Part 3: Syndication

Mike: Welcome back to the flipnerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Bill: Hi, I’m attorney Bill Bronchick, an instructor at flipnerd.com. And in this video series, we’re going to explore partnerships, joint ventures, and syndications all different types of partnership investing. All right, in this discussion, we’re going to go over the syndication which is a much bigger project as a partnership than simply a joint venture or general partnership or LLC with two partners or two members.
Mike: This REI Classroom real estate lesson is sponsored by theinvestormachine.com, FlipNerd’s private investor coaching program and your blueprint to investing success.
Bill: When you’re dealing in syndication, typically what happens is you’ll form an LLC or a limited partnership where you’re either, if it’s an LLC you’d be the managing member, if it’s a limited partnership you’d be the general partner. And then the limited partners or the non-managing members in the case of an LLC, would be passive investors. No control, no say so except for maybe some minor voting of XY and Z rules, but for the most part it’s geared towards control and decision making in favor of the syndicate.
Now, this would be pretty common in a commercial project where millions of dollars are needed for a down payment. Say you have a $15 million project, you need a $6 million down payment and you can’t raise that on your own. So you sell membership interests, non-managing membership interests to other investors who will become your partners in the LLC or limited partnership.
But the challenge with this is that a lot of people don’t realize is, this falls within securities regulations. What does that mean? Securities as in stock market securities? Yes, yes stock, Google stock that’s a security, a bond is a security interment, but also by definition any investment in which the person putting up the money expecting a profit is not going to be managing the investment or procuring the profits, okay? So that’s pretty broad, that’s a very broad definition.
Clearly, if you’re going to have an LLC and then have five passive partners putting up money and you’re the managing member those interests you’re selling in the LLC would be considered securities. Now, what does that mean? Well, all kinds of paperwork, rules, regulations, federal, state. There are many exemptions where you can get away with not having to deal in the securities realm, you have what’s called an exemption.
Now, just from the front, if you bring in, it could be 1 partner or 20 partners, that’s still a security. If you only have one or two partners, the easiest way to get out of it being a security is to make them involved. Because by definition a security is a passive investment whereas a partnership is everybody’s a manager, everybody makes decisions. You could be the head honcho manager, but you could also put together maybe a board of directors or board of managers with the other investor so that they’re involved, you have meetings. That would take it out of securities regulations entirely. But if you’re within the securities realm, then there are exemptions.
First, you have to find a federal exemption and an estate exemption in the states you’re dealing in. So let’s say you’re dealing in New Jersey. You form the LLC in New Jersey, to buy a property in New Jersey and all the investors you’re soliciting are in New Jersey. Well, the FCC rules won’t even apply because it’s wholly intra within a state.
So you have to deal with finding an exemption under the New Jersey rules. But as soon as you step across state lines and solicit someone in let’s say Pennsylvania, then you have to deal with FCC regulations and deal with an exemption there. I’m not going to go into the nitty-gritty and the technical things of securities regulations but just a couple of things you have to keep in mind.
In most cases, you cannot publicly solicit investors. That means email blasts, radio, TV, standing in front of a group of 20 people at a business meeting, those are all public offerings. You can’t do public solicitation unless all of the people that you’re soliciting and eventually become members of your company or what we call accredited investors.
I’m not going to get into the definition of it but, let’s just suffice it to say that’s a rich sophisticated person. Not someone who’s got 40 grand, okay? So if you’re going to sell small interests like 30, 40 grand a clip, you’re definitely dealing with securities and you’re definitely dealing in the realm of most likely non-accredited investors. So you can’t do both soliciting. You have to go within your realm of friends and family and business associates.
You have to have an operating agreement for the LLC and this one is going to be much different than say, this one between A and B. It’s going to be favoring you much more, it’s going to make it very difficult for them to fire you as a manager and so forth. But, you have a very high fiduciary responsibility to your investors and you want to make sure you disclose all of the risks upfront in writing and we call that writing a private placement memorandum or PPM, or offering memorandum. And that’s something that an attorney does that is anywhere between 50 and 200 pages of disclosures, disclaimers and all kinds of legal jargon.
So people don’t come back later when the deal goes bad and say, “He didn’t tell me that could happen” or “She didn’t tell me that could happen.” And if they’re right, then you can get sued for securities fraud. That sounds really bad but, it just means you didn’t disclose something that was material to the risks of the investment.
So to sum it up we’ve got the joint venture one-shot deals, we have the general partnership which could be done under an LLC or just two people, two entities, under a general partnership agreement. Then we have a syndication which is usually done under a manager-managed limited liability company.
The bottom line is, no matter which one you go make sure you’ve got something really good in writing between the parties. It makes it so much easier when everyone understands what their rights, their roles, and their responsibilities are upfront, so there’s no, “Oh, I thought you meant” and “I thought you said” and “Didn’t you say this” and digging through e-mails. Put it in writing.
This is Bill Bronchick, I hope you’ve enjoyed this discussion of partnerships, joint ventures, and syndications.
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