What is a Syndication?

What is a Syndication?

In laymen’s terms, it is when a group of investors pool their money to buy something that they would otherwise not be able to afford individually, this gives investors purchasing power. These types of investments are generally structured in a Limited Liability Corporation (LLC) which contains at least two classes of owners: General Partners (GP) and Limited Partners (LP). The GP’s and LP’s own shares in the company based on the amount they invest (LP) or the work they do (GP).

The difference between the two classes of owners is important to understand. Most, if not all syndications are considered ‘securities’. As such, they are governed by the Securities and Exchange Commission (SEC) and must conform to their guidelines and requirements. An investment is a security when it meets the Howey Test, names from a 1946 Supreme Court case SEC v W.J. Howey Co. The test involves these four questions:

1. Is there an investment of money?

2. Is there an expectation of profit?

3. Is the investment of money intended for a common enterprise?

4. Do any of the profits come from the efforts of a promoter or a third part and not from the efforts of the investors?

So, let’s use a hypothetical scenario to explain these questions. Let’s say I have in contract a self-storage facility priced at $2.5M and I don’t have 25% for a down payment of $625,000 plus closing costs. So, I want to raise capital from investors. This makes me the “sponsor” of the investment.

• - Is there an investment of money? YES!
• - Is there an expectation of profit? I would sure hope so!
• - Is the investment of money intended for a common enterprise? YES!
• - Do any of the profits come from the efforts of a promoter or a third part and not from the efforts of the investors? YES, and this is where the difference in GP’s and LP’s comes from and what makes this a security and not a Joint Venture.

The limited partners will not have significant control or oversite in the management or operations of the LLC or asset. This means the general partners must act in accordance with the SEC guidelines of a security. If you are planning on syndicating a real estate property then you should find a lawyer that is well versed in all things related to syndication and securities. Also, you want to make sure that this lawyer is well versed in the state laws regarding securities where the property is located as well as the federal laws. Get a lawyer! Let me repeat. Get a lawyer!

More on the different kinds of securities that can be offered in another article. Stay tuned!