Coming from a background as a real estate agent, team leader, or even a veteran real estate investor can make you think that putting together syndication deals and a private placement memorandum will be easy. After all, what do you have to do to raise capital and is there really a need PPM lawyers?
Finding investors should be easy enough, as you know the general property investor profile. Making an income-generating asset profitable should be even easier seeing how you’ve probably done it many times before.
All you need to get out of a private placement offering is enough money to go after the assets you can’t afford to buy on your own.
Of course, dealing with partners and selling equity to investors requires you to pay attention to some additional state and federal regulations. You may have to prepare real estate syndication documentation and a disclosure document, of which one of the most common papers is the private placement memorandum.
But if you know the industry well, it’s tempting to believe that the legislation governing it will be very easy to understand. This is the first mistake many syndicators make at the start of their venture in this segment of the real estate industry.
While the laws might be specific to property transactions, they’re still laws. They weren’t made by real estate investors, developers, or brokers.
Although the question of whether to have PPM lawyers draft your Reg D PPM is quite common, the question itself doesn’t cover enough.
The real question to ask yourself is this:
Do I need legal counsel when putting together a private placement memorandum and starting a real estate syndication?
This article will focus on the common challenges that syndicators experience when they don’t have the proper legal guidance regarding documentation and other aspects pertaining to real estate syndications.
The Challenges of Real Estate Syndication Offerings
Who Takes More Risks?
Let’s look for a moment at the parties involved in real estate syndications. Those who fund most of the capital required to close the deal are passive investors or limited partners. But what does it mean to be a passive partner?
In essence, these individuals or companies have no involvement with putting a deal together, reaching out to other investors, or managing the income-generating property asset. Passive investors may not even have knowledge of the real estate industry.
The sponsor or general partner is responsible for handling all aspects of due diligence, management, and generating profits. Furthermore, the Securities Act of 1933, which governs securities laws on a federal level, was enacted to protect investors from securities issuers.
In the case of real estate syndication, issuers are deal sponsors or syndicators. They are the ones raising capital. This means that as a syndicator, you take on all of the risk associated with managing the property, making transactions, structuring the deal, and selling the asset after the term of the deal ends.
As far as the law is concerned, and in the eyes of your investors, you’re the only entity that can be held liable for any issues regarding the asset’s management once investors give you their money.
One of the most common reasons for litigation is a disgruntled investor. Say that your PPM outlined a pathway to profits of over 20% return on investment. After drawing the line, the investor only makes around 18%. While that’s still a good return, they could be well within their rights to start a lawsuit against you for not meeting the agreed-upon target.
In this scenario, your private placement memorandum for your securities offering can either save you or make you liable in the eyes of the court. Should the investor’s lower return be due to reasons outside of your control, such as various industry-related risks clearly outlined in the PPM, the investor might not have legal grounds to sue you.
Making Investors Feel Comfortable
Which investor, individual or organization, will willingly fund a securities offering when they’re not comfortable with the offering’s sponsor? As an investor, you probably wouldn’t buy stocks in a company you don’t like or don’t trust. That’s the same mentality that potential investors rely on when analyzing your private placement memorandum.
So, one of the biggest challenges in raising capital for real estate through Regulation D exemptions is to gain the investors’ trust.
Investors expect complete transparency from the general partner or partners. Once they trust that they know what they’re doing, investors will feel more comfortable with the passive nature of their partnership.
But to do any of this, you need the right tools and strategy to win over prospective investors. Thus, the documentation you prepare has to be spot-on regarding material facts, risks, profits, and relevant information about your business, among other things.
This is where a real estate syndication attorney can help.
Having dealt with numerous previous private placement offerings, a syndication attorney will know how to formulate your PPM in a way that both fully informs and appeals to potential investors. They can build a checklist for what is needed in a private placement memorandum to make sure it is complete – this gives your investors confidence.
Building Long-Lasting Relationships
Say you’ve closed two or three syndication deals, and you’ve started working on your next project. You found a property, created a business plan, and all you need is to raise enough capital.
So, you start shopping around your offering to accredited and non-accredited investors. But just because you have two or three successful syndications under your belt doesn’t mean this makes you the go-to sponsor in your niche.
What if you have to find an entirely new group of investors this time around?
It could take months to close the deal on the property. That’s time in which your competitors can swoop in, and time you’re not spending putting together new offerings.
Achieving trust is one thing.
Building long-lasting relationships is completely different. Of course, real estate syndication revolves around enduring partnerships, communication, and sponsor performance. To make your life easier as a syndicator, you need to find those loyal investors that would follow you into any deal.
Once again, this is where your PPM structure can help you gain more credibility.
Ppm lawyers understand what investors look for when assessing the competency of general partners and securities issuers. Therefore, your ppm lawyer can emphasize vital material facts and topics in the PPM document to ensure that investors find out everything they need to know.
The goal is to create your own network of accredited investors so that you can fund future deals faster. You don’t want someone to join your venture once, stay the term, and then go into business with another sponsor. And much of an investor’s decision to give you their time of day and listen to your proposals comes from the comprehensive PPM document that you should prepare for every private placement memorandum.
Many syndicators follow this investment path because they don’t have the necessary capital to close massive deals. They might know the space, have plenty of real estate assets, but can’t grow past a certain level because of capital limitations.
So, forming real estate syndications is the next logical step.
You already know the types of people and organizations willing to use this investment vehicle. You know how to make an income-generating real estate asset profitable.
But when you’re not the sole owner anymore, when you decide to form a partnership with other investors, things get complicated from a legal standpoint.
This is when federal and state securities laws can start to govern your every action, from how you structure an offering to how you manage the property. Just because you have real estate experience doesn’t mean you know all there is to know about the Securities Act.
Not having counsel means willingly risking creating an offering that’s unsuitable for the type of investors you have in mind. You risk not being compliant with certain requirements and therefore not qualifying for Regulation D exemptions.
Over the years, the Securities Act of 1933 has seen plenty of changes. Many of them actually targeted Reg D and altered its rules to make it easier for startups and syndicators to raise the funds they needed. Many regulations were loosened as a result.
However, this only made the job easier for PPM lawyers who were already well-versed in all matters regarding the sale and transfer of debt, stocks, equity, etc. Someone who didn’t know securities laws prior to their amendment and simplification would likely find them equally difficult to navigate now as opposed to a few decades ago.
Remember that the SEC regulations were put in place not to give any advantages to securities issuers but rather for the benefit of investors. Whether you’re partnering with one investor or a large group of them, you still need to meet very distinct requirements.
Understanding How to Market and Qualify for Exemptions for Your Private Placement Memorandum Offering
If you want to make a Regulation D offering, you’re probably looking to benefit from its exemptions. It can simplify the investor vetting process and seriously cut down on time and expenses associated with registering public offerings with the SEC.
But as previously mentioned, these exemptions are only possible when you meet specific criteria. One of the disadvantages of using Reg D is that some of its rules prohibit advertising while others don’t.
Here are some examples.
Rule 506(b) Private Placement Memorandum – No Advertising
With a Rule 506(b) offering, you’re allowed to sell equity to as many accredited investors as you want and up to 35 non-accredited investors. You can also raise unlimited funds for your offering but at no point are you allowed to advertise your offer or engage in general public solicitation.
Essentially, your only marketing tool is your PPM which ends up in front of a select group of investors.
Rule 506(c) Private Placement Memorandum – Can Advertise In Specific Cases
This rule is an offshoot of Rule 506 of Regulation D, which remains unchanged but was renamed Rule 506(b).
Under Rule 506(c), you can benefit from the Reg D registration exemption and advertise your private securities offering. That said, you’re restricted to raising capital only from accredited investors if you want to advertise (no non-accredited investors).
Rule 504 Private Placement Memorandum – Serious Limitations
The exemption requirements for a Rule 504 offering are even fewer and easier to meet. If you want to advertise to accredited and sophisticated investors, you can do it. Even better, you can get a federal exemption and be spared various filings or disclosure documentation.
But here’s what you might not learn if you decide to forgo working with ppm lawyers such as a syndication attorney.
Under Rule 504 of the SEC Regulation D, according to the amendment made on October 26, 2016, you’re not exempt from blue sky laws or state laws. Another thing you might not know is that this regulation puts a cap of $5 million on the amount of capital you can raise in any given 12 months period.
If you’re not knowledgeable about securities laws, Rule 504 may seem attractive on the surface. It requires less paperwork, or so it would seem, and you can advertise your offering.
But once you unravel this regulation, you find out that you can only sell equity to accredited investors, you’re not exempt from state laws, and you can’t raise more than $5 million every 12 months.
Of course, this rule has some advantages too, but they’re very situational. Making your life easier and your deal more profitable will depend on your ability to know what Regulation D Rule applies best to your situation.
A real estate syndication attorney knows these things and is up to date on all potential changes to the legislation so that you’re never caught off guard.
Are the Cases Where You Can Forego the Services of a Syndication Attorney?
If you want to be as protected as possible and have contingencies for every scenario, you shouldn’t ever forgo legal counsel like a securities attorney, especially when you decide to raise capital.
However, there could be exceptions, albeit very specific. Syndicators who understand the importance of counsel may opt not to use it, even when drafting PPM documents, if they work with the same small group of investors over and over again.
Long-standing relationships and trust can minimize the risk of litigation or of not meeting accreditation requirements.
In other words, if you trust your investors that much and the sentiment is mutual, you have some basis to spare yourself legal service expenses. But anything can happen in business, including changing allegiances.
When working with new investors, it’s never a good idea to not have proper legal counsel. Keep in mind that in most cases, your potential investors will have their own lawyers review your disclosure documents, so you can’t afford to let them identify weaknesses that leave you vulnerable to litigation.
Concerning matters of registration, or in the case of private placement offerings, filing a Form D, that’s something you can easily do on your own. And even then, are you confident you know under what Rules of Regulation D you have to file it?
Here’s something that some syndicators don’t know, primarily when operating out of state. In New York, for example, sponsors or securities issuers are mandated to file Form D with the SEC and Form 99 with the state for their private placement offerings.
Laws and regulations can vary wildly, more so when it comes to compliance, even when you’re trying to simplify things by going with Regulation D.
It doesn’t matter if the paperwork and criteria have been streamlined if you’re not sure what to file and where to do it.
Is the Risk of Doing a Private Placement Memorandum Yourself Worth the Trouble?
You may ask yourself, “Why do I need a private placement memorandum?” Here’s a scenario that has nothing to do with real estate syndication but has everything to do with being knowledgeable and an expert in a particular area.
Say you need minor surgery done. You know where the problem is, and surely you can find some accurate medical instructions online on how to perform it. After all, plenty of medical blogs can teach you how to differentiate between having the flu or a cold and help you realize when you should get a consultation.
But what are the implications of misdiagnosing a cold versus cutting yourself open?
You probably wouldn’t even sign off on a surgery performed by a first-year resident, let alone taking the scalpel into your own hands to save a few bucks. You’d want the most knowledgeable and experienced surgeon making vital calls and wielding the scalpel.
Why should your approach concerning legal matters be any different? If things don’t work out and you run into legal trouble, you can lose your reputation and money.
PPM lawyers are experts at securities law as much as you are an expert in real estate and know how to negotiate deals, find properties, and turn a profit. They can draft the right legal document for the job (be it a disclosure document, notice of risk factors, anti-fraud provisions, etc).
PPM lawyers can help you stay compliant with federal and blue sky laws and regulations governing the private securities market. While most legal matters are handled by traditional law firms, when dealing with very niche counseling needs, you’ll want the right guidance. Thus, a syndication lawyer is your best bet at drafting a private placement memorandum, that legal document that lets your investors know all of the risk factors, for your offering, thereby engaging your desired investors, maintaining compliance, and protecting yourself against potential litigation from said investors, state and federal authorities, and other three-letter agencies.
Tilden Moschetti, Esq., is a highly sought-after syndication attorney with nearly two decades of experience. His clientele ranges from real estate developers and startups to established businesses and private equity funds. Tilden’s expertise in syndication law comes not only from his knowledge of syndication and securities law but from real, hands-on experience as an active syndicator himself in every real estate product type and nearly all markets in the US. His knowledge and experience set him apart and established him as the Reg D legal services leader.