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Kaliser Law Blog

Where Control is Derived from on a Standard Deal

In a basic LLC structure control is derived from two primary locations.  The first is the Manager, analogous to the Board of Directors of a corporation, the Manager has the power to hire and fire executives, make the majority of business decisions, enter into contracts on behalf of the LLC, etc. The second area in which control is derived is the Members.  Analogous to the shareholders or owners of a corporation, the Members power comes from the ability to vote in and out the Managers.

As a liability protection technique we typically recommend creating a second LLC to serve as the manager of the asset holding LLC.  Typically, the Manager and sole Member of the MGR LLC is the lead, and they can exercise complete control over that MGR LLC (as reflected on the chart above-to the left of “MGR LLC” the lead is reflected as a Manager and below “MGR LLC” the lead is reflected as its sole member). So where is control derived from in this instance?

Similarly, the Members (Investors) of “Asset LLC” will have the ability to vote in and out the Manager (MGR LLC) of that entity.  The MGR LLC will have the typical authority appointed to a Manager.

Special caution is advised with regard to the structuring of the MGR LLC.  If the Lead provides someone else with a controlling ownership interest of the MGR LLC, that other party will have the authority to vote in and out Managers of the MGR LLC. This means they could remove the Lead as Manager of the MGR LLC, and in essence take control of the deal. The only way for the Lead to regain control at this point would be for the Members of Asset LLC to vote out MGR LLC as their Manager, and then vote back in the Lead.

To summarize, it is critically important that the Lead maintain a controlling interest in the MGR LLC to remain in control of the deal.  However, there is no guarantee the Lead will remain in control even doing this as the Members of Asset LLC will always have the right to vote out their Manager.

-Written By: Greg Ehrlich, Associate Attorney, Kaliser & Associates PC.

*Please note the information provided here is not legal advice and all information provided is merely for discussion purposes.

Featured post

Family Limited Partnerships

 

May 24, 2017

FAMILY LIMITED PARTNERSHIPS

THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY.  THIS DOCUMENT IS NOT TO BE CONSTRUED AS LEGAL ADVICE.

A Family Limited Partnership is simply a limited partnership in which all of the partners are family members.  Like other limited partnerships, an FLP consists of two types of partners; general and limited.  General partners control all management and investment decisions and bear 100% of the liability.  Limited partners cannot participate in the management of the FLP and have limited liability.

  • At least one general partner must be designated to accept personal liability and manage the affairs of the partners The general partner can be an individual or Husband and Wife, typically in the senior generation in a family; or a Texas LLC can be formed to be the general partner. Then,  the remainder of the partnership interests are held by family members who are limited partners.  The limited partners must agree to take no active role in the day-to-day management of the business of the partnership. By doing so, the limited partners will be protected from personal liability for the actions of the partnership.
  • In an FLP, generally, the senior family members (parents or grandparents) contribute assets in exchange for a small general partner intere They can then give all or a portion of the limited partner interest to their children and grandchildren.
  • Additionally, limited partnerships are pass-through entities for federal income tax purpose Meaning that the FLP itself isn’t taxable – instead, the owners of a partnership report the partnership’s income and deductions on their personal tax return, in proportion to their interests.
  • After setting up the FLP, selected family assets are transferred into it. When the transfers are complete, family members, no longer own a direct interest in these asse Instead, they own a controlling interest in the FLP, and it is the FLP that owns the assets. The general partners have management over the affairs of the partnership and can buy or sell any assets they wish, subject to the terms of the partnership agreement.  The general partners also may have the right to determine what portion of partnership income and assets are retained by the partnership and what amount is to be distributed to the partners.
17101 Preston Road, Suite 110, Dallas, Texas 75248
Telephone: 469-398-2780    Facsimile: 469-398-2777

BENEFITS OF AN FLP

  • Centralized Management of Family Assets

An FLP allows the general partner to control the partnership and its assets, while at the same time allowing transfer of ownership of portions of the assets to family members who are limited partners.  This works particularly well for real estate, rather than multiple transfers  of specific real estate assets, the GP can transfer a specified percentage of a collection of real estate assets to each limited partner.

  • Estate and Gift Tax Benefits

Transferring limited partnership interests to family members reduces the taxable estate of senior family members.  The senior family members transfer the value of the asset to their children, removing it from their estate for federal estate tax purposes, while retaining control over the decisions and distributions of the investment.

Transfers of limited partnership interests are also eligible for the annual gift tax exclusion and the value of limited partnership shares can be discounted when transferred to family members.

  • FLP Discounts

For gift and estate tax purposes, assets are valued at their fair market value – what a willing buyer would pay a willing seller for those assets.  FLPs typically have restrictions on their transferability.  For example, transfers to non-family members may be prohibited unless other family members agree.  Also, there may be fewer people interested in buying limited partnership interests than there would be for the underlying assets. These factors – restrictions on transferability and lack of marketability – can make the price a willing buyer would pay for an FLP interest less than what the same type buyer would pay for the underlying assets.  This difference – the discount – can reduce the amount of gift and estate tax payable.

  • Simplification of Probate

The assets held by a family limited partnership are not part of an individual’s estate; rather the partnership interest is part of the estate. Therefore, a lengthy probate inventory can be avoided.  Only the partnership interest is declared during the probate process, keeping the assets help by the FLP confidential.

  • Sale of Real Estate Post-Death

When an estate is selling real property, title companies require an Estate Tax Closing Letter before the title company will insure a clear title to a buyer purchasing property from a decedent’s estate.  This often means that property cannot be sold out of a decedent’s estate for a considerable period of time following the date of death, until the probate process is

complete. On the other hand, if real property is held in an FLP that does not dissolve upon the decedent’s death, there is no requirement for a closing letter and the property should be available for immediate sale.

  • Creditor Protection

Assets within the FLP cannot be legally seized by a judgment creditor of a partner. Instead, the law provides that the creditor’s remedy is limited to a charging order – a right only to partnership distributions to the debtor, when, if ever, such distributions are made. Moreover, creditors may not force cash distributions, vote, or own the interest of a limited partner without the consent of the general partners.  As a result, the limited partnership interests of family members are much less attractive to any judgment creditors. The partnership structure also provides asset protection to family members in the event of a divorce or in the event of their own financial irresponsibility.

Families with business assets which they wish to own in common – including assets which some family members wish to pass on to other family members- may benefit from an FLP. The FLP permits the family to have flexibility in dividing ownership and control in ways which work for its members. The use of an FLP should be considered for the potential benefits of providing administrative convenience, potential income tax, estate tax and gift tax reductions, as well as asset protection.

If you have any questions, please feel free to contact us at the number listed above.

Contacts:
Merrill L. Kaliser (469) 398-2781
mkaliser@kaliserlaw.com
Cindy Mirliss (469)398-2782
cmirliss@kaliserlaw.com
Greg Ehrlich (469)398-2783
gehrlich@kaliserlaw.com
Megan Oh, Paralegal
(469) 398-2784
moh@kaliserlaw.com

Regulation D Rule 506(c)

May 8, 2017

Regulation D Rule 506(c)

THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY. THIS DOCUMENT IS NOT TO BE CONSTRUED AS LEGAL ADVICE.

With the passage of the JOBS Act in 2012, one of the most exciting developments was the addition of rule 506(c) to Regulation D.

Under 506(c) as opposed to 506(b) and most other private exemptions, a company can broadly solicit, generally advertise, and raise an unlimited amount of capital if the following conditions are met:

  1. The investors in the offering are all accredited investors; and
  2. The company takes “reasonable steps” to verify that its investors are accredited.

These are obviously both departures from 506(b) where you are allowed up to 35 unaccredited investors and you can more so rely on investor self-certification as to their status as accredited or not.

Similar to 506(b) as discussed last week, 506(c) preempts state law. In other offering exemptions, you must be particularly careful you are not only following the federal exemption, but also the states securities regulations as well. What federal preemption means in terms of 506(c) is that as long as you are in compliance with the federal regulation, you are in compliance with the states’ regulations as well.

Issuers should be filing Form D with the SEC (your attorney should handle this). Typically, the only state requirement is a notice filing with a copy of Form D and a filing fee in each state an investor resides in (New York is the exception to this rule as their requirements are more onerous).

Issuers are not even required to have their advertisements submitted or approved by the SEC. Be very careful though, fraudulent or misleading statements in advertisements could lead to civil penalties and even criminal charges.

Another major benefit of this offering is that so long as it is a legitimate offering (not merely being done to circumvent the rules), you can utilize the substantive relationships you develop via a 506(c) offering in future 506(b) offerings for forthcoming deals.

Below we will discuss the SEC’s interpretation of conducting “Reasonable Steps” and how an issuer can go about verifying accredited status.

 

Reasonable Steps

“Reasonable steps” are to be determined in the context of the particular facts and circumstances of each purchaser and transaction. The SEC released a nonexclusive list of factors an issuer should consider when determining the reasonableness such as: (1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (2) the amount and type of information that the issuer has about the purchaser; and (3) the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

Income Requirement

When attempting to qualify an investor as accredited via the income requirement the SEC has recommended issuers conducting due diligence by reviewing the following non-exclusive list of documents: (1) W-2’s; (2) 1099’s; (3) K-1’s; (4)1040’s; and (5) any other documentation that reports the investor’s income the previous two years. The SEC also requires obtaining a written representation from the investor that he or she has a reasonable expectation of reaching the requisite income level to qualify as an accredited investor.

Net Worth Requirement

When attempting to qualify an investor as accredited via the net worth requirement the SEC has recommended obtaining the following documentation dated within the previous three months for assets: (1) bank statements; (2) brokerage statements; (3) other statements of securities holdings; (4) certificate of deposits; (5) tax assessments; and (6) appraisal reports issued by independent third parties. For liabilities the SEC has required obtaining a credit report from at least one of the nationwide consumer reporting agencies. Also required is a written representation from the investor that liabilities necessary to make a determination of net worth have been disclosed.

Third Party Verification

An issuer can be deemed to have satisfied the verification requirement of 506(c) by obtaining a written confirmation from: (1) a registered broken dealer; (2) an SEC-registered investment adviser; (3) a licensed attorney; or (4) a certified public accountant. This written confirmation must state that such person or entity has taken reasonable steps to verify the investor is accredited within the prior three months and has determined that such investor is accredited

Previous Investors

Any natural person who invested in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of Rule 506(c) (September 23, 2013) and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement in Rule 506(c) with respect to any such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

 

If you have any questions, please feel free to contact us at the number listed above.

17101 Preston Road, Suite 110, Dallas, Texas 75248
Telephone: 469-398-2780
Facsimile: 469-398-2777
Contacts:
Merrill L. Kaliser (469) 398-2781
mkaliser@kaliserlaw.com
Cindy Mirliss (469)398-2782
cmirliss@kaliserlaw.com
Greg Ehrlich (469)398-2783
gehrlich@kaliserlaw.com
Megan Oh, Paralegal
(469) 398-2784
moh@kaliserlaw.com

Regulation D Rule 506(b)

April 26, 2017

Regulation D Rule 506(b)

THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY. THIS DOCUMENT IS NOT TO BE CONSTRUED AS LEGAL ADVICE.

Of the various exemptions from full-fledged registration with the SEC, Rule 506(b) of Regulation D is our preferred offering exemption. 506(b) is the traditional exemption from SEC registration and often makes the most sense for multifamily syndications.

Under 506(b) solicitation and advertising of a private offering is prohibited. The standard means of acquiring investors is via a pre-existing relationship. Generally, we recommend at least three (3) meetings with the individual before discussions of investing, and this relationship should exist prior to the property going under contract.

506(b) allows issuers to raise an unlimited amount of capital; however there are restrictions on whom you can raise the money from. Under 506(b) eligible investors include up to 35 sophisticated unaccredited investors and unlimited number of accredited investors. Below gets into what each of those two terms mean.

As opposed to 506(c), the verification process is self-certification, and an investor questionnaire along with a reasonable belief you are receiving accurate information is the general means of accomplishing this.

Another major benefit of 506(b) compared to other offering types is that it preempts state law. In other offering exemptions you have to be particularly careful you are not only following the federal exemption; but also the states securities regulations as well. What federal preemption means in terms of 506(b) is that as long as you are in compliance with the federal regulation, you are in compliance with the states’ regulations as well.

Issuers should be filing Form D with the SEC (your attorney should handle this). Typically, the only state requirement is a notice filing with a copy of Form D and a filing fee in each state an investor resides in (New York is the exception to this rule as their requirements are more onerous).

What is an Accredited Investor?

A natural person can be an accredited investor via one of several ways. The first is an annual income exceeding $200,000 in each of the prior two years and reasonably expecting the same for the current year. This definition of an accredited investor can also be met if an individual together with a spouse combines for at least $300,000 annual income each of the last two years and reasonably expects same for the current year.

The second manner a natural person can be an accredited investor is to have a net worth of over $1,000,000 excluding the value of the person’s primary residence.

A bank, insurance company, registered investment company, employee benefit plan if the investment decision is made by a bank, insurance company, or registered investment adviser; or an employee benefit plan with more than $5,000,000 of assets are all accredited investors.

A private business development as defined in Section 202(a)(22) of the Investment Advisers Act of 1940 is an accredited investor. These are generally the private venture capital entities.

Business entities (partnerships, corporations, etc.) and trusts will also be deemed to be accredited investors if the entity owns assets in excess of $5,000,000 and is not formed for the specific purpose of acquiring the interests offered.

What is a Sophisticated Unaccredited Investor?

A sophisticated unaccredited investor is loosely defined by the SEC. Obviously they are unaccredited if they do not meet any of the standards listed above. However, to be considered “sophisticated” they must have “sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”

If you have any questions, please feel free to contact us at the number listed above.

17101 Preston Road, Suite 110, Dallas, Texas 75248
Telephone: 469-398-2780
Facsimile: 469-398-2777
Contacts:
Merrill L. Kaliser (469) 398-2781
mkaliser@kaliserlaw.com
Cindy Mirliss (469)398-2782
cmirliss@kaliserlaw.com
Greg Ehrlich (469)398-2783
gehrlich@kaliserlaw.com
Megan Oh, Paralegal
(469) 398-2784
moh@kaliserlaw.com

Multifamily Acquisitions

SEC Compliant Fund Raising for Multifamily Acquisitions

When leads bring in other individuals as partners in a multifamily acquisition, these individuals are not buying a direct ownership of the property.  They are purchasing ownership of an entity (usually an LLC) which is the sole owner of the property.

When selling equity in a business (LLC, Inc, etc.) to raise capital you are selling investment securities.  The securities industry is regulated by the Securities and Exchange Commission.  Typically, when doing this you are required to register with the SEC which can be an incredibly expensive and time consuming process.  However, there are statutorily defined exemptions from registration that allow you to avoid this arduous process.

When choosing to raise capital to fund a multifamily acquisition the exemption known as Rule 506(b) of Regulation D typically makes the most sense.

Under 506(b) solicitation and advertising of the offering is prohibited.  The standard means of acquiring investors is via a pre-existing relationship.

506(b) allows issuers to raise an unlimited amount of capital; however, there are restrictions on whom you can raise the money from.  Under 506(b) eligible investors include up to 35 sophisticated unaccredited investors and unlimited number of accredited investors.

As opposed to other offerings, the verification process is self-certification, and an investor questionnaire is the general means of accomplishing this.

What is an Accredited Investor?

A natural person can be an accredited investor via one of several ways.  The first is an annual income exceeding $200,000 in each of the prior two years and reasonably expecting the same for the current year.  This definition of an accredited investor can also be met if an individual together with a spouse combines for at least $300,000 annual income each of the last two years and reasonably expects same for the current year.

The second manner a natural person can be an accredited investor is to have a net worth of over $1,000,000 excluding the value of the person’s primary residence.

A bank, insurance company, registered investment company, employee benefit plan if the investment decision is made by a bank, insurance company, or registered investment adviser; or an employee benefit plan with more than $5,000,000 of assets are all accredited investors.

A private business development as defined in Section 202(a)(22) of the Investment Advisers Act of 1940 is an accredited investor.  These are generally the private venture capital entities.

Business entities (partnerships, corporations, etc.) and trusts will also be deemed to be accredited investors if the entity owns assets in excess of $5,000,000 and is not formed for the specific purpose of acquiring the interests offered.

What is a Sophisticated Unaccredited Investor?

A sophisticated unaccredited investor is loosely defined by the SEC.  Obviously they are unaccredited if they do not meet any of the standards listed above.  However, to be considered “sophisticated” they must have “sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”

Possession of a Property

??? WHEN ARE YOU IN POSSESSION OF THE PROPERTY ???

You have a firm anticipated closing date. You begin to coordinate with third parties such as staff, maintenance workers, a management company, accountant etc… You schedule parties to be present at the property on the morning of the closing day. You instruct them to perform some minor duties at the property, such as cleaning out some trash from a vacated unit. Later in the day you check in with the Title Company and your legal counsel as to the status of closing. You are informed that your wire did not arrive to the Title Company prior to the wire cutoff time. The Title Company is unable to close and fund the transaction that day because they can no longer wire funds.

What does that mean? The premise of the contract is an exchange of money for a property. As the Title Company is unable to fund the seller on the intended closing date, it means that the seller is still in possession of this property. Until the seller receives possession of the funds from the sale of the property, the buyer is not in possession of the property.

Taking this scenario one step further, the worker, hired by you to clean out the trash, fell and broke his arm on the property. He reported the incident to you and later he hired an attorney. The attorney will sue the employer and the owner of the property which on the date of incident was not You. A liability situation has been created because the worker was on the property and he was not employed by the current owner on the day that the incident occurred.

How can this situation or similar situations like this be avoided?

Our firm always recommends to a buyer that they wait to deploy any third parties to the property until they have received a Congratulatory email from our office indicating in writing that they are now in possession of the property and they may take over. This may happen after 5:00 p.m. if the closing is down to the last minute, it may happen on the following day as closing rolled into the following day. It could even happen on a Monday after an intended closing that should have occurred on Friday.

Best advice that our firm can provide is to make sure that you know, in writing, you are in possession of the property. Remember, You give the Seller Money, the Seller gives you a Property.

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