My plan WAS to get several family/friend investors to lend to me Personallly (or my llc) unsecured money....SEC issues?

Question

I THOUGHT I had a good idea, but now reading about SEC I am not sure. I am working hard right now on my business plan and investment proposal because my plan is to ask for loans from some people I know who have money. These were not going to be based on any deals. My goal is to raise $300,000 in unsecured loans (or possibly secure with equity on my primary residence but that's another post all together). They'd lend me the money at a rate we agree on, and a term we agree on. The money would then be mine, in my account. I would use this money however I needed, paying cash to buy flips, paying for down payments if I get a loan, paying for renovation costs on seller financed flips...really whatever I wanted, however I wanted/needed.

Basically my question is, is there a problem with this? I don't know much about the SEC and what kinds of loans fall under their guidelines. I guess I thought this wouldn't...because I will be the only one on the deeds, these would be cash deals as far as purchasing is concerned.

Please let me know what you know. And more questions on this raising of funds I am working on will come later! ;-)

Jon Holdman · Answer

@Amy Solomon if you get one person to loan you enough money to do one deal and give them a security interest in the property you're flipping, you are probably OK. By security interest I mean a mortgage or deed of trust or whatever is used in FL. As @Ned Carey points out, even this may be considered a security. However, this is quite commonly done. This is the classical "private lender" situation. OTOH, if you have two or more people funding the deal, and if they don't have a security interest in the property, then you have just created a partnership. No formal paperwork is required, its automatic. When people are investing money into your partnership, you're "selling securities". Sorry you don't like this, most folks trying to do this don't like it either. But this is the legal situation. Yes, you can of course get loans from friends and do whatever you want with the money. Its a dangerous road. And you've already run off the smooth part of this road into the very rocky part when you write: "In fact, I may be OVER confident in my abilities to not lose money." Yes, you are. If you do this right you will give your investors two key documents - a "private placement memorandum", which describes the investment they're making, and an "operating agreement", which describes how you will run your company. The private placement memorandum, or PPM, will contain words very much like "This is a terrible investment. You will lose all your money. Only an idiot would make this investment. If you lose all your money, don't blame me." That last bit is key and will be repeated throughout this paperwork. It is a key point for your investors. This paperwork is primarily meant to protect you. Not your investors. They're admitting they're idiots by signing. YOU. At this point you must assume this investment will go badly. You must assume that you will lose money and your investors will want to sue you. Family or not. So this paperwork is designed to protect you when that happens. If you do a deal like this without this paperwork you are not only improperly selling securities but you're leaving yourself in a much weaker position if things do go badly. Its very easy at this point in this project's lifecycle to see the upside. It is absolutely essential for you to also take a hard look at the downside. If you cannot do that now you have no business going down this road. Because bad things do happen. Any number of things could happen that cause you to need an extra $10K or more. I made a loan to a rehabber who got only some of the permits they needed. My mistake for not figuring it out. His mistake for not doing it. He got caught. He ran out of money and couldn't finish. I only lost a few grand on the deal. He lost about $30K. If you cannot think through such situations now, when things are calm and there is no money or feelings on the line., you're sure not going to be able to work them out later when they, inevitably, come up. If you can only see the "happy path" as we call it when writing software you don't yet have the full picture of actually doing this work. I'm sorry, but yes, you are very naive. Have you ever actually fix and flipped a house? I get the impression you have not, but perhaps I'm mistaken. Transaction costs on buying and selling a house will eat 10% of the sales price. A few cosmetic updates will rarely generate the sort of price increase to cover those costs. A rule of thumb is that your purchase price plus rehab costs must be less than 70% of the price you'll get when you sell. If you do that you will have good returns for your investors and a nice profit for yourself. You seem very confident you can find those deals, which tells me you've not done it. These deals are VERY hard to find. Its also very easy to fool yourself into thinking you have such a deal only to find you've underestimated the rehab budget and overestimated the selling price. Like my rehabber above who was experienced and was a real estate agent.

Jon Holdman · Answer

Getting individual loans is generally considered to be OK. OTOH, if that money is being pooled together into a company that then does something with it (what isn't important), you're "selling securities". That is governed by SEC and state regulations. You're on the right track with getting money from people you know. To formalize this you should create an entity, do the property "private placement" paperwork and register your offering. This would be under Regulation D, chapter 504, 505 or 506. You will need a securities attorney and this will be somewhere between $10K and $25K to do the paperwork. But this is the proper way to pool money.

Shawn Dandridge · Answer

The SEC is a joke. They couldn't even stop Madoff who was stealing hundreds of millions in plain sight. I say go with your original plan, I don't think you have anything to worry about.

Bryan L. · Answer

If you are looking for "the right Realtor", consider becoming a Realtor yourself. IMHO, if you plan to buy listed properties, it's the only way to go.

Amy Solomon · Answer

@Jon Holdman Thank you so much for taking the time to write back with such a lengthy post. Some great information. However, I don't only see the happy path. I know there are many things that can go wrong. I also know much of this can be prevented by taking the time to find the right deal. I also know that not going ALL IN can also prevent a HUGE number of issues. I see investors use every last cent for a flip before they even get started. Meaning they have no way to buy themselves out of trouble. I don't go into any reno without proper budgeting, and having at least $10,000 - $20,000 left over. That's my personal way that I try and protect myself as best as possible. I've had to dip into those funds before, thankfully they were there for me. I am not an experienced flipper, no. But I have bought, renovated and rented out 4 homes since 2006. I have what 8 years or so in the real estate industry. This is all I've ever wanted so experience or not, I can and WILL succeed with the right information, training and support...much of which I find here on this site from kind people such as yourself. I might need to start a new thread to continue this topic, but I will post here first to see how it goes. Ok, so let's put pooling funds from personal loans on the back burner. I am working all sorts of angles to try and get funding. What if I keep each investor's funds separate and use them for separate properties. IF I am working with more than 1 house at a time, using different investors, should I have multiple LLCs or can I use the same LCC for different properties with different lenders. Here are some other thoughts/ideas. I feel that I might be able to get small unsecured loans. $25,000-$50,000 or so. If so, can I just take that money, get with a HML or even a conventional lender or home path and work on 1-2 houses at a time with that money...with only the one investor involved? I also feel that I may be able to get money secured by the specific property I will be buying. Perhaps up to $200,000. Can you please point me in the direction of where I can go to read up on how to structure such deals with my private lender and what documents I'd want, how to get the deals written up, etc. I feel that I also might be able to get a family member to give me a 2nd mortgage on my home. I have about $100,000 in equity and I am not eligible for a conventional heloc at this time. I could then use that money on a deal without using funds from another investor. Can you direct me to information on how to structure this deal and get this deal written up? These are some of the things I am thinking about/working on. What are your thoughts? I am also in the midst of trying to find the right realtor to help me. I think the first several properties I buy will range from $30,000 - $60,000 in price. I don't want a realtor to think I am not worth their time. I also really want someone who is on top of the REO game but also not someone who is always giving me sloppy seconds that their other investors didn't want. Tall order isn't it? I tried using my personal realtor, I've purchased 2 homes from her in the past 2 years, but it was quickly apparent she wasn't the right realtor for what I am looking for now. Thanks all for reading and commenting....

Ellis San Jose · Answer

I have done Reg D, & other forms of joint ventures. Nothing in this business is without risk. I am happy to hear you have done research & are aware of the potential pitfalls. Pooling money raises your fiduciary responsibility and liability. The amount of money you need to raise you are talking about won't make sense in a Reg D. offering. Either have one lender per loan with secured against property. Or they get title and you have an option to buy it from them.

Jeff Greenberg · Answer

I do believe that if you stay in your state with your investors and the investments are also in that state, you are clear of the sec. You will however have to abide by the state securities. The problem is this. You can do a dozen of deals and eveything go great, but all it takes is one to go sour and someone call foul.

Bryan L. · Answer

@Amy Solomon - Amy, I'm no attorney and I am not giving legal advice. But let me ask you this? How in the heck is the SEC even going to know? Our government gets in our lives too much and why do we think that we have to do everything that the government tells us to do? Really, is it any of their friggin business? Again, I'm no Constitutional Law Professor like some famous person that we all know, but when I read the Constitution, the Feds only have power to regulate interstate commerce. So, if you are working with a few local people in your own state to fund projects that will also be in your own state, then where does the SEC think that they have any right to do anything with that? Sorry, that's just my somewhat libertarian rant for the day.

Shawn Dandridge · Answer

@Amy Solomon You should be covered under Regulation D of the Securities Act of 1933. I have pooled money together for a couple of investments, not real estate more like a private equity fund. If you want more reading I would start here: http://en.wikipedia.org/wiki/Regulation_D_(SEC) Generally as long as you're under the 5 mil mark your good. I'm not an attorney so don't take my own personal experiences as the gospel. You should still check with an attorney for your own piece of mind.

Steve Ramsey · Answer

You might try partnering on one deal at a time with one individual at a time. You could sign a note to the lender and have a lien on the note. If they trust you, a simple approach would be to get a promissory note and then have it notarized. You don't even have to file it at the courthouse most likely (check into that). You can find them online for free or cheap. This keeps it from appearing to be a "gift" in the eyes of the IRS. Eventually, after a few of these deals, you won't need their money at all. You could have more than one deal going at a time with different partner/lenders. I would caution you to go slowly. One bad deal can offset 5 good ones.