Real estate operators and investors often face the challenge of raising capital for their projects. Whether developing a new property, rehabilitating an old one, or simply expanding a portfolio, securing funding will usually be one of the many tasks that an operator must undertake.
Selling securities is a common way to raise the necessary capital, but what exactly are securities, how can they be sold lawfully, and how can finder's fees be legally obtained in the process?
This brief guide dives into the nuts and bolts of these topics to assist in keeping real estate operators compliant while successfully raising the needed capital.
Using other people’s money (OPM) is a canon in real estate. OPM is a way to grow and scale faster. To acquire real estate, an operator may have various pieces to their capital stack such as traditional debt, grants, tax credits, and of course, other people’s money.
In most cases, taking on passive investors means that a security is being sold. If one sells a security, they must register that security or have an exemption from registration. By selling securities, the investors gain a stake in the project, and the operator has the funds necessary to move forward.
When raising capital, it is common for real estate operators to seek assistance from individuals known as finders. Finders help identify and introduce potential investors to the project, and in return, they receive a fee. While this arrangement sounds straightforward, it can get complex very quickly, and many people, unfortunately, do it incorrectly.
The Securities and Exchange Commission (SEC) and some state regulators have stringent rules regarding the payment of finder’s fees.
In most cases, individuals who facilitate the sale of securities or introduce investors to issuers generally need to be registered as brokers. Brokers must be registered with the SEC and be members of the Financial Industry Regulatory Authority (FINRA). The registration process involves meeting specific qualifications, ongoing compliance obligations, and adherence to conduct standards.
If one is not registered with FINRA but still wants to be compensated for finding investors to purchase securities, there is a narrowly defined exception for those who simply introduce parties without engaging in activities that would necessitate broker registration. To ensure that the finder doesn’t run afoul of securities laws, the finder must:
Further, the finder cannot receive transaction-based compensation. Transaction-based compensation essentially means that the finder’s payment structure and right to payment are not contingent upon an investment being made and/or the amount of investment being made. In other words, a non-licensed finder cannot be paid a commission. Instead, they must be paid a flat rate that is earned at the time an introduction is made and is not contingent upon an investment being made.
One thing to keep in mind is that there are both state and federal securities laws, and they are not always the same. Each state has its own securities regulations, often referred to as “Blue Sky” laws.
In some instances, federal securities laws preempt or supersede state securities laws, but not in every instance. Some states allow finders to receive compensation without being registered as brokers, under specific conditions. Check your state’s regulations to ensure compliance.
To safeguard all parties, it’s essential to draft a clear, written agreement outlining the finder’s role and the compensation arrangement. This agreement should explicitly state that the finder is not engaging in broker-dealer activities but is solely being compensated for introductions. The agreement should state the amount of compensation and when the compensation is earned.
Again, if the finder is not licensed, the compensation must be earned for the introduction and cannot be contingent upon capital being raised.
When selling securities and dealing with investors, disclosure and transparency are critical. Investors should be fully informed about the finder’s role and compensation structure. This disclosure helps ensure that investors are aware of all relationships and potential conflicts of interest.
Depending on which exemption the operator is using, it is likely that they are legally required to disclose the fact that finder’s fees are being paid and how much they are. Proper disclosure is not only a legal requirement but also fosters trust and confidence among investors.
Correct.
However, in 2020, the SEC proposed a rule to establish a safe harbor for finders, allowing certain limited activities without the need for broker registration. This rule, if adopted, could provide more clarity and flexibility for real estate investors and finders. Staying updated on these regulatory developments is crucial as they could significantly impact how finders operate and how they can be legally compensated.
Do Your Homework: Know the laws and requirements regarding securities generally, and finder’s fees specifically, before engaging a finder. Ensure that the finder is not performing activities that would necessitate broker registration.
Seek Legal Advice: Consult with a securities attorney who can help navigate the complexities of securities laws. An experienced attorney can provide tailored advice to ensure compliance and help structure capital-raising activities lawfully. Legal counsel can also assist in drafting and reviewing agreements and disclosures.
Clear Documentation: Be sure that you have a clear agreement with your finder and ensure that that agreement is compliant with both state and federal securities laws that are applicable. Keeping meticulous records of all agreements, disclosures, and communications with investors and finders is critical. Proper documentation can provide evidence of compliance in case of regulatory scrutiny. Good record-keeping practices also help in maintaining transparency and trust with investors. Most importantly, be sure that the compensation is not contingent upon an investment being made or how much is invested.
Maintain Transparency: Full transparency with investors is crucial. Clearly disclose the finder’s role and compensation in all communications and offering documents. Ensuring that all parties understand the nature of the finder’s involvement and any potential conflicts of interest is essential.
Monitor Regulatory Changes: The regulatory landscape for securities offerings and finder’s fees is dynamic. Staying informed about changes in laws and regulations that could impact activities is essential. Regularly reviewing practices and policies helps maintain ongoing compliance with current laws.
By adhering to these guidelines, real estate investors can effectively and lawfully utilize finders to raise capital for their projects. Understanding the legal requirements and maintaining compliance is essential to avoid penalties and ensure a smooth fundraising process. The key to successful capital raising lies in working within the regulatory framework and fostering transparent, trustworthy relationships with investors.
About the Author:
Nic McGrue is a tenured professor of law and the founder of Polymath Legal PC. At Polymath Legal PC, Nic helps real estate investors lawfully raise capital allowing them to generate passive income while creating generational wealth.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.