In any legally structured syndication, prospective investors should expect to see a professional offering package. This package will contain legal documents prepared by an SEC attorney that you must review and sign in order to invest.
There are three major documents that you'll receive in the offering package of a multi-family syndication. They are the: 1) Private Placement Memorandum 2) Operating Agreement and 3) Subscription Agreement. In this article we’ll take an in-depth look at these three documents, and discuss the key items to look for in each.
A PPM essentially tells the “story” of the investment. It gives investors a full understanding of the securities being offered and the company’s objectives. The PPM is the disclosure document that’s legally required by the Securities and Exchange Commission (SEC) for a private placement offering. The rest of the offering documents are exhibits to the PPM. Let’s take a look at what a PPM contains.
The name of the company for which membership units are being sold, the price of each unit, the minimum and maximum dollar amount that the company will raise. This section also mentions the date on which the offering commenced, the date by which the minimum dollar amount must be raised, and the date by which the offering will close - if the maximum dollar amount is not raised.
This section describes what exemption is being used (506(b) or 506(c)). It further explains that the securities being offered involve risks - in which investors must rely on their own examination of the company, its merits and risks of the investment. This section also includes the sponsor’s contact information so that prospective investors know where to direct questions.
The Executive Summary provides a brief overview of the rest of the PPM content. Its summarized sections include:
This section describes the requirements and restrictions of the securities exemption (typically 506(b) or 506(c)) that has been elected under this particular offering, and how they relate to investors in this offering. For example, in a 506(b) offering, general solicitation or public advertising is prohibited. Information about the offering must be communicated to investors privately - such as a private mailing list, and not through public platforms like social media. Another restriction mentioned here is that all investors must be either Accredited Investors or Sophisticated Investors. For Self-Directed IRA investors, the beneficial owners of the IRA must be either accredited or sophisticated..
This section typically contains a table that breaks down what sources of capital are involved in the deal and what that capital is being used for. The table may also show how the use of proceeds may differ based on how much of the anticipated capital the sponsor is able to raise. For example, if only the minimum dollar amount is raised, the sponsor may defer reimbursing themselves for their expenses, defer their acquisition fee, and even loan the company money to cover closing costs in order to get the deal closed.
Our objective in purchasing and operating multi-family properties is to produce cash flow that we can distribute back to investors. This section explains that this is our intent. It also explains that it’s up to the Sponsor to determine how much cash is distributed. It’s the Sponsor’s responsibility to ensure that there is sufficient working capital and reserves on hand before distributing cash out to investors. We believe that the viability of the property's performance comes first, and we do not want to ask investors to send cash back because the property is under-capitalized. This section also details how the preferred return (if applicable) factors into the cash flow distributions.
One very important aspect to verify in this section is that cash flow distributions are treated as a “return on investment” and not a “return of investment”.
The final parts of this section will outline the order by which capital is returned to investors in the case of a refinance or sale of the property.
There are several ways that Sponsors are compensated. Each of the fees and reimbursements due to the Sponsors are outlined in this section along with a description, frequency, and amount.
The Sponsors serve as the manager of the LLC that the investors are investing into. They have a fiduciary responsibility to:
The purpose of this document is to disclose all of the potential risk factors that may affect the investment. We’re legally required to disclose these "potential" risk factors. While you should be aware of them, also consider the many steps and strategies that we use to mitigate our risks.
A few of the standard risk factors you’ll see in any multifamily syndication are:
Objectives and policies that are outlined for a typical multi-family syndication include:
The PPM encourages investors to consult with their tax professional in order to determine the effects that the tax treatment of this investment will have on them. It then provides several general tax-related facts that investors should consider.
For example, the company is typically a partnership LLC. These are pass-through entities, meaning that instead of reporting income or loss at the company level like corporations do, the members of this LLC will report their pro-rata share of profits and losses on their personal tax return.
Another tax treatment disclosed in this section of the PPM is "Depreciation Recapture". When we use cost segregation to accelerate our depreciation, we are able to write-off large losses in the first year of ownership; however, this depreciation strategy may be required to be reported at the sale of the property, and could be taxed at a marginal tax rate that is higher than the typical long-term capital gains rate. The PPM will disclose what’s accurate based on current tax code, but tax law changes over time. So the actual tax treatment at sale could vary.
For Self-Directed IRA investors, the PPM discloses the possibility of owing Unrelated Business Income Tax (UBIT). Whether or not this tax applies to your investment is a topic to discuss with your CPA or tax advisor.
Finally, the last page of the PPM is the signature page - which is to be signed by the Sponsors who are serving as managers of the company. The Sponsors are your partners and are working on your behalf to close the transaction, and execute the property's business plan.
An Operating Agreement is the governing document for company operations, and describes in detail the rights and duties of the members and the manager, how meetings and votes of the members will be conducted, how and when cash distributions will be made, where the company will keep their books and records, how disputes will be resolved, allocation and taxation of profits and losses, and how the company will ultimately be dissolved. This agreement is the legally-binding, enforceable contract between the LLC members and the LLC manager.
Much of the terms in the Operating Agreement have already been described in the PPM. What’s most important here is that the Operating Agreement is in line with what the PPM says. There should be no contradictions.
The Subscription Agreement is a form that must be completed, signed, and submitted to the manager in order to invest in the deal. It requires investors to represent and warranty their qualifications and suitability to invest in the offering - in addition to the amount they are investing into the offering. Upon receiving an investor's signed Subscription Agreement, the Sponsor will add their signature to acknowledge and accept the investment.
Here’s what you’ll need to fill out on your Subscription Agreement:
The total amount of money you’re investing and the number of membership units that represents.
If you meet the SEC’s criteria of an “Accredited Investor”, then you will check a box to self-certify that.
If you are not an accredited investor, then you must at least be a “Sophisticated Investor”. You will check a box to indicate that you meet the SEC’s definition of a “Sophisticated Investor”. Generally, you’re able to claim this status if you have prior business experience, invested in real estate before (i.e. owned rental properties), taken a real estate course, or if you are being advised by a Professional Advisor who has this type of knowledge and experience.
If you are consulting with a Professional Advisor such as an attorney or CPA in your decision to invest, you will be asked to provide that person’s contact information and indicate if there is any relationship between the Professional Advisor and the company raising capital.
You’ll be asked to enter your own contact information and contact info for any co-investor such as a spouse. Also in this section, you’ll be asked how you intend to to hold the membership units that you are purchasing. You may be purchasing them as an individual, as a company, in a trust, in a retirement account, etc. If you are purchasing as an LLC, you will be asked to provide a copy of your LLC’s Articles of Organization and a resolution signed by an authorized person authorizing the investment.
You’ll be asked which state you live in, which state you pay income taxes in (this determines where state securities notices must be filed), your age range, job titles / positions you’ve held over the last 10 years that demonstrate your experience in financial and business matters, and the nature of your prior personal or business relationship with the sponsors.
If you are acquiring over 20% of the company’s membership units, then you’ll be required to answer several “Bad Actor” questions. A Bad Actor is someone who has been convicted of a crime involving securities fraud or other financial crimes within the last 5 - 10 years. People that have committed these types of acts are prohibited from raising capital and typically prohibited from borrowing from the government sponsored agencies like Fannie Mae & Freddie Mac.
If you reside in certain states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) the membership interests you are buying by investing in the deal are considered the community property of you and your spouse. If you intend to keep this separate from your spouse, it’s none of our business but, you must fill out this waiver, have it signed by your spouse, and get the waiver notarized.
The final page of the booklet is your receipt. After accepting your investment, the sponsor will fill out a receipt with a submission date, investment amount, number of units acquired, acceptance date, and their signature. We’ll then send you a copy of this page to serve as your receipt. Keep this signed receipt for your records. There are no membership certificates.
If the deal is oversubscribed, meaning that we have more subscriptions from investors than we have room to take in, then your Subscription Agreement will not be signed and any money you’ve wired to the company will be returned.
Now that you're fully educated on what to expect when a Sponsor presents a live investment opportunity! Although the offering documents can be quite cumbersome and tedious, we encourage all investors to read the“fine print," and be informed on what the documents actually mean. We encourage investors to read these documents carefully and to ask us questions if anything isn’t clear. The better informed you are, the more confident you’ll be about your ability to make sound investment decisions.
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