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.”