506(b) Exploration and Advice Needed

[Beau Brockway]

Hello, 

My business partner and I have just set up our LLC and are beginning to source properties for our first purchase under our LLC. We are purchasing our first property(s) by using a funding source from someone we know personally, with the commitment to pay that person back what they lent us, plus a 2.75% interest rate.

After having listened to episode 354 on the Bigger Pockets podcast, we feel like we may be very closely resembling a 506(b) approach. We do not plan on the 506(c) approach but would love to get to that after we get to a certain size and have demonstrated our ability to do this successfully. Before we make any purchase, we want to determine if we should explore a 506(b) more formally. 

We are eager to learn and do this the right way, so are seeking any advice or insight when it comes to 506(b) funding/investing and how to operate correctly and legally under this structure. Any advice, documents or web pages that can get us pointed in the right direction would be great. Some initial questions that come to mind are below: 

1) What do we have to do to operate formally/legally in a 506(b) structure? 
2) What are the downsides of a 506(b) structure? 
3) What are the upsides of a 506(b) structure?
4) Does a 506(b) replace an LLC or operate in-tandem to an LLC?
5) Can the initial 506(b) funding serve as a down payment for a property and the remainder of the property be financed through a bank?
 

[Taylor L.]

Many of these questions are addressed in free or low-cost books from syndication attorneys. Check out Mauricio Rauld's YouTube Channel and just watch a ton of those videos. He'll clear a lot up for you. 

506(b) is an exemption in Regulation D that allows you to raise capital from passive investors under certain conditions. It is not a corporate structure like an LLC or a JV, that is separate.

Generally speaking, the upsides are that you can have investors who are both accredited (unlimited number) and non-accredited/sophisticated (up to 35). The downside is that you cannot publicly solicit. More details are laid out in the link to the SEC's website I put above.

Many syndicators use LLCs to hold properties. Common setup is investors get Class A shares, which have limited voting rights but own a majority of the equity. The syndicator gets Class B shares, which have the rights to control and operate the company and make important decisions. These days I'm seeing more and more types of passive investor shares, with different waterfall structures and minimum investments.

It is very common to use bank financing with investors contributing most or all of the downpayment and capital expenditure money. The lender will want you to have money in the deal as well.

Not a lawyer, just a guy who likes 506(b)s :)