Why "Pooling" Private Lenders Creates Problems (and what you can do about it)

"Pooling" private money gets a lot of buzz. Some of it is necessary, but some of it overkill.

If you listen to some "experts" enough, you'd probably come to the conclusion that you should never bring more than one private investor in on a particular deal.

In fact, if you listen to enough "experts" on enough subjects, you might not want to leave your house in the morning for fear that the sky would fall.

Thankfully, you're not a henny-penny and you don't think that the sky is falling.

With private money, pooling means bringing multiple private investors funds together, combining those funds and using them for a real estate transaction (actually, there's probably a more lengthy legal description, but this is what it means in plain English).

So what's the big deal?

Well, the securities regulators want to make sure that you aren't misusing your private investors money. They want to make sure you aren't taking money from one person to pay off another person. They want to make sure that you are making proper disclosures to your investors about where their money is going and how it is being used. They want to make sure you file the proper paperwork with them to let them know what you're doing.

Whew! All of this sounds like a whole lot of big brother, doesn't it?

Yes, it probably is for the average real estate investor who wants to raise $100k for their first flip deal.

Fear not.

You can handle the pooling issue quite easily when you know how.

Let's start from the top and I'll tell you how I personally avoid potential problems with pooling.

1. I don't bring multiple investors in under a single collateralized investment. What this means is that I don't put more than one investor on a mortgage. I don't form a company for my investors, put them all into a company and have that company loan me money for a deal where I give that company (made up of private lenders) a mortgage or lien. It creates way too many potential headaches. If two private investors both want a senior lien position, I will give one of them a first mortgage in exchange for a lower interest rate and the other will get a slightly higher interest rate for a second mortgage. As long as the LTV is within a good margin, there's should be no issue with there being significant principal coverage in the event of a worst case scenario for the lender(s)
2. I use equity investors - the pooling issue is easier to overcome if you bring private investors in as equity partners in the deal. That way, each investor owns a % of the company in proportion to the funds invested. The investor funds aren't commingled together under one particular security. The security being offered is a unit interest in an LLC or LP. The disclosure documents and other offering paperwork provided to the private investors show them what their investment is. The partnership or LLC paperwork spells out exactly how distributions are handled and whom will handle them in the event that the manager (me/my company) fails in their capacity to perform or is incapacitated (dead/injured) and cannot perform duties. I know this one sounds complicated - especially for beginners - but it's really just a matter of common sense and putting yourself in the investors shoes
3. I use accredited investors as often as possible - you're life is a lot easier when you bring in capital from investors for which a $50k or $100k investment is not a large % of their net worth. This way, you don't have to worry as much about redemptions and you can have more breathing room operating your business
4. I make the proper disclosures and file the right documents - it goes without saying that you have to be compliant with your state (and federal) securities laws.  I use Reg D exempt securities offerings (for the most part) and mostly Reg D 504 to be more specific.

Each time I touch on this subject matter at all, I always have to tell my readers that I'm not an attorney or tax professional and that I recommend everybody have a securities attorney that they can use, as well as other professional counsel. It might sound like standard mumbo-jumbo, but it's just plain true when you think about it.  It's foolish and unprofitable to pretend like you can do everything on your own in real estate and raising other people's money. Don't be a lone ranger.

Now if anybody tells you that you cannot bring mutliple investors in together on a deal, you can tell them that they don't have their facts straight. You can (and will often need to, as your business grows) bring multiple investors together to fund a deal. As long as you handle things the right way, you're in no danger of anything except proabably making a lot of money for yourself and your investors.

Private money is the best way to acquire just about any type of deal out there (unless you are already wealthy)... and right now cash is king and will hold the crown into any kind of forseeable future.

I always laugh when people tell me that private money isn't that important because the credit markets are improving (FUNNY!) and they feel as though they can haggle with a bank who will let them steal a commercial property off their books for 50 cents on the dollar and THEN hold the paper on that same  deal, while at the same time coming with zero cash or nor management record.

You could spend a whole lot of time doing those types of strategies and get maybe one deal every so often (if you're lucky - but, if you were that lucky, why not put a chip down on the roulette wheel?) or you could spend a little time raising some real cash and build an ongoing system of acquiring properties with none of your own money that put you in total control.

As I always say, private money isn't for everybody. It's only for those real estate investors that want to be at the top of the food chain eating steak while their competitors squabble for the table scraps.

-Happy Investing