When is it syndication?

Question

I’ve done some flips in the past using multiple investors.  I’m thinking about buying a portfolio and would need to get 5+ investors together.  Can I do this without it being classified as a syndication?

J Scott · Answer

Very generally speaking, if you're pooling money from investors who don't have any control over the investment (they are just passive investors), that's going to be governed by SEC regulation.  If the investors share control (they have decision-making authority), that is a partnership and is not governed by SEC regulation.

Jerel Ehlert · Answer

What you are really asking is: When is it an investment contract?  The US Supreme Court answered this in SEC v. W. J. Howey Co., and came up with the Howey rule:  "a contract, transaction or scheme whereby a person invests his money in  a common enterprise and is led to expect profits solely from the  efforts of the promoter or a third party."  The Howey test is used for franchise agreements, partnership interests, pension plans, and bank instruments...mostly.

The form of the agreement and what parties call it is irrelevant, courts and regulators will look at the substance of the contract.

For notes, the Supreme Court created the "family resemblance test" under Reves. This  test provides a way for issuers of a note to show that the note should  not be considered a security, by showing that the note has a "family  resemblance" to other investments that are not considered securities.  That case also gave us a multifactor test to determine if a note is a security based on the motivation of buyer/seller, plan of distribution, reasonable expectations of the investing public, and other factors that reduce risk.  When using the family resemblance test or Reves' multifactor test, you don't apply the Howey test.

For "stocks", the Supreme Court came up with the Forman test.  The label of stock is dispositive if it has typical characteristics.:

• give rights to dividends that are contingent on profits,
• are negotiable
• can be pledged or hypothecated,
• confer voting rights in proportion to number owned
• can appreciate in value

AND under the circumstances it was reasonable for the investor to rely on the word “stock” in assuming that the transaction was covered by the sec. law.

Under the Forman test, you do not apply the Howey test.

Based on other situations there are other cases that address the situation we make reference to.  There are also SEC bullitins, "no action" letters, and other publications that the SEC makes available for guidance.

Greg Dickerson · Answer

If the investors are passive and have no active role you have a security and is regarded a syndication .

If they are each active you have a partnership or JV and are all clear.

Google Howey test for rules regarding what constitutes a security and make sure to run this by your SEC attorney.

Mauricio Rauld · Answer

Im a syndication attorney (SEC lawyer).  Its a security.  The 1st one you mention is also likely a security unless, as Greg correctly points out, everyone was actively participating in the deal.  You can have 1 investor and that could be a sale of security if investor is passive and not structured properly.  It going to be a challenge to argue that all 6 of you are actively participating in the deal and pulling their fair share.  I have some You Tube educational videos you can check out.

John Corey · Answer

Splitting hairs a bit. Based on a test that works in another jurisdiction. It made me wonder if the same test would be used in the USA.

If a group of investors all have an 'active role in the management' yet they do not have the ability or competence to perform the active role, it would not be possible for the promoter of the transaction to claim the other investors are actually active. Saying they can vote on decisions is not the same as the people with the votes having a realistic way to exercise good management.

Theo Hicks · Answer

You can if the 5+ investors have an ongoing active role in the deal so that it qualifies as a JV. If the investors are entirely passive, it is a syndication.

Mauricio Rauld · Answer

Not a DIY project but another option is just 1 investor that provides you a note secured by a mortgage.  That may fall into an exception.  Also 1 investor for a loan less than 9 months may be another option.

Alina Trigub · Answer

@Joshua Pope

As @J Scott and @Mauricio Rauld stated what you're presenting sounds like a sale of security. You may want to consider buying each property individually with one or two investors and giving each of them some sort of active role if your intent is to go JV route. Alternatively, if taking a syndication route to buy a portfolio, make sure that it is still cost effective and calculations make sense.

Best!

Joshua Pope · Answer

@Greg Dickerson

Will do thanks

When is it syndication?

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