Private investor ready...whats the first step?

Question

HI everyone,

I'm looking to get started on my 2nd project and I have a potential private investor who has expressed interest in getting involved with me but strictly on an investor level.

I've read enough to know that this may be a great resource but I need some direction to set it up correctly.

I would love to hear more about how you all have dealt with investors?  How did you structure your proposal? What were your offers to them in terms of return? length of time?

Any of your best practices in dealing with a willing private investor would be greatly appreciated!

Thanks in advance.

J Scott · Answer

As usual, I'm not a legal professional or an expert in this area, but I don't believe this information is correct...I certainly could be wrong though...

As long as the borrower isn't publicly soliciting for the investment, I see nothing wrong with an investor making a passive investment.  If that were the case, every time my brother wanted to borrow $20 and promised to pay me back $25, I'd have to register with the SEC...  :)

As for structuring the deal, the way I do it is offer a first mortgage lien against the property with a fixed interest rate for some period of time.  Generally, I borrow from private investors at 1 point upfront, 8% interest for 6 months.  My investors have been happy with that return, as have I.

Bryan Hancock · Answer

I'm not an attorney either, but the advice above is correct IMO.  The Howey Case is the landmark case for defining what constitutes a security:

Howey Case

1.  investment of money due to
2.  an expectation of profits arising from
3.  a common enterprise
4.  which depends solely on the efforts of a promoter or third party

Item 4 ties in to voting rights and such.  The rules get very murky at this point and I am sure some de minimis rules apply.  Small, private money loans are still securities the way I read things though and you need to be careful.  There are always exemptions you can fall under too and I think the 504 exemption says that if you raise funds all in one state beneath $1M you have some exemptions.  That may be why these loans are overlooked some.  Maybe Don K. or some more experienced investors can jump in and comment here.

Publicly soliciting is not allowed even if you have a PPM and some exemptions.  See the SEC site:

SEC Q&A For Small Businesses

Be careful...consult an attorney.  Do things the right way!  This is one area where you don't want to skimp.  People get thrown IN JAIL for doing things the wrong way with raising funds.

Account Closed · Answer

it was my understanding that you couldnt' solicit for these investors..it sounds like there's already a preexisting relationship here though...could be wrong

Account Closed · Answer

i would determine what the money is worth to you and offer that...when i first started out, i offered different options, and it just confused the potential investors and added more questions and concerns of theirs...i now give them my offer, and that's the offer...why don't you find out what he's looking for, and then prepare your offer??  some investors want ownership bc they want the appreciation potential, others want monthly cashflow payments, etc.

Rob Gillespie · Answer

First, I would not get paralysis of analysis. Everyone on here brings up good points, but there are always reasons why something is a little gray. The biggest thing to worry about is do you have the ability to pay the investor back? You need this deal to be so solid that you can screw it up 15 different ways and still make money. Problems occur when people loose money, no one ever complains over making a profit.
I would structure the deal with giving your partner a first mortgage at a very low LTV. I would have the investor order an appraisal as is, and subject to value. The investor needs to sign off that he or she accepts the values. I would also have them sign a disclosure that this is understood to be a business loan for business purposes, and you are not giving a guarantee beyond what the note states. 
I would structure the note as a zero coupon note. This means that no payments are due throughout the term. Interest will accrue, but not compound. This will help with cash flow while working on selling or refinancing the project. You can make payments if you wish to lower the burden at the end of the term, but it is not necessary.      ( make sure you factor in the interest due throughout and make sure it does not leave you up side down at the end of the day.)
Finally, give yourself a nice balloon time with and extension clause if necessary. 6 months goes really quickly, I would shoot for 24 months at a minimum.

Bryan Hancock · Answer

Apparently Section 3(a)(11) of the Securities Act:

See Section 3(a)(11) of the Securities Act Here

offers and exemption too.  See part VI of the SEC Q&A above. My guess is that this is the exemption most private money borrowers would rely on when using funds.

JScott is right that first position DOTs are the way to go when using funds.  That gives the lender security interest for the loan and you some peace of mind.

Sagnik Lahiri · Answer

Thanks for the responses, guys.  I appreciate everyones input.  To further clarify my situation, it's a friend of mine that recently sold two businesses and has seen what I have done with my first property.  He has made a serious amount of cash...which is not working for him at this point in time.

He offered to "partner up" by providing the financing for my next deal.  At that point, I had no idea what to offer...or how to structure.

Since I did my first deal borrowing $ from family...I wasn't sure how to move onto the next stage...with what I called a private investor.

He's looking for a strict % return without having to get involved.  I will be sure to read and re-read the responses above and proceed.

Feel free to add more if you wish!  
Thanks, again

Bryan Hancock · Answer

I agree that analysis paralysis may be creeping in a bit, but things need to be done properly.  I also agree that making sure you can pay the loan back even in the worst case is the best way to stay out of trouble.

Some of the commentary above was in response to general solicitation, which is not permissible even with a PPM.  Even full scale registration only allows for "tombstone ads" and such.  You can't go blasting information all over the web about how you are going to make everyone a bunch of money on your investments.  My former business partner was working with a local guy who just had the state securities commission come and and close the place down.  The guy running the company will likely go to jail too after ignoring a C&D letter.

Justin S. · Answer

Sagnik-

It depends on what your investors comfort level is with you.  Are they willing to lend in 1st position with set interest rate, or a profit share, or unsecured note or 2nd position note?  If you let us know that, we can answer your question better.

Private investor ready...whats the first step?

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