You can start a business, especially a service business, on a shoestring budget. But it’s tough to start real estate investing with no money. If you don’t have your own money, you’ll need to use OPM. OPM is other people’s money.
One idea I hear on a regular basis is, “I’ll start a syndication!”
In this article, we’re going to look at what it takes to start a syndicate. If you skip a step, you can get into a lot of trouble. It’s important to understand the rules and hire professionals. If anyone tells you that you can “do-it-yourself”, be very wary. That’s especially true if it’s your first time with such a structure. If you break one of the rules you can get heavy fines with the SEC and even face jail time.
Here are some basic things you will need to have in place before you meet with your legal team.
Who will your partners be? Not the money guys, but the people actually doing the work. What will they do? What experience do they bring? You need to make sure your team has successfully implemented the type of deal you’re putting together. Without that experience, you have a greater chance of failure. That becomes a lot more problematic when you’re investing with other people’s money.
You need to have a solid plan for handling worst case scenarios. Assume things will take longer to get to profit and it’s going to cost you more money. How will you raise extra money if you need it?
When you buy a property or properties, you will need to make sure adequate due diligence has been performed. It’s not just your money that’s at risk now. It’s other people’s money as well.
How often and how will you communicate with your investors? Lack of communication makes investors nervous and that never ends up well.
That’s just the beginning of the things you’ll need to consider. There are some other serious legal issues to consider.
A syndication is a security and that means you must follow securities law governed by the Securities and Exchange Commission. Before you take a single penny from an investor, you must have the proper documents drafted and registered. You’ll need to have a securities attorney on board to sign off that you have followed the rules. Plus, make sure the money doesn’t touch your hands. It goes directly into a business account.
Accredited Investors and Sophisticated Investors
You’re going to hear a couple of terms that are important as you’re raising money for your syndicate. That is accredited investors and sophisticated investors.
Accredited investors are investors that are allowed to participate in unregistered security offerings. In other words, if your investors are accredited, the requirements required of you, the syndicator, are less.
Your investors need to meet at least one of the following:
Net worth exceeding $1 million, excluding primary home
Have an annual income of $200,000 if individual or $300,000 for married, filing jointly for the preceding 2 years,
Be a general partner, executive officer or director of the owners are accredited,
Be a private business entity with over $5 mill in assets, or
Hold certain professional certifications related to SEC license.
A sophisticated investor is a high-net-worth individual who has extensive market experience and knowledge. This definition is a little more nebulous. In the US, a sophisticated investor has “sufficient knowledge and experience in financial and business matters.” A sophisticated investor may not have the wealth or income to qualified as accredited, but they need to have needed knowledge.
Some syndication offers will allow up to 35 sophisticated investors. However, not all do. This is something you need to discuss with your legal team.
It’s tempting to want to jump into raising money for real estate, especially if you find a project that looks promising. Proceed carefully, though.
