The Role of a Syndication Attorney in
Private Placements and Raising Money.
It doesn’t matter whether you’re the CEO of General Motors looking to raise money for your latest tech startup, or seeking funds from friends and family to invest in a small real estate deal. You better understand security laws and the laws concerning how to raise money legally.
Now, don’t feel bad if you’ve never heard of these things before. Quite frankly, most lawyers don’t even fully understand these concepts, and they’re very complicated as most lawyers are not qualified syndication attorneys. I’m going to be moving through the general laws and how syndication attorneys view and solve these situations. If you have any questions or comments, please feel free to reach out to me directly.
Key Takeaways.
- Understanding Securities Laws: Raising money for a business, whether a large corporation or a small startup, requires compliance with state and federal securities laws.
- Security Offerings vs. Business Partnerships: If investors contribute money without actively working in the business, it qualifies as a security offering and must comply with securities regulations.
- Exemptions for Private Placements: The SEC provides exemptions, such as 506(b) and 506(c), allowing businesses to raise capital without full public registration.
- Accredited vs. Unaccredited Investors: Accredited investors meet wealth or income thresholds, while unaccredited investors may participate under certain conditions in 506(b) offerings.
- Consequences of Non-Compliance: Failure to properly follow securities laws can lead to fines, criminal charges, and the requirement to return investor funds with interest.
To fully grasp some of the concepts we discuss today, it should be helpful to quickly go through some definitions:
Sponsor or Syndicator – A person or business seeking to raise money from investors in exchange for ownership/securities in a company.
Security Laws – Both state and federal Laws designed to protect the public from purchasing fraudulent stock/securities/interest in a company from a dishonest Sponsor.
Syndication – When a Sponsor gathers investors together for a Security Offering.
Security Offering – When a Sponsor Raises money for a business from investors and said investors contribute money without working in the business.
Private Placement – A private sale of securities (via security offering) that often utilizes exemptions instead of conducting a general public offering.
Private Placement Memorandum – The required information that a sponsor must (generally) provide to the investors in a private placement syndication.
506(b) & 506(c) – The most common private placement exemptions from federal security laws that protect and shield the Sponsor from the investors.
Form D – The document the syndication attorney files with the SEC to elect an exemption and protect the sponsor.
Intrastate – Where all of the investors are from the same state as the company issuing the security offering (and federal law may not fully apply).
Preemption – The federal law (higher authority of law) will displace state law (lower authority of law) when the two conflict.
Syndication Attorney, Private Placement Attorney, or securities lawyer – The attorney/lawyer who is hired by the Sponsor to ensure the Sponsor is protected from the investors.
Basics of Securities Law from a Syndication Attorney.
A long time ago dishonest business people would create a company that did not have any assets or real value and then convince investors to give them money in exchange for stock in the company, assuring investors that the company was the next ‘big thing’ when in reality it was all just a scam. So the government stepped in and created securities laws to protect investors by requiring any security offerings to the public to be registered with SEC and certain information about the company be made public so any potential investors could fairly evaluate the investment.
The problem is that full public registration of a security offering is very expensive, and thus small and medium-sized companies can’t afford to complete the registration. Therefore, exemptions were created so that those smaller/medium sized companies could actually raise money.
There are both federal and state laws that govern how you raise money (more on this later and please consult a syndication attorney for the specifics of your deal). But, the general rule for raising money is, unless there is an exemption, all offers and sales of securities must be registered with the SEC.
What is a Security/Private Placement offering?
A security offering (otherwise known as a private placement offering), is a transaction where an investor is expecting to receive money solely from the efforts of a third party (Sponsor). So what does that actually mean? Well, let’s take a look at a couple of examples here. If I and my accountant invest money to buy a commercial real estate property, is there a security being offered?
Well, if I do all the syndication attorney legal work and my accountant is doing all the accounting and tax work for the property, and we’re both working in the investment, then in this case, neither investor is expecting a return of money without doing any work = No actual security offering. Generally speaking, in this situation you do not need to do anything or even hire a syndication attorney.
Now let’s change things around a little bit and add another party, my dentist. Now, my dentist intends to invest in the same investment with myself and my accountant, but in this case, the dentist is not going to be actually doing any work or putting forth any effort for the company.
So in that case, between myself and my accountant, there still is no security offering, but with the relationship of the dentist with the company, there actually is a security offering, and that does qualify as a security offering under the law.
So the basic rule is:
Investor does not contribute work => Security is being offered.
Investor works in business => No security offering.
Therefore, whenever you want to raise money from investors and the investors are only contributing $ and not doing any actual work, you are offering securities (just the same as General Motors or any other major company issuing stock/securities).
Security Offering Exemptions 506(b) and 506(c).
So if you are offering securities you need to register your offering with the SEC, and that is extremely expensive and time consuming for both you and your syndication attorney (you do not want to have to do this), so do easier paths exist? Yes, security laws provide for certain exemptions from full registration of the securities offering.
Technically under federal law, there are a lot of exemptions (and your syndication attorney can advise you best on which exemption to choose), but the two most common exemptions are the 506(b) and 506(c) raises. Here, we have the differences between the 506(b) raise and the 506(c) raise.
The first issue is money. There is no ceiling on the amount of money that you could raise with either a 506(b) or a 506(c). It is unlimited. So you could raise $50,000 or $50 million; it doesn’t matter. The second issue is accredited investors.
Accredited Investors and Unaccredited Investors.
Now, an accredited investor is someone who has over a million dollars in assets not counting their house, or makes $200,000 in salary per year, or $300,000 in salary combined for the past two years. (Someone who is well-off.) The government wants to protect people from being swindled by an unscrupulous sponsor trying to steal investor money. So, if you are the sponsor raising money, the best investor is someone who is wealthy (and thus qualifies as an accredited investor).
Now, there’s a slight difference in terms of what you as a sponsor need to get from an accredited investor. In the case of a 506(b), all you need is a self-verification document from that investor stating that they qualify as an accredited investor. But, you’ll have to go a bit further than that for 506(c).
You (or your syndication attorney) will have to take an additional step of getting certification or verification from the investor’s attorney or accountant stating that, in their expert opinion, the investor qualifies as an accredited investor. So, it’s an extra step of verification that you have to go through as a sponsor of an investment to qualify accredited investors under 506(c).
For 506(b), there are 35 maximum unaccredited investors permitted in that raise, and they have to be sophisticated.
Sophistication = experience and education (without the money to qualify as accredited).
An unaccredited investor may not have the money to qualify as an accredited investor, but they have to be sophisticated with business. Unaccredited investors must have advanced degrees or other sort of business acumen that evidence is the fact that they’re sophisticated business people.
Private Placement Memorandum.
The law requires that a sponsor provide certain kinds of information to your investors for a 506(b) and 506(c). You have to provide information very similar to what you would have to provide in a standard stock registration, and the level of information really depends on how much money you’re raising.
The document which your syndication attorney will assist you with drafting and contains this information is referred to as a private placement memorandum. The private placement memorandum is a shield that protects you from your investors proving that you disclosed the necessary information that you are required to disclose under the law and that a standard investor would want to see.
Now, for a 506(c), you’re not technically required to provide any information. However, realistically, your investors will require the same information that you have to produce for 506(b), so you might as well just create a private placement memorandum for a 506(c) anyway. (A good syndication attorney can help you here.) Here’s a big difference between the two exemptions: Advertising.
On the 506(b), you cannot publicly advertise. You as the sponsor, has to know the investors and have some sort of personal relationship with them before discussing the offering terms (otherwise it is a public advertisement). However, for a 506(c), there are certain circumstances where you can publicly advertise the securities offering to people who you don’t know, but there are some detailed intricacies here that we will not get into today. But just be aware of the general rule that there’s no advertising for a 506(b), and possible advertising with a 506(c).
Preemption and How Federal Securities Law is Supreme.
The exemptions 506(b) and 506(c) are exemptions from federal law. There exists a right of preemption of state law, which basically means that you don’t actually have to follow the state laws as long as you follow the federal law and do everything properly. In that case, you’ll only need to provide notice to the state. Finally, for a 506(b) or 506(c), the only document you really need to file with the SEC is a Form D, which is a relatively simple two-page document.
What Happens if You Do Not Complete a Private Placement Properly?
So, what happens when you break security laws that we’re discussing today? Well, there are some pretty significant consequences. The SEC generally does not go looking for violations, usually it only happens when your investor complains either to the SEC or the state’s version of the SEC. But be advised that there can be criminal charges, fines, and you could be required to return the investor’s money with interest.
Intrastate Exemption of Securities Laws.
So, let’s put it all together and take a quick look at a couple of examples to see how this actually plays out in the real world.
Let’s say myself and 20 silent investors from multiple states invest in an apartment building. In this example, our syndication attorney is going to do a 506, provide our private placement memorandum to investors and file a Form D with the SEC.
Another example, let’s say myself and 20 silent investors, all New Jersey residents, purchase the same apartment complex. In that case, it would also be wise to direct our syndication attorney to do a 506, provide our private placement memorandum to investors and file a Form D with the SEC.
Now, let’s say, going back to my original example, myself, my accountant, and my dentist, all New Jersey residents, invest money to buy an apartment complex. And here’s where it gets a bit tricky because this is technically an intrastate deal and also falls under the 10 investor max for New Jersey security laws. So, technically, you really don’t have to have your syndication attorney file anything with either the state or the federal government.
However, it is a bit more complicated than that because if you are only raising a small amount of money ($50,000 to $100,000), it doesn’t really matter. However, as the amount of money goes up, it’s wiser to consider, at the very least, doing a 506 and filing a Form D with the SEC.
Remember, if your syndication attorney does not do things properly and your investor gets upset and sues, or if there are complaints to the SEC, the remedy for the investor is for you to pay their investment back with fines and interest. So, that means if you have a small investment of $50,000, it’s not quite that big of a deal, but once you start getting into $500,000, $1 million, $2 million, $10 million, it’s much wiser to actually do a 506 to protect yourself properly.
Final example: myself and my accountant invest money to buy commercial property. In this case, because we’re both working the business, I’m doing the legal work and my accountant is doing the tax work, there is no offering of securities, and residence is irrelevant.
Frequently Asked Questions.
1. What is a security offering?
A security offering occurs when a business raises money from investors who contribute capital without actively working in the business. (These transactions must still comply with securities laws.)
2. Do I need to register my private placement with the SEC?
Not necessarily. Most private placements use exemptions such as Rule 506(b) or 506(c) to avoid full SEC registration, which is costly and time-consuming. However, you still need to file a Form D with the SEC. (Usually the safest option for you.)
3. What is the difference between a 506(b) and a 506(c) offering?
A 506(b) offering allows up to 35 unaccredited but sophisticated investors and prohibits general solicitation, while a 506(c) offering only permits accredited investors but allows public advertising. (It is usually better to do a 506c if you can because there is less required disclosures and safer for you.)
4. Who qualifies as an accredited investor?
An accredited investor is someone with a net worth of over $1 million (excluding their primary residence) or an annual income of at least $200,000 ($300,000 for joint filers) for the past two years.
5. What happens if I don’t follow securities laws?
Violating securities laws can result in fines, criminal charges, and the requirement to return investor funds with interest. Complaints from investors can trigger SEC investigations.
6. What is a Private Placement Memorandum (PPM)?
A PPM is a document that outlines key details of a private placement offering, including risks, investor rights, and disclosures. It serves as a legal ‘shield’ for sponsors against investor claims.
7. Can I raise money from friends and family without complying with securities laws?
No. Even if investors are friends or family, securities laws still apply. You must either register the offering or qualify for an exemption.
8. What is preemption in securities law?
Preemption means that federal securities laws override state laws in certain cases, such as 506(b) and 506(c) offerings. (This means you can only abide by the one Federal law vs 50 state laws.)However, notice filings with state regulators may still be required.
9. Do I need a syndication attorney to structure my offering?
Yes. A syndication attorney helps ensure compliance with securities laws, drafts necessary documents like the PPM, and advises on the best exemption for your offering.
10. What is Form D, and when do I need to file it?
Form D is a notice filing submitted to the SEC after a securities offering under an exemption. It provides information about the issuer and the offering but does not require SEC approval.
Conclusion.
Raising capital legally requires a thorough understanding of securities laws and the appropriate exemptions available for private placements. Whether you’re structuring a small investment deal or a large-scale syndication, compliance with SEC regulations is essential to avoid legal pitfalls and financial penalties. Understanding the distinction between a security offering and a business partnership, as well as the requirements for accredited and unaccredited investors, can help you navigate the complexities of fundraising.
To ensure your offering is legally sound, working with a knowledgeable syndication attorney is crucial. Proper documentation, such as a Private Placement Memorandum, and adherence to filing requirements like Form D can protect you from potential legal disputes.
So that’s the basics on private placements, security offerings, and how to raise money legally. If you want to speak with a syndication attorney/SEC lawyer, please feel free to reach out to me at the above telephone number. Have a great day!
John M. Shari is a seasoned business and real estate attorney with over 20 years of experience. As the founder of Law Offices of John M. Shari, LLC, he represents clients in complex real estate transactions, commercial leasing, business acquisitions, private placements, secured financing, and entity formations. His background includes serving as Lead Acquisitions Counsel at Diamond Communications and practicing at respected law firms, where he honed his skills in structuring and negotiating high-value deals. John is committed to providing legal guidance tailored to each client’s needs.