For many real estate investors, the thought of raising capital to increase their purchasing power is an irresistible allure. However, how one goes about this business can have serious long-term ramifications for the uninformed.
When you’re dealing with other people’s money, you need to make sure you are setup correctly. In the post Madoff climate, we now find ourselves with state and federal agencies that are pursuing a take no prisoners attitude when it comes to investors who raise money. Failure to comply with the securities laws increases an investor’s risk of lawsuits by other investors – and can even lead to criminal prosecution. Remember, ignorance of the law is no excuse and even an innocent mistake can lead to court and likely jail.
If you are not deterred by these warnings, then here are a few things to consider if you plan on raising money:
If you plan on raising money with an LLC, start by registering your LLC in the state where you will be working. A mistake made by many investors is raising money through a Nevada entity without proper registration. This is a path to jail where you will not pass “go” if things turn south for your investors.
Draft an operating agreement that details how the funds will be invested, distributed, managed and any fees paid for management. This is a crucial step for any investor because the operating agreement puts everyone on notice as to how the funds will be handled i.e., it’s a point of agreement between you and your investors about how the LLC will operate.
Many real estate investors will not proceed past this point in their fund raising activities. In other words, I have my LLC so let’s start making money. Unfortunately, to stay completely legal (out of jail) you must also be mindful of state and federal securities laws.