All Forum Posts by: Mitch Conrad

Quote from @Shafi Noss:

Hi Mitch, it would be helpful to know how much you are thinking of raising and between how many people. 

If your objection is time, expense and compliance issues, it's not clear to me this alternative is less expensive or time consuming, and likely is even dicier on compliance. If it walks like a duck and all that. 

I'm also not sure what you mean by 'avoid bank requirements' and 'middle-man syndication'. Is your bank putting requirements on how you source your downpayment? If you are offering a secured promissory note, a bank would probably like that less than syndicated equity. Or are you trying to syndicate the entire capital stack? Knowing those details would help us evaluate more precisely. 

Hi Shafi.  I haven't taken the next steps with the banks yet so I'm not sure how happy they would be with the down payment coming from a debt LLC.  But I have a few local and regional banks I've worked with that might be open to it.  If no bank is willing to allow debt as a down payment, I would need to raise the capital stack which would usually be around $10MM.  So my challenges will be either to find a lender willing to accept debt for the down payment or raising the entire capital stack but I'm not sure I would have enough 'friends' to raise that much and the more members in the LLC, the more it acts like a security.

When I stated 'avoiding the bank requirements,' I was referring to the process of going through committee approval, extra documentation, negotiating any covenants, etc.  For the middle-man syndication I was referring to the extra costs I incur in using capital from the syndication fund we've been using who give us a lease-option on the properties after they purchase.  It seemed that having my investors for their own LLC and loan me the down payment or the entire capital stack would be less expensive than the rent I pay.  In that scenario, I would also get depreciation benefits as the title holder.

Using the syndication fund as been pretty smooth and easy, however, I'm not sure they have been raising enough capital to keep up with our growth pace so I'm looking for another alternative.  I think my best bet is to find a flexible bank and bring in the down payment as debt.

Quote from @Chris Seveney:

@Mitch Conrad

The other option is for them to do a participation agreement between each other.

Can you give me more details of what you mean by a participation agreement?  Thanks for your time and comments!

Quote from @Greg Dickerson:

This is an easy one @Mauricio Rauld can help you.

I agree.  Mauricio would probably be my first call but I wanted to get feedback from this forum before taking that step.  This seems like such a grey area of the law.  Even discussing with my real estate attorney, his first response was that a note is a security (unless you're a bank).  But the more I questioned things and asked, "How can I", the more he came up with similar requirements similar to Chris's comments.

Quote from @Don Konipol:

Quote from @Mitch Conrad:

Quote from @Don Konipol:

My take on this is you’ve gotten advice 10 years old.  Since 2014 debt is considered no different from equity in determining if an investment is a security.  Whoever creates and sponsors the syndicate needs to comply with the SEC regulations for securities offerings UNLESS the offering qualifies for an EXEMPTION from registration.  The most common exemption is the exemption for private offerings.  This doesn’t mean the offering isn’t a security, it just means it doesn’t have to be registered with the SEC.
One could have an offering relying on the GENERAL exemption for private offerings.  However, this type of offering while least costly and fastest has some big disadvantages, mainly (1) provides the sponsor with almost no protection from being sued by disgruntled investors and (2) investors with any savvy will only invest in offerings where the offering is compliant with Reg D.
Reg D is a “safe harbor” requiring the offering to be FILED, not REGISTERED with the SEC.  Cost is mostly legal, with about $10K - $15K being average. Depending on the amount being raised, there is Reg D 504, 505, 506B, and 506c.  
investors holding a note secured by a assisted living facility will require an interest rate of 9 - 14% depending on desirability of property and strength of operator/borrower.  Returns demanded by investors are much higher for assisted living than for apartments as the loss from default is much higher. 

Thanks for the reply! Do you have any documentation showing there is no
difference between debt and equity in determining if an investment is a
security?

My research so far shows that debt and equity investments are treated differently when determining if they qualify as securities under U.S. law. The primary test used to determine whether an instrument is a security is the Howey Test, which originated from the Supreme Court case SEC v. W.J. Howey Co. The Howey Test defines an investment contract (a type of security) as a transaction where a person invests money in a common enterprise and is led to expect profits solely from the efforts of others. While debt holders expect repayment of principal and interest rather than profits, the interest received can be seen as a form of profit derived from the issuer's efforts.

SEC regulates the offering of securities.  A security is "[a]n instrument that evidences the holder's ownership rights in a firm (e.g., a stock), the holder's creditor relationship with a firm or government (e.g., a bond), or the holder's other rights (e.g., an option)." Black's Law Dictionary, 10th ed.

Since 2014 the SEC has clarified that it regards loans as securities.  Further, most loan participations are in the form of LLC units, which in itself is an equity security with the company in question holding a debt instrument. 

The Howey test is still somewhat applicable for determining if the sale of a business interest is a security or a business opportunity .  It does not apply to debt offerings. 

Thanks for the feedback again!  Do you have any feedback regarding Chris's comments concerning notes? 
The members of the debt LLC would raise money specifically for a property purchase; members would not be investing in a business for profits, they would receive monthly payments according to the terms of the note; and the LLC would receive collateral in the purchased property.  Number 2 seems pretty vague as to the number of members that would be acceptable.

Quote from @Don Konipol:

My take on this is you’ve gotten advice 10 years old.  Since 2014 debt is considered no different from equity in determining if an investment is a security.  Whoever creates and sponsors the syndicate needs to comply with the SEC regulations for securities offerings UNLESS the offering qualifies for an EXEMPTION from registration.  The most common exemption is the exemption for private offerings.  This doesn’t mean the offering isn’t a security, it just means it doesn’t have to be registered with the SEC.
One could have an offering relying on the GENERAL exemption for private offerings.  However, this type of offering while least costly and fastest has some big disadvantages, mainly (1) provides the sponsor with almost no protection from being sued by disgruntled investors and (2) investors with any savvy will only invest in offerings where the offering is compliant with Reg D.
Reg D is a “safe harbor” requiring the offering to be FILED, not REGISTERED with the SEC.  Cost is mostly legal, with about $10K - $15K being average. Depending on the amount being raised, there is Reg D 504, 505, 506B, and 506c.  
investors holding a note secured by a assisted living facility will require an interest rate of 9 - 14% depending on desirability of property and strength of operator/borrower.  Returns demanded by investors are much higher for assisted living than for apartments as the loss from default is much higher. 

Thanks for the reply! Do you have any documentation showing there is no
difference between debt and equity in determining if an investment is a
security?

My research so far shows that debt and equity investments are treated differently when determining if they qualify as securities under U.S. law. The primary test used to determine whether an instrument is a security is the Howey Test, which originated from the Supreme Court case SEC v. W.J. Howey Co. The Howey Test defines an investment contract (a type of security) as a transaction where a person invests money in a common enterprise and is led to expect profits solely from the efforts of others. While debt holders expect repayment of principal and interest rather than profits, the interest received can be seen as a form of profit derived from the issuer's efforts.

Thanks for the reply!  Do you have any documentation showing there is no difference between debt and equity in determining if an investment is a security?  

My research so far shows that debt and equity investments are treated differently when determining if they qualify as securities under U.S. law. The primary test used to determine whether an instrument is a security is the Howey Test, which originated from the Supreme Court case SEC v. W.J. Howey Co. The Howey Test defines an investment contract (a type of security) as a transaction where a person invests money in a common enterprise and is led to expect profits solely from the efforts of others.  While debt holders expect repayment of principal and interest rather than profits, the interest received can be seen as a form of profit derived from the issuer's efforts.

Quote from @Chris Seveney:

Quote from @Mitch Conrad:

My wife and I own and operate 23 senior living communities (assisted living, memory care, and independent living) across Colorado and we are now expanding into Arizona.  I've often had people ask if they can invest to help with our expansion, but for the amount of capital needed, this would require pooling funds as a syndication.  I don't want to syndicate because of the time, expense, and compliance issues; and typically, when I discuss syndication with investors, they expect a split of the operations in addition to ownership of the property.  I understand this is the way syndication works with multifamily properties because the operations are generally only a few people, however, in senior living, the operations are much larger and more litigious because we are providing 24-hour care, medication management, meals, transportation, activities, etc.  The entity structure is typically different than multifamily as well.  In a senior living business, the operations are usually a separate entity and the operation entity rents from the property entities to keep operations completely separate from the property. 

I currently work with an investment fund group that purchases the properties we want and then offers us a lease with an option to purchase the property after three years. We basically execute a form of the BRRRR strategy by targeting communities that require significant renovations or improved management to bring them back to profitability and then we are able to use the increased equity when we exercise the option. This system has worked well and has allowed us to expand much faster than we could on our own, while at the same time, keeping the business operations separate from the property entities. The biggest downside in the system is that our rents are significantly higher than mortgage payments would be if we were able to purchase at the beginning.

Recently, I met an apartment investor who uses private investors for his purchases. He stated that he was able to avoid the classification of a security by treating the investors like a bank rather than as a syndication. The private investors form an LLC and get standard loan terms in a promissory note without equity or profit sharing. Basically, he is able to avoid all the bank requirements and cut out the middle-man syndication. He is paying a rate higher than a bank but lower than hard money and he can refinance after his equity has increased. I've discussed this with my real estate attorney who isn't a syndication attorney, and he seems to think that this could work, but to be safe, should be a small group without any association with my company. I'd like to discuss this with a syndication attorney but I thought I'd ask this forum first as I'm not sure how many syndication attorneys would honestly say we don't need their services and give steps needed to avoid being classified as a security.

 If you are getting a loan from one entity, you do not really need to be discussing it with a syndication attorney but any loan docs and agreements you should have an attorney review.

The people who would need the attorney are the people forming the LLC as they are each pooling funds and would need to determine who is in control of the entity, what if someone wants out of that entity etc. This is more a "them problem" than a you problem and its a way for them to pool monies without you forming a syndication.

 Agreed.  That would be a "them problem."  Probably enough of a problem that my private investors wouldn't be interested in taking on forming their own syndication.  Thanks.

My wife and I own and operate 23 senior living communities (assisted living, memory care, and independent living) across Colorado and we are now expanding into Arizona.  I've often had people ask if they can invest to help with our expansion, but for the amount of capital needed, this would require pooling funds as a syndication.  I don't want to syndicate because of the time, expense, and compliance issues; and typically, when I discuss syndication with investors, they expect a split of the operations in addition to ownership of the property.  I understand this is the way syndication works with multifamily properties because the operations are generally only a few people, however, in senior living, the operations are much larger and more litigious because we are providing 24-hour care, medication management, meals, transportation, activities, etc.  The entity structure is typically different than multifamily as well.  In a senior living business, the operations are usually a separate entity and the operation entity rents from the property entities to keep operations completely separate from the property. 

I currently work with an investment fund group that purchases the properties we want and then offers us a lease with an option to purchase the property after three years. We basically execute a form of the BRRRR strategy by targeting communities that require significant renovations or improved management to bring them back to profitability and then we are able to use the increased equity when we exercise the option. This system has worked well and has allowed us to expand much faster than we could on our own, while at the same time, keeping the business operations separate from the property entities. The biggest downside in the system is that our rents are significantly higher than mortgage payments would be if we were able to purchase at the beginning.

Recently, I met an apartment investor who uses private investors for his purchases. He stated that he was able to avoid the classification of a security by treating the investors like a bank rather than as a syndication. The private investors form an LLC and get standard loan terms in a promissory note without equity or profit sharing. Basically, he is able to avoid all the bank requirements and cut out the middle-man syndication. He is paying a rate higher than a bank but lower than hard money and he can refinance after his equity has increased. I've discussed this with my real estate attorney who isn't a syndication attorney, and he seems to think that this could work, but to be safe, should be a small group without any association with my company. I'd like to discuss this with a syndication attorney but I thought I'd ask this forum first as I'm not sure how many syndication attorneys would honestly say we don't need their services and give steps needed to avoid being classified as a security.

I have 22 residential care homes and 2 commercial senior living communities in Colorado. 

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