Real estate syndication is quickly becoming one of the biggest wealth drivers on a global scale. Its availability to investors is greater than it has ever been, which means that interest has skyrocketed in recent years. This is excellent news for any real estate syndicator committed to buying properties with raised capital and managing them into profitability.
However, syndicators rarely have sufficient capital on their own to pursue big deals and buy millions’ worth of income-generating properties. As a result, they often have to go into business with more than one investor.
So, one of two things can happen. Some syndicators opt for the public route of capital raising by creating an IPO, establishing an investment trust, registering with the SEC, etc. Others take advantage of the lucrative private securities market responsible for trillions of dollars worth of transactions per year.
If you’re interested strictly in syndication and private placement offerings, then you have probably already done some research. You should know by now that making offers under the Regulation D exemption is arguably the best strategy.
But from a legal standpoint, issuing offerings for your syndication to investors through Regulation D might not be as straightforward as you think. This article will focus on key areas regarding the Securities Act of 1933, Regulation D, and what you need to know to be compliant and protected against various liabilities.
SEC Regulation D
Before getting into the best practices of raising private capital for real estate, we need to talk about this Regulation. Private placements are often the best alternative when you don’t want to jump through the hoops of creating a public offering to get funding.
But like any other type of securities offering, private placements are also governed by a series of rules and regulations to prevent fraud, investor misinformation, etc. Regulation D, or Reg D, is a mandate imposed by the Securities and Exchange Commission (SEC) to oversee exemptions concerning private offerings.
By using Reg D exemptions, securities issuers or real estate syndicators can gain access to the capital they need fast and cheaper. This Regulation enables the sale of equity and debt securities to raise funds without demanding the securities be registered with the SEC. Of course, on a case-by-case basis, other federal or state regulatory mandates can still apply.
So, what’s so special about raising capital through this SEC Regulation?
A Reg D investment doesn’t carry the same strict restrictions that often accompany public offerings. Therefore, companies and individual issuers can save time and money. They may also keep the nature of the offerings and transactions private.
That said, putting forward an offering under Regulation D still mandates that issuers and entrepreneurs create the necessary framework and legal disclosure documentation. For example, the SEC requires securities issuers to adhere to a Form D filing.
Understanding the Form D SEC Document
Form D is a filing made with the SEC that’s necessary in some situations when companies or individuals sell securities under Reg D exemptions. In essence, it’s a short notice document that contains standard information about the company making the offering. This document must be filed within 15 days after completing a sale to investors.
SEC Form D is also referred to as the Notice of Sale of Securities, as a requirement under Regulation D, Section 4(6) of the Securities Act of 1933. Intended as the Act to govern over the securities market, its laws emphasize and mandate full disclosure from securities issuers to investors.
Prior to the Act’s creation, the U.S. went through a period of hypermarket inflation as there were no regulations in place to prevent issuers from presenting bad offers to investors. Thus, in response to the Great Depression, the Securities Act of 1933 was created to help investors make better decisions with their money and keep securities issuers honest.
This is where the Form D document comes in. Although it’s substantially thinner than a traditional securities registration form, it still contains essential material facts about the business or individual making a private placement offering.
What’s a private placement?
It’s the sole area of focus of the entire Regulation D section of the Securities Act of 1933. In simple terms, a private placement is an attempt to raise money without making a public offer. For example, instead of launching an IPO, a company may opt to sell stocks to several handpicked investors within its network.
However, those investors must meet certain requirements to qualify and to allow the securities issuer to have their offer exempt under Reg D.
The JOBS Act of 2012
For decades, the SEC Regulation D remained unchanged. Even though it was created as a means to allow the investment market to flourish and simplify the sale of securities while still holding issuers accountable to state and federal laws, its framework was basic.
In 2012 a new piece of legislation was signed by then-President Barack Obama. This legislation was called the Jumpstart Our Business Startups Act (JOBS.) Its primary scope was to loosen various SEC regulations imposed upon small businesses.
For example, it simplified the reporting and disclosure documents previously required for companies that generated under $1 billion in revenue. Another significant change was regarding the advertising of private placement offerings. It even made crowdfunding easier and made certain exemptions available to a broader range of securities issuers.
The new Act had a double purpose. On the one hand, it was designed to empower startups to raise capital. On the other hand, it also made it easier for retail investors to put their money in startups.
It was received with mixed opinions. Some argued that SEC regulations were too harsh for small securities issuers and startups, while others emphasized the need for transparency and oversight to prevent fraud.
Regardless, the JOBS Act was signed into law by the President, and it brought with it some interesting changes to the SEC Regulation D.
Nicknamed a safe harbor, Rule 506 outlines the requirements a private offering must meet to qualify for exemption under Regulation D, Section 4(2), of the Securities Act of 1933. Securities issuers who use the Rule 506 exemption can raise unlimited capital, but only if they meet very specific guidelines.
That means that companies or syndicators aren’t allowed to use general solicitation or advertise to the market except when they commit to accepting investments from accredited investors.
The SEC defines accredited investors by the following criteria:
- Individuals with an income of at least $200,000
- Individuals with a net worth of over $1 million
- Join income partnerships with a combined gross income of at least $300,000
- Banks and other financial institutions
- Organizations with assets worth over $5 million
Before the JOBS Act went into effect, a Rule 506 offering allowed issuers to also raise money from up to 35 non-accredited investors but were prevented from marketing their securities to them.
With the introduction of the JOBS Act of 2012, Rule 506 got separated into Rule 506(b) and Rule 506(c). Rule 506 remained virtually unchanged but renamed Rule 506(b), while the new Rule 506(c) enabled issuers to advertise their private placement offerings as long as they met certain requirements.
- Selling only to accredited investors
- Verifying the investor qualifications
The new statute essentially imposed on the SEC to lift the previous ban on general solicitation. After the JOBS Act amended Regulation D Rule 506, syndicators gained substantial benefits as no limit was placed on the capital they could raise.
The SEC also amended the Form D documentation to reflect the changes. Issuers can check a box indicating whether they’re filing under Rule 506(c) and engaging in general solicitation when filing the paperwork.
New Verification Requirements
Raising private capital for real estate is still easier than opting for an IPO and other methods. But that doesn’t mean that bifurcating Rule 506 into two different offering exemptions didn’t make things trickier for syndicators.
Whenever multiple choices are involved, there’s an inherent need to understand the legislation and legal criteria required to file under a specific exemption. No matter how simplified the private placement process is compared to public offerings, you’ll often still need the services of a syndication attorney.
Let’s go into some of the specific verification requirements of the amended provision so you can understand what it means for your future capital raising events.
On the surface, Rule 506(c) looks fantastic. It enables general solicitation and advertising, thus potentially allowing you to target even more investors. The farther your reach, the better your chances of getting the money you need to buy an income-generating property.
But there’s obviously a catch. This newer Regulation D regulation limits you to a single kind of investor – accredited investors. Unlike under the previous framework, you now have to take steps towards verifying that any investors interested in taking your offer are accredited, as per the SEC guidelines in Rule 501 of Regulation D, of the Securities Act of 1933.
Previously, you weren’t obligated to verify the validity of your investors’ claims. Things are different now if you want to benefit from general solicitation exemptions.
The new rule emphasizes investor verification through a principles-based approach and a list of non-exclusive methods to validate the accreditation.
Of course, the process itself doesn’t have to be strenuous. Looking at the facts and circumstances of a potential investor in the context of a transaction, you should be able to determine if said investor qualifies. The more likely qualified they appear to be, the more straightforward the accredited investor status verification.
Such verifications are often conducted by third parties.
With that in mind, what can you do to determine the accreditation status?
You can access vast amounts of information such as publicly available state, federal, and local filings with regulatory authorities. Property records, deeds, tax returns, W-2 forms, and even pay stubs can be used to make a proper assessment. Of course, relying on third-party verification service providers can be much faster.
According to the SEC, the process can be simplified even further by using a non-exclusive method of verification that applies to very distinct cases. For example, you can use this methodology when dealing with an investor you previously worked with on other deals. Once verified, the SEC would only require written representation from you that the investor in question continues to qualify as accredited.
But you’d have to be certain that the investor’s information is up to date.
When you don’t have an existing network of investors to target with your private offering, under Rule 506(c), you have to determine the accreditation of potential investors. As such, the following non-exclusive methods accepted by the SEC are essential to know.
- IRS Document Reviews
You can check copies of IRS forms filed by the investor, such as the 1099 and W-2 Forms. You may also look at the Schedule K-1 Form or solicit a copy of Form 1040 for the two previous years. In this case, it may be necessary to obtain a written representation from the investor claiming they can meet the minimum requirements of an accredited investor within the current year.
Note that the verification process should be extensive. That means that you need written representation from both spouses in a join investment scenario.
- Third-Party Written Confirmations
SEC-registered investment advisors, brokers, dealers, CPAs, and licensed attorneys can simplify the verification process for you. The SEC would accept written confirmation from these third-party entities if they completed the accreditation check within three months of filing your Form D.
Another type of accepted written confirmation is one that verifies a pre-existing accredited investor status from prior participation in a Rule 506(b) offering before Rule 506(c) was enacted.
You may also present a written representation obtained from an individual at the time of sale, stating that the person in question meets the accredited investor status and that you, as the issuer, took reasonable steps to verify their accreditation.
- Other Document Reviews
Satisfying your issuer obligations doesn’t always involve digging very deep into an investor’s background unless you want to be very thorough in your due diligence.
However, reviewing bank, brokerage, and securities holdings statements, certificates of deposit, appraiser reports, and other tax assessment statements, dated within three months of the sale, should be enough to meet the SEC Regulation D Rule 506(c) mandates. This is the case if you simultaneously provide a written representation of full liability disclosure.
It’s important to understand that making a private placement offering under Rule 506(c) involves more legwork. Sure, you can take advantage of general solicitation and marketing exemptions when done right.
But while the SEC may impose strict criteria, it still offers a lot of leeway. Therefore, there’s a lot of temptation to take the easy route, trust investors, and proceed with minimal research and written representations or confirmations.
While in theory and in practice, this can help streamline your dealings with the SEC, it can work against you too if it is revealed that some of your investors don’t meet the necessary accreditation status. This is where working with an experienced real estate syndication attorney can help you do your due diligence, ensure compliance, or figure out other avenues for raising private capital for real estate under Regulation D.
Make no mistake that the two variants of the old Rule 506 are the most popular ways to gain exempt status and raise money for syndication deals. However, there’s another rule worth mentioning that can be leveraged in specific scenarios.
Under rule 504, securities issuer can raise capital up to $10 million during 12 months. To present an offering under this Regulation, issuers must not be labeled as blank-check companies. Another requirement is not having to file reports, according to the Securities Exchange act of 1933.
This exemption usually prohibits issuers from advertising their securities and engaging in general public solicitation. Furthermore, any investors will receive restricted securities that can’t be sold without registration or meeting specific applicable exemption criteria.
Without working with a syndication attorney, you might not know that there are provisions under Rule 504 that enable issuers to solicit and advertise to the public while also offering non-restricted securities.
To qualify for this exemption, you have to meet one of three criteria. Firstly, you can advertise and solicit the general public if you register your private placement offering in at least one state that requires publicly filed registration statements and provide investors with disclosure documents.
The second scenario involves the sale of securities in states that require and don’t require registration and disclosure documents. Suppose you sell your offering in both and want to engage in solicitation. In that case, you must deliver disclosure documentation to investors in all states you do business in, even if there’s no state law requirement.
Alternatively, if you accept only accredited investors and meet state law exemptions governing these transactions, you may use public advertising for your Rule 504 private placement offering. It’s very similar to filing under Rule 506(b), but it comes with a limit on the maximum capital raised.
If you want to raise capital through Rule 504, understand that you’re not obligated to disclose delivery or registration, as long as you’re not looking to qualify for advertising and general solicitation provisions. Nevertheless, you’ll still have to participate in the Form D filing, as you would under Rules 506(b) and 506(c).
Before moving on to some of the fundraising methods you should consider, it’s important to touch on another common term regarding Regulation D – bad actor disqualification.
What Is a Bad Actor?
Not all securities issuers can raise private capital under Regulation D if they meet the criteria listed so far. The SEC has bad actor provisions in place to disqualify some issuers that aren’t perceived as trustworthy.
Charges of securities fraud, securities laws violations, convictions, and other similar situations are considered bad actor or disqualifying events. If you fit any of these categories, know that you could do everything right to structure your offer and target investors but still fail to meet the requirements for a Regulation D exemption.
A disqualification event is usually measured from the time of the sale. But it wasn’t always like this. Before 2020, the look-back period for disqualification events was longer because it was measured starting at the time the issuer filed an offering statement.
Raising Private Capital For Your Syndication With Regulation D
Becoming a successful real estate syndicator comes down to four things:
- Finding investors
- Locating properties
- Structuring the deal and managing the property profitably
Of the core elements that make a terrific syndicator, the first two are all about getting the funding you need.
As you can see, securities law is no walk in the park. That’s why research should become your top priority. You simply can’t afford any confusion regarding exemptions, qualifying criteria, how much money you can raise, how you can reach investors, filing forms, etc.
During your research, you’ll come across many three-letter agencies such as the SEC, IRS, and others that oversee and govern the real estate syndication market, securities issuers, and potential investors.
Even though Regulation D was enacted to eliminate, or minimize, some of the restrictions imposed by the SEC through the Securities Act of 1933, this section of the Act can still be challenging to navigate. Hence, the first step in raising private capital is to understand the various ways you can do it legally.
It might take a very long time to do so if you don’t have a syndication attorney advising you. And while there’s nothing wrong with getting comfortable with the legal aspects of securities and syndication, the time you spend learning is time you’re not going to spend putting deals together and finding investors.
Speaking of investors, this is another core element of raising capital.
Let’s say that you don’t need help with being compliant when creating Regulation D offerings. It doesn’t mean much if you can’t get investors interested in your offer. Even worse, it does little good if you can’t find investors.
Therefore, here are a couple of things to keep in mind.
The best thing about the SEC Regulation D exemption is that it enables securities issuers to bypass lots of red tape and raise capital faster. But experienced companies and syndicators may already have access to private groups or networks of accredited investors.
This means that it takes them no time to get the offer in front of the right individuals, businesses, and organizations. Furthermore, having access to a network of investors means that you wouldn’t have to worry about general public solicitation and advertising.
Immediately, all the legal guidance, investor verification, and other processes become simplified. So, to increase your chances of raising the funds you need to finalize a syndication deal, you should consider networking.
Like any other industry, networking and being an active community member can greatly increase your opportunities to succeed.
Besides, keep in mind that the easiest Regulation D offerings you can create are those that don’t rely on marketing and advertising. Thus, it’s helpful to get to know some investors, preferably with proven accreditation status. You’ll build your contacts list over time, establish relationships, and gain a certain level of trust that you can leverage in your offerings.
Try Raising More Than You Need
No matter how well you plan your spending, it’s never a bad idea to raise more than the exact amount you need. Some investors might back out of a promise at the last moment. Of course, you’re trying to do the best job you can in convincing them of your offering’s profitability.
Still, you can’t afford to delay your proposed timeline. It would make you seem unprofessional or inexperienced to investors who are interested in signing the documents and becoming limited partners.
Over time, you’ll become a better and more trusted syndicator. Therefore, you’ll be more likely to have the same accredited investors follow you into multiple offerings, and you’ll see your dropout rate reduced.
But even when your reputation isn’t in question, you should still raise more. Do you need $5 million for your next offering?
Why not set your mental target at $6,250,000? That extra 25% cushion can come in handy if unexpected liquidity concerns come up, investors spot better deals, or someone loses their accredited investor status.
Inform and Educate Investors
Want to work your way towards raising unlimited capital for your syndication through Regulation D? You need to earn investors’ trust and make them see the same dollar signs that you see in any given deal.
One effective strategy is to use the 50% rule. This is particularly helpful when dealing with new investors, first-timers, or individuals who don’t know the real estate syndication sector.
The rule states that you should encourage investors to come in on the deal at 50% of what they would be inclined to commit. For example, if an investor would be willing to put up $1 million, you could advise them to come in at $500,000. This rule aims to earn trust and give investors enough time to understand the business model and see it in action with less risk incurred on their part.
Thus, as you create other offers, you’ll have more credibility, trust, and investors should be more likely to invest more in future deals. The same rule can be applied when working with known investors.
If you want to put together multiple deals in succession, understand that your investors might be working with limited capital. Therefore, it makes sense to create that cushion or backup plan for future funding of new opportunities.
When selling equity in an income-generating property under Regulation D, you have to meet very specific requirements to qualify for this Securities Act exemption. Legally, you’re typically only obligated to file Form D with the SEC and nothing else.
Be that as it may, disclosing material facts regarding your business, the industry, and the offering itself is necessary.
Raising private capital is much easier when you provide investors with ample information and documentation. In this case – a comprehensive private placement memorandum, or PPM.
A PPM is a document you always hear about in syndication circles and securities law. It’s a legal document that makes potential investors aware of everything from your background to offering risks to potential and promised profits and ROI.
The PPM is your opportunity to shoot two birds with one stone. On the one hand, it keeps you honest and holds you to a clear process to ensure compliance with Regulation D, qualifying your offer for exemption.
On the other hand, it’s in most cases your only way to advertise your offering to accredited investors. While a significant portion of a PPM is dedicated to explaining risks, disclosing bad actor events, presenting your financials and the terms of the deal, another serves a more marketing-oriented purpose.
Oftentimes, syndicators and other securities issuers can mistakenly think of a PPM as a business plan. In reality, the PPM can contain your business plan along with other more factual or less-speculative information.
This is another area in which real estate syndicators struggle. Drafting an offering-specific PPM almost always requires input and guidance from a syndication attorney. The paperwork itself touches on many of the requirements your offering must meet to qualify for the Reg D exemption. As such, creating a PPM that would minimize your exposure to litigation needs a mind with legal experience.
Don’t Limit Your Reach
Many syndicators are afraid to step outside their local sphere of influence. But here’s the thing about real estate. You can buy property two states over and still have your business registered in your state of residence.
You can be a New York native, live in Washington D.C while operating and managing a real estate syndication business in Nebraska, and partner with Californian accredited investors. Syndication is a nationwide, even global, business venture.
When raising private capital for real estate, you shouldn’t be afraid. If you can’t seem to get enough funding from a handful of trusted investors, simply expand your reach. There are ways to make your offering meet Regulation D exemption criteria while working with investors across multiple states and investing in properties hundreds of miles away from your main office.
To raise unlimited capital, you need to tap into a vast enough network of investors. And if the only thing stopping you is a lack of knowledge regarding securities laws and regulations, enlisting a syndication attorney can quickly turn things around in your favor.
Find Profitable Properties
It’s worth touching on this principle for a moment because not everything about raising capital involves navigating state and federal securities laws and exemptions.
The first rule of raising money under Regulation D is to know how you can do it and what investors you can target. But that’s an area where legal assistance can streamline the process for you.
However, it’s your job as a syndicator to find great properties, negotiate a sale, and present investors with highly lucrative investment opportunities.
With that in mind, you should focus on learning the differences between Class A, B, and C properties. Each property class comes with a long list of pros and cons. Finding the right balance will allow you to target profitable buildings with solid cash flow generation and above-average market appreciation over time.
If you don’t present investors with something enticing and reliable enough, it doesn’t matter how compliant you are with state and federal regulations. You need to get investors to bite to make everyone money.
Experiment with Profit Distribution Structures
As part of the business plan section in the PPM, you’ll have the chance to educate investors on profit splits. Syndication deals often involve syndication waterfall profit distribution structures. These consider principal payments, cash flow thresholds, and investor classes to deliver an equitable sharing of the profit.
It will take time to find the winning formula since not all investors might have similar short and long-term goals. Regardless, your profit distribution structure serves as a marketing tool and could make the difference between raising $5 million and $50 million for your next private placement offering.
Being a 1% Syndicator Is Possible
If you want to be a top-level syndicator, you have to start thinking of this as running any other business. You’re creating a business out of buying income-generating properties with money from accredited or non-accredited investors on the private market. The more great deals you make, the more access you’ll have to other investors and even more money.
It’s truly a niche of the real estate industry in which you can snowball into wealth and prestige.
But in terms of running a business, some things never change regardless of the industry. You won’t be able to know and micromanage everything. In this particular instance, the legal environment surrounding securities, registrations, and exemptions, it a tough area to master.
And it’s not as if you don’t have other things to focus on as a syndicator: identifying properties, convincing investors, structuring deals, managing properties, etc.
One of the best things you can do to give yourself the edge over many of your competitors is to accept help in areas where you lack expertise. The world’s largest brands are successful because their leaders filled essential roles with the right people instead of attempting to become experts in everything. When you’re ready to take your syndication game to the next level and reduce your time, energy, and financial costs of navigating the legal framework of securities, remember that a syndication attorney can help you do that.