interest arise (because there always are conflicts of interest when you’ve got somebody making a profit off of an investment vehicle). So what are those conflicts of interests? Let’s disclose them and put them out there.
What are the risks that are inherent in an investment? Investments are inherently risky, but let’s go into a little more detail. So it doesn’t just seem like we’re saying, “All investments are risky,” but what are the risks that are specific to the asset class that you’re doing? If you’re doing a real estate development deal, well, there are certain things about doing real estate development that are just inherently risky: you may not get the permits, you may not get the zonings, cost overruns, things like that. If you’re doing a business, there may be specific things as it relates to your business: intellectual property disputes, how are you going to handle that? What is your mechanism to do that? You have key personnel that are critical to the success of this enterprise. Those are the kinds of things that need to be disclosed. Those are the risks that are inherent.
Also inherent is how exactly you’re going to use this money. So if you’re raising 5, 10, 15, 20, 100 million dollars, well, what are the investors giving you this for? How exactly are you using it? That should be disclosed and described, so that the investors know. And of course, provide a way to contact you. So if an investor has more questions, they need a way to get in touch.
Now, of course, that leads us to number two: following the rules of syndication, or putting a fund together. One of those rules is describing the things that I just talked about. Giving this information to investors is critical. It is very, very important. And that’s why number one is so important – it’s having that private placement in place. But following the rules and regulations about syndications and funds are part of that as well. And that is perhaps even more important, because there are other rules that are part of a private placement that necessarily just have to be there.
Talking about your investor base: Do they need to be accredited investors only? If you’re advertising, obviously it needs to be accredited investors only. If you’re not advertising, well, maybe it doesn’t need to be accredited investors only. But how many investors can there be? There can be up to 35 non-accredited investors – 35 people that you actually count whether they formed an LLC or not, in any 90-day period. It’s just one of the rules that is inherent if you’re going to be doing a Rule 506(b) offering.
So following all the rules is important. If there’s a bad actor situation, that may disqualify you completely from even doing the offering. But it’s better to know before you put it together, rather than after you’ve already put it together and raised investor money. That’s when some real big trouble could be brewing. Probably that’s not applicable to you. But it’s worth looking at. It’s worth looking at your partners to say, are any of these people considered bad actors? Because if they are, you need to know it ahead of time. So following all those rules together is critically important for success.
Number three is don’t try to be fancy. This kind of goes along with choosing your investors. Don’t try to get too fancy. Don’t try to go too far into the gray area about finding investors, or what you can offer, or being too ambiguous on certain things. It’s not going to fly. You just can’t get too fancy, too clever – it doesn’t work. Being smart and transparent: that’s what works in this world. If it starts looking opaque, if it starts looking like it’s being too clever, or things are getting hidden, that’s when regulators start perking up their ears.
Remember, these are very, very smart people. These are people who have trained for this, who are ready to regulate to protect that investing public. And so trying any tricks just isn’t going to work. They’ve seen it all before, and they will see right through it if necessary. So if it starts seeming like you’re being a little too clever, you probably are. And it’s time to back off, and start thinking about how you can put your business plan together where you still can be successful, but you can still do what you’re trying to do. Because there are answers out there. There are solutions to every problem that don’t need to rely on clever tricks or fancy gimmicks.
Number four: don’t pay finders, just flat out. Don’t pay finders. If you’re paying for performance, it’s just not going to fly. You will get caught; it’s going to happen. And if and when it does, it will be very bad. Don’t try to get too fancy on finding people who aren’t really finders (talking about rule number three), but don’t try to skirt that line. Don’t try to do the “Well, why don’t you come into my syndication and be a general partner,” but really, you’re just looking for funds. It’s not going to fly, and the SEC and the state regulators know this is a problem, and they are going to start regulating it more and more. I’m certain of it; it’s going to happen. And if you’re doing it, if that’s what your business plan is, don’t. You can redo your business plan in a much smarter way.
Number five is file the Form D and notify the states. Once you file a Form D, what happens is you’re automatically in that safe harbor of Regulation D. So you’re automatically covered as long as you’ve complied with the rules of Regulation D. Now you’re protected; you have the protection of this set of rules. And that starts with filing the Form D. Then it follows up with notifying the states because the states still need to get notice, or most of them do under their own blue sky statutes. All the states are required to do under Rules 506(b) and 506(c) is ask for notification. So as long as you’ve done that, you’ve met the rules. Now the states can’t regulate you except if you’ve deviated outside of the rules. So the safe thing to do: file the Form D, notify the states.
Number six is the golden rule. Now, this is the golden rule of investors. So how you deal with investors is: do unto your investors as you would wish your syndicators to do unto you. Put your hat of an investor on and think about what your action would be like if you invested $10,000 or $100,000 into this investment. How would you feel about that?
So, things that kind of cross the line that I’ve heard are: “Well, what if we just borrow this money to do this new project? And then pay it back?” Well, let’s think about it under the golden rule of dealing with investors. If you were an investor in this, and you put in $100,000, and then you found out that your syndicator was taking some of that money to start a new project, and you’re not going to get any benefit from that? How do you think you’d feel about it? You’d probably be pretty darn angry. So obviously, that fails the golden rule of dealing with investors.
Or communications: how would you feel if you invested $100,000 and you never heard anything from the syndicator? You’d probably be pretty darn angry and wondering what’s happening to your money. Now, the syndication could be going fantastic. But if you haven’t heard anything, you’re going to be angry. So do unto your investors as you would have another syndicator do unto you. Put yourself in their place. And just think about it. Think about how it’s going to be. Because if you do that analysis on those decisions that you’re making, you’re going to stay on the good side.
Really, at the end of the day, all of the rules and regulations come down to doing the right thing for your investors and the investing public. That’s really what the whole point of almost all of it is: to make sure that the investing public, that your investors, are well cared for. So do unto them as you would have another syndicator do unto you. Pretty simple.
And number seven: engage a syndication attorney. As experienced syndication attorneys who have done deal after deal after deal, we’ve seen many, many problems arise. As a syndicator myself, I’ve seen hundreds of deals, not only through the eyes of an attorney but also as somebody who’s been in the trenches there with you. Engage a real syndication attorney who’s got the actual experience of doing Regulation D work. Engage somebody who you know is a specialist in this field, not just somebody who’s a fly-by-night, who just does it on and off.
Real estate attorneys are not syndication attorneys, and syndication attorneys are not real estate attorneys. We wear two completely different hats; our thought process about how to do everything is entirely different. When I’m focusing on a syndication client who’s hired me to be their lawyer, my job is to focus on that syndication, making sure it all works. I’m not thinking about the real estate at all; the way the real estate works is kind of irrelevant to me, except to the extent of what I need to tell the investors about it to protect my syndicator. My entire job is to protect the syndicator, not anything else.
If the real estate attorney, on the other hand, is not thinking about the investors, they’re thinking about the property, they’re thinking about the owner, and they may be thinking about the tenants. But those are very different things. When I think about tenants, I just think about them as little engines in the cash flow, and the risks associated with that. That’s it. It’s a much more important thought for a real estate attorney than it is for me as a syndication attorney.
So hire somebody specifically, and do not listen to non-attorney advice about how syndications work. Now, it’s all well and good to talk to somebody who’s done a lot of syndications and talk to them about how they do it. That’s all very helpful. But talk to a syndication attorney who knows what they’re doing, who has experience, who’s a specialist in this field, when you have questions or when it’s time to put that offering together. Because the nuances in this field are great. They’re really vast. And there are many situations that will have come up for the syndication attorney that somebody who just does deals isn’t going to know.
There are also going to be plenty of nuances that happen to the syndicator who doesn’t know, who will have more nuances going on than the syndication attorney has knowledge of, which is why my firm has both. As a syndication attorney, I’ve seen all those setup problems. As an active syndicator myself, I’ve seen all this set of problems. So I’ve seen all these things and I’ve seen how they come together and how they play out.
But don’t rely on it. I’ve heard so many things about, “Well, you don’t need to put a PPM together because of XYZ. You don’t need to do this. You don’t need to spend any money. It should cost this much amount of money. Oh wait, you can’t ask for fees. You can’t do these different things.” I’ve heard the weirdest things. Talk to a syndication attorney. Really, you’re putting in a lot of time and effort in this. And ultimately, your investors are paying the fees, ultimately, anyway. So isn’t it worth your time to do it right?
Well, I hope you found this seven-part series useful for you. At the end of the day, all I want to do is make sure that you stay out of trouble, make sure that you’re in compliance, because ultimately, as a syndicator myself, the more that the bar is set higher for all of us syndicators, the more ethical we act, the more in compliance we act, the better it is for the whole investing public, and they’re more apt to invest in our investments anyway, which is good for everyone.
So I hope you found this helpful. If you’d like to talk to me about being your syndication attorney, I’d be happy to speak with you. Please give us a call. We can talk about your Regulation D Rule 506(b) or Rule 506(c) offering.