Hey, everyone. Maricio here, legal advisor to Ken McElroy.com.
And today we're going to talk about the five things
every syndicator must know to stay out of jail.
Now, I will admit the jail is probably a longshot
unless you're out there defrauding investors and committing,
you know, flat out fraud like Bernie Madoff.
The odds of you going to jail are slim.
However, the consequences of violating securities laws are actually
pretty severe.
And what I found lately especially, is that people just don't
tend to take securities laws
that seriously, which is why I wanted to come up with a title.
I wanted to get your attention.
You can certainly go to jail, so that's not out of the question.
But hopefully, if you're listening in this video,
you're not in the business of trying to proactively defraud your investors
or come up with Ponzi schemes or what have you.
So probably not going to go to jail, but there are some very, very significant
consequences to violating securities laws, which are by the way, primarily
number one is restitution, which means even if it wasn't your fault,
if you violated securities laws,
you're going to have to return all of your investors money plus interest.
Those are the rescission rights, which essentially means
you're guaranteeing your investors money, meaning they invested money with you
and maybe the deal blew up no fault of your own.
There was a financial crisis like there was in 2008.
Doesn't matter that it wasn't your fault if you didn't follow the securities laws,
that's going to be your violation.
You're going to have to give their money back, which tends to not be there.
If your deals blown up,
you probably don't have the 2 million, 5 million, $10 million that you raise.
And so the next consequences, obviously, is bankruptcy.
You have to file for bankruptcy, which is obviously a very severe consequence.
And third of all, it's
very likely that you're going to be barred from raising capital
for a certain amount of time in the future.
So if this is your business having that ability
to actually raise capital
and be barred for three, five, ten years is not something you want.
So these are very serious consequences and I feel like people aren't necessarily
taking them seriously.
So here are five things that every syndicator must know to stay out of jail.
Number one, creatively structuring your real estate syndications
to avoid securities laws won't work.
Now, this gets broken down into sort of two categories.
One are the brand new syndicators who don't know any better.
And then there's the seasoned investors who know better,
but they just think that they're going to get creative.
One of the things to understand, and we've spoken about this before
and prior videos that you can check out over here,
is that the definition of a security is that any time you take money
from passive investors where the returns are generated by your efforts,
that is the security and the structure itself doesn't matter.
So I see a lot of people trying to put together deals where,
hey, we'll do a joint venture or Hey, we'll do a side agreement
or we'll do a promissory note or we'll do some side contract
in order to avoid securities laws.
None of that matters.
The SCC doesn't care how you structure syndication.
They're going to look right through it and see at the end of the day,
are the returns being generated by your efforts.
And if that's the case, it's going to be a security.
Now, that's a big deal for new syndicators
because a lot of times they just don't know.
They're just going out there and they're buying a piece of property.
And the reason, a couple hundred grand
and they don't realize
that what they're doing is syndication, but that's not going to get
them out of trouble.
Remember, ignorance of the law is not an excuse or not a defense.
And so even though you're not aware
that you're violating securities laws, you are still filing security laws.
And on the season side,
I just know a lot of people are trying to get creative
and trying to put some
really spicy structures together to avoid securities laws.
And none of that's going to work.
And like I mentioned earlier, probably my favorite ones,
the ones I see
the most, is this issue of calling something
a joint venture or saying, hey, this is not a security, it's a joint venture.
At the end of the day, the FCC is going to look straight through that.
And if anybody on that joint venture team is passive
and they're not doing any work or they're not carrying their weight,
that's going to be it's going to be a security.
And so I encourage you to check out the of macro video that I did not too long ago
that talks about, you know, when is when is a deal a joint venture.
Number two, the FCC has zero tolerance when it comes to advertising your deal
on social media when you're not supposed to remember that
if you're doing certain type of exemptions, primarily A, five or six B,
you're not allowed to advertise your deal or generally solicit.
For some reason, people don't think that applies
to their social media post when it absolutely, absolutely does.
So any post that you put on social media that actually talks about your deal,
hey, I've got 100 unit apartment building and I'm raising $1,000,000.
Call me.
Clearly that's advertising clear that generally solicitation
would still be prohibited
if you're relying on an exemption that doesn't allow it.
But there's also something called conditioning the market.
So any time you post something on social media
that gets people excited about your deal, even though you don't reference it
specifically, that can also become or be considered an offer by the FCC,
which would be covered under the advertising rules.
Now, this is one of the reasons that I typically recommend
that if you're doing an active deal, you're actually currently raising capital.
My recommendation would be to stay off social media.
If you're doing A, five or six B or some other exemption
that prohibits advertising, there's just too much uncertainty.
And it's very easy for the FCC to come back at you and say, hey,
that post or this post is something that is conditioning the market
or you're promoting your deal and that would effectively blow
your five or six B exemption and you would now have an unregistered security.
So any time you're doing a deal, be very, very careful and check
with your securities attorneys before you post anything on social media,
because there's no difference between social media and a TV
and a newspaper ad that's considered advertising.
And the FCC has zero tolerance for that.
Number three is that you cannot pay, unlike people, to help you raise money.
This has really become a big deal lately, and there's a lot of people
doing it right now.
But if somebody helps you raise capital, makes a referral or literally
goes out and raises capital for you, you can not pay them to do that.
You need to have a broker, an SEC, broker, dealer license in order to do that,
just like you need a medical license to practice medicine or a legal license
to practice law.
If you're going to be in the business of raising capital for other people,
you need a broker dealer license under FINRA or the FCC.
Now, this applies not only for straight cash purposes,
but it also applies when
you have a large group of general partners or a large group of sponsors
where one or two of the
sponsors aren't doing anything substantial other than raising money.
This happens all the time.
And in fact, I get emails all the time about people saying, Hey, Mauricio,
I can go and raise $1,000,000 for your deal or $2 million for the deal.
And they literally want to have
a piece of the pie, a piece of the pie in exchange for how much money
they raise and contingent on happened upon how much money they raise.
So for example, hey, if I bring in $1,000,000, can I get 5% of your GP?
Or if I bring in $2 million, can I get 10% of your GP?
That is what we call transaction based compensation
and that is the hallmark of broker dealer activity.
So if you are in the business
of getting people to refer you some investors, that's fine.
The referral part is fine, but you cannot pay them.
And to be honest with you,
this has really become a major issue because many, many people are doing that
and that's kind of the excuse like I'm hearing, well, everybody's doing it,
but that's going to become an issue very shortly.
When things start to turn a little bit, they're going to be looking at that
quite a bit.
So make sure you're not paying capital raise.
In fact, don't even call them capital raises
because you cannot pay capital raisers to go raise money for your deal.
Specifically, if you're a GP or a general partner
and you're trying to argue that you're not getting compensated
or simply raise capital, you have to be doing essentially three things.
Number one, not getting paid transaction based compensation,
because as we said earlier, that's the hallmark of broker dealer.
You have to be doing what we call substantial duties.
You've got to be a real co-sponsor.
You've got to be rolling up your sleeves
and doing the work like every other syndicator.
You can't just go out there, raise money, and then once a deal is done,
you go home and not do very much. You've got to be at managing.
You've got to be doing the thing.
And then number three, your primary role, your primary responsibilities
needs to be doing those substantial duties and not primarily raising capital.
That was kind of an easy are you spending more time raising capital
or you're raising are you spending more time actually doing the thing?
So if you can prove those three things, then you're going to not be
considered a capital raiser.
But if you're just out there raising money for your team
and then once the deal closes, you're nowhere to be found,
you're a capital raiser and you cannot get compensated,
whether it's cash or interest as a capital raiser.
Number four, syndicators need to understand
what a preexisting thing substantive relationship is.
This is the key on a specific exemption,
which most people use, which is the five or six B exemption in order.
Since you cannot advertise and you cannot generally solicit
in order to be able to have an investor committed to your deal,
you generally have to have what we call a preexisting substantive relationship.
You can't just meet somebody to conference one day, get them on your mailing list,
and then the next day
send them a deal
because you have to have a substantive relationship with your investor
or your potential investor, which we'll talk about in a second.
And that relationship must predate the offering,
must predate your syndication.
So once your syndication starts,
you mathematically can't have a preexisting substantive relationship.
So you've got to enter into the relationship first.
And then once you've established
that substantive relationship, then you can offer them a future deal.
They're not even eligible for your current one.
So what exactly is a substantive relationship or
maybe a better way to frame it is how do you take a complete stranger
that you met on social media, or maybe you met on an event a seminar or something?
You got their contact information.
What are the steps
that you need to take in order to take them from a complete stranger
over to somebody that you have a preexisting relationship with?
And we have talked about this in a prior video,
which we'll link up below,
but the probably the two most important, there's actually eight of them,
but the two most important are number one,
to send them a questionnaire, a very detailed questionnaire,
where you can actually find out pertinent information about your perspective.
Investor not just are they accredited and what's your favorite color, but,
you know, what are their goals, what is their experiences?
You know, are they looking for cash flow, looking for equity?
Are they aggressively conservative,
you know, really trying to get a good understanding
of what type of investor they are because you're trying to determine whether
these investments are suitable for those investors.
So step number one would be to send out a questionnaire,
get that completed and set back to you.
And then number two, you've got to get in front of them
phone call, lunch, coffee, whatever it takes.
But you want to have a one
on one interactions or your team should have one on one interactions.
Go through the questionnaire, go through what your philosophy is asked
about their philosophy is, ask them what their goals are, and get to a point
where you really get to know that's what the SCC is really looking for.
They're looking for that.
They want you to foster that relationship with your prospective investors
that at the end of the day you can sit back and say, Hey, look,
I spent enough time with my investor that I believe
that they are sophisticated enough to invest in my deal.
And whenever that date happens, that's the date
that you have a substantive relationship with your investor
and you could offer them a future deal
because again, you have to have a preexisting substantive relationship.
And probably
the most important thing of all of this is make sure you're documenting
make sure you're documenting your emails with your investors, your phone calls.
Some clients record their phone calls.
Just make sure that you can document this process
so that if it's ever questioned by the regulators, you can show them a file
and you can show them all the steps you took to take them from a complete
stranger to somebody that you have a substantive relationship with.
Number five, don't use other people's PPM templates.
One of the things we have to do, obviously, is provide the investors
with a private placement memorandum or a PM,
which are all the disclosures that we must provide to investors.
There's a bazillion PMS on the Internet.
You can go on the Internet, you can grab one for free,
or you can go on the SCC website and you get other people's easily.
And I know too many people actually do that,
but the templates are the PM itself.
They're kind of worthless.
They're really more of a what I like to call a pipeline or a
a conduit where you're actually you have to stuff that with information.
You've got to put the disclosures and the risks and all that information
pertaining to your specific situation, the information about your sponsors, risks
from your sponsors, information about the market, information
about your specific property, information about your specific financing product.
So just having a generic PPM isn't going to be sufficient
to provide your investors with all the disclosures.
And remember, what the SEC's really looking for is
you want to make
sure you're giving the investor all of the information that they need
so that they can make an intelligent decision
as to whether this is an investment that they want to make
and just handing them some templated PM with sort of boilerplate language
isn't going to fulfill your requirement to give them all of those disclaimers.