Can You Skirt the SEC with Joint Ventures?

As real estate investors, we're trained to be creative. We try to find different ways to make the deal work. And, if it doesn't, we go back the drawing board and try again until all options are evaluated. It's no wonder, then, that some people become creative when it comes to securities laws.

I hate the word 'compliance' as much as you probably do - it reminds me of a  CIA/government training program from a TV show or movie. But, until they change the laws (not likely) we have to make sure we operate under SEC guidelines for raising money. It gets a lot easier when you learn how.

Getting creative with trying to side step completing offering documents or filing forms with federal SEC or state securities regulator is not a good idea. In the long run, it's bound to trip you up. One way real estate investors get creative is to raise private money from individuals and call it a 'joint-venture'. The scenario basically breaks down like this:

You have deals. Your investor has the money

You bring your investor in as a full blown partner in your business. The premise of this is because you are bringing in an 'active' partner (could be LLC member/manager, etc.) that you aren't technically offering a security because the person is active (even though they aren't really active - they aren't participating in the management, rehab, etc.) as opposed to a passive investor. This assumes, then, that securities laws only apply to passive investors.

This is not true.

Take a quick look at the 'Howey Test' (Supreme Court case which established ground work for what is considered offering a security).

An investment contract under the Howey Test was defined as follows:

1. an 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

Clause #4 gets to the heart of the 'joint venture' question. Because you are offering somebody an opportunity to profit by entering into business with you and those efforts to profit depend solely on you, you are thus offering a security and have to take care of your securities law disclosures and any SEC filings you may have to do.

Along these same lines, the real meaning of 'joint venture' is defined as "A joint venture (often abbreviated JV) is an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses and control of the enterprise (courtesy of Wikipedia).

A true joint venture might involve you raising the private money to buy a property and then partnering with a contractor to commit the resources and funds for the rehab and then splitting the profits and/or cash flows. You might also form a joint venture where you bring the deal to an investor who will acquire it and you retain a small equity interest or receive a fee.

There are many ways to be creative in real estate, and you should never turn your brain off to the possibilities. But, when it comes to raising money, if you promote the deal and your investor brings the cash for a return on their money, you'll want to give your securities lawyer a quick call and have everything locked down tight on your end. It doesn't take much time or money compared to not doing things the right way. Credibility and integrity are the cornerstones of raising money.

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