E315 | What’s the Right Capital Raise Structure for Your Investment?

Welcome back to the Papertrail podcast.

Today I want to talk about which capital raising strategy actually fits your deal.

So whether you're a note investor looking to start your first fund or other types of real estate investors and you're launching that fund raising first startup, scaling your portfolio, knowing the rules can not only save you time, but money and most importantly, a ton of headaches.

So let's first start with the four main options with some pros and cons of ways to raise money.

First, we'll talk about a regulation D506B, as in boy offering.

Now this is a private round investment and what I mean by that is you cannot advertise.

The sec, this is an exemption or doesn't allow you to advertise.

It's open to accredited investors which are people who either have a net worth of a million dollars outside of their primary residence, have made over $200,000 a year or combined 300,000 over the last few years and continue to look at that.

Now you also can include what they define as 35 sophisticated investors with the accredited investors.

Now these can be non accredited, but you have to still vet them.

So as part of this, when your rule that you can do again, you cannot advertise.

It's usually the most cost effective way to set up a fund or entity and we'll talk about that later.

The second that we'll briefly talk about is what's regulation D506C.

Now on a 506C.

Now some people nickname this the megaphone round.

Why?

Because you can advertise publicly anywhere but and here's the big but, every investor must be accredited and you're required to also verify that.

So it's your responsibility to verify the investor is accredited.

So you've got 506B which is no advertisement accredited and 35 sophisticated 506C can blast it out, but everyone's going to be accredited.

Third, this is what we have done is the regulation A plus offering, which we'll nickname the retail round, which is like a mini IPO.

Now, with Regulation A Plus offering, you can raise up to 75 million per year and it's open to anybody.

So retail, as long as you're over 18, you can invest.

Now, there's limits if you're not accredited on what you can invest and then you can of course have the accredited.

I will say it is expensive, it's time consuming, it requires an SEC qualification and you also need audited financials.

Lastly, there's regulation cf which is a crowdfunding round Some people call this community round ideal for local projects startups.

You can raise up to 5 million through an online portal.

It's open to everyone but comes with limits and a lot of platform fees.

I view Reg CF not as much as a real estate avenue, but more for tech startups.

But we still see some real estate people doing that reg CF offering.

So I've tried to highlight quick snapshot of four types of offering.

Again, you got reg 506B, 506C, reg A, reg C F.

Now let's break these down into some categories on how much you can raise advertising, who can invest, the speed on which it can get qualified and of course the cost.

So we're going to go probably simplest to most challenging.

506.

You have unlimited funds.

You cannot advertise again.

And I apologize if I'm repeating this, but people again really need to get an understanding to see what fits within their profile.

So that 506B unlimited raise no ads accredited and 35 non accredited super fast.

Meaning you could have your PPM and documents up and running in two to four weeks as low cost.

We'll talk cost later but consider a 506B, 10 to 15,000 to get going.

506C unlimited like the B, you can advertise.

So that's a difference with the B accredited only slightly different than the B.

But speed and cost are the same whether you're putting a 506B or 506C together.

Every attorney that I've done and I have done a B and a C as well, it's the B is a little bit more documentation but but they consider them unequal footing.

Now let's talk about regulation A plus again it's limited.75 million per year, which most real estate investors not a problem because that's investor money.

So if you're doing a 75 or $100 million multi family project, you know you're probably going to get 60 or 50 million in financing and raise 50 or 40 million you still match.

You can advertise like a 506C.

The difference again is anybody can invest.

So retail investors can invest and you'll typically see the regulation A offerings have lower minimums.

We'll talk about that a little later.

The speed is very slow.

It can take three to six months to get qualified by the sec.

Which the B and the C.

You just submit form D with the sec which is you file it that day and you're good.

Regulation A, the SEC actually reviews it and provides comments and feedback.

Again, it's like a mini IPO, cost high.

You're going to spend six figures getting it qualified and reg CF.

Now, again, it's limited to that 5 million and this is why you don't see a lot of it in real estate.

Yeah, you can do the ads.

Anyone can invest.

It's not as slow as a reg A, but it's not as fast as A Reg D, 506B or C.

And the cost is medium in that medium level.

So if you're going to go real estate, I would tell you cut out the reg cf, but we'll still talk about it, give you the information.

But for most people it's really not that fit.

So.

So the takeaway from this, the faster and cheaper you want your raise, the fewer bells and whistles you do get, the more inclusive and retail friendly you want it.

The more blue ocean strategy of people you want to be able to invest, the more time, cost and compliance unfortunately you're going to face.

Now let's dive into costs.

Okay.

For a 506B and a 506C, your attorney will create, they'll create an entity.

So there's probably an operating agreement, LLC documents.

There should be what's called a private placement memorandum, which is 30 to 50 page document outlining what's your investment, what are you investing in?

So that's called the prospectus on a public company is what it would be considered.

And then what's called a subscription agreement, which is the actual contract that says I'm investing $100,000.

Here's all the rules.

So many important things to review in that.

And one of the things I always recommend, have your attorney review that your attorney should review any contract you're signing.

If you're signing a $100,000 contract to invest, let them review because do you know what rights you have in regards to documentation?

If there's a conflict, can you sue?

Is it arbitration?

Is it a class action?

Can you not do a class action?

There's so many finite details in there.

And you also want to understand the ownership structure in regards to are you investing in an entity that's investing in the fund and that entity basically goes belly up.

You could get wiped out from everything.

So much you need to look into within the 506B and C.

As an investor and as a sponsor, you want to make sure this is clearly defined as well.

Because you want to make sure you have a path to understand if things go wrong, what is the path and leave it up to you, not different investors to come up with different paths.

And as I mentioned, a 506B or 506C can be done 10 to $15,000.

But that's typically, I think, where most of them fall.

Now let's dive into the regulation A because I have a lot of people call me, say I want to do a reg A.

Now when you hear the term reg A or reg A plus, it's the same, they're interchangeable.

Technically a reg A plus, but you can raise a lot of money.

We've raised 40 plus million dollars.

It's open to everybody.

It levels the playing field.

So we have investors who invest 5,000, we have investors who invest 500,000.

If you've got set up a IRA for with $6,000, you can invest that in an alternative like a regulation A offering and not have to worry about the 50 or $100,000 minimums.

But let's follow the paper trail and see what it really costs.

So you have to draft an offering circular which is a PPM on steroids.

The legal fees to draft this can be anywhere from 25 to $75,000.

Now, if you've done multiple, yes, it can be slightly less, but anticipate spending 25 to 75,000.

Maybe you got a good attorney that can do it for less.

That's what I would ballpark.

Then you have to have annual audited financials.

Now, if you just started your company and you're doing your first audit, I call it a snowflake audit.

Because you put a hundred bucks in a bank account for that, you don't need a powerhouse auditor.

You could.

For ours, we spent I think about 7,500 bucks for that initial audit.

Now, when people think of an audit, I just want to be clear.

You think, oh, it's just the money.

No, it's a lot more behind it.

Especially for an SEC audit, they want to know your process, your rules, who, who's approved.

Is it one person who can pay the bills and move money around, or is it multiple?

They want to know that you have documentation, if you have employees, that their salaries are in writing.

There is a ton of things within these audited financials that need to prove not just where the money goes, it's all about the operations of the company.

Now, once you're up and running, you're going to spend anywhere from 30 to $75,000,000 a year on audits.

Now that legal fees, that's just a startup.

We'll get into continuing costs, but you'll have your audits as well.

So let me just talk about continuing costs.

On legal Every year you have to submit in a regulation A plus offering a semiannual report which is unaudited financials with updates to the company.

Expect that to cost 5 to $10,000 depending where you do it in house or still have to have attorney reviews.

You have to after your audited financials you have to submit what's called a 1k form which I included that 30 to 75, that's part of that cost.

And then every year you have to resubmit your offering circular.

You have to refresh it every year to keep going and that is going to be another five to $10,000 in costs.

Now for us, our first year we submitted, got renewed and these okay, you're qualified, re qualified.

Second year they came back with about 10 pages of comments.

It was the same exact offering, but it was just a different reviewer.

And we had to spend that second year, probably an extra $10,000.

So it's very unpredictable on what those costs could be.

Promoter and marketing fees.

Now we work with a broker dealer for blue law compliance about raising money in all these states which they take anywhere from a half a point to 1% of the money raised.

So think about that and if you are marketing and you are a new sponsor, you've never raised money before, expect your marketing fees to be about 10%.

If you could get it for 5 or less, be thankful.

But it's going to be expensive.

It's going to cost you a million dollars to raise 10 million.

And I know you're going to say that's not feasible or viable.

If you look at it over a span of your offerings, five years, you know it's about 2% per year, amortize over that time, you should have 2% within your numbers.

But I see people doing 12 month offering or shorter term offerings, I don't know how they make money but that is the one area, the marketing fees where people underestimate.

And let's say you go institutional route and you have working with an ra, a wholesaler, broker, dealers, their fees are going to range from 5 to 10%.

When I see people talking about oh it's going to cost me 1 to 2% to raise money, 99% of the people will never be able to hit that number.

Now for your first million or 2 million, yeah, you might have friends or family and people who can contribute, but if you're looking to raise 25, 30, $50 million, you are going to spend a considerable amount in marketing fees, commissions and other costs.

Now, other costs that you may incur.

We have the broker, dealer, we have an escrow agent so the money doesn't come right into our bank account.

We also have a transfer agent who holds a capital stack so an investor can call up and say how many, confirm how many shares and stuff they have.

So if I disappeared off the face of the earth, which some sponsors have, it's a third party company that says, hey, you still have this.

So just to launch, to add up the legal, audited financials, marketing fees, everything else, it's gonna cost you over a million dollars.

Now take away the marketing fees in just the legal auditing and just getting qualified, you know, I would anticipate spending 100 to 150,000 before you're allowed to raise money.

So I want to say that again.

It's going to cost you 100 to $150,000 before you can raise money.

If you don't have that money already, you're not going to be able to get qualified because your attorneys and everybody else are going to get, need to get paid the cheapest.

I think I've seen somebody do it has probably been for about 40 to 50,000, but that was bare bones.

But if you're thinking you can try and get something done for 10 or 20,000, it's not going to happen.

So regulation A is powerful, but it's not a beginner's game.

Designed for sponsors who have some money, an established brand and bigger goals and like I said, deep pockets.

With all that being said, we wrap up this episode.

Who should use what?

So here's my advice and where I think you should which type of offering you should use.

If you're raising money from your own network, doctors, lawyers, high net worth, friends and people, go with a 506B.

Low cost, private, flexible, can't advertise, but you already have a network of people.

So that's what I would recommend.

Especially if you're going to raise up to 5 million, go with that network, go with the 506B.

That's probably, you know, your best bet.

If you have some type of brand, some type of influence, podcasts, big email lists, social media following, use a 506C.

You can advertise, but it's only for accredited investors.

But just because you might be a good marketer, you still got to have a really good business plan and get these people through your marketing funnel.

Want to invest in your offering because a lot of times These are not your own network.

These are people that you, you have to outbound marketing with.

If you're looking to raise 30 million or more and have that brand and are offering something a little bit different, a reggae may be worth the cost of effort.

It just really depends between the 506C and the regulation A plus now it really depends on if you're doing a large multifamily deal.

I would do a 506C.

If you're doing an evergreen fund like we have, I'd consider it a regulation A because it's open and you can allow investors to continue to come in and leave.

So that's where the regulation A fits in.

Also depend on your offering debt funds.

I actually prefer the regulation A because when I try and compete against multifamily investors who are offering 20% returns, they may get it, they may not.

But you know that's an equity play, an income play like a debt fund that provides payments monthly or quarterly but it's more consistent with little to no upside.

You'll get more get regulation A people or non accredited people in that offering as well.

Lastly, if you're launching really small deal and your startup under 3 or 5 million, try the right CF.

Personally again, I'm not a fan of the reg CF.

I know people who have done it, but not many for real estate.

And again, if you have some app or technology, reg CF is awesome now.

So I'm not discouraging reg CF for real estate is where I'm wondering if it is actually the right fit.

But just remember, there's no one size fits all when it comes to raising capital.

There's only the right tool for your specific audience and goals.

And I want to just eat that a little bit into the ground because just because I am doing a regulation A doesn't mean you should be doing a regulation A.

Just because they're doing a 506B doesn't mean you should or I should do a 506.

You need to map out what fits your plan and what is best for you and what are you going to try and get to accomplish your goals.

So at the end of the day, your capital raise should align with your business strategy, not for your business to fit the raise.

Lastly, I'll leave you with this.

Know the rules, pick your path and follow it with clarity and confidence.

And again, know the rules.

I can tell you I know three offerings right now that are competing against mine that are 506 that have never filed the exemptions with the SEC and their documentation and paperwork.

Looks like it was made with ChatGPT and not an attorney.

And this goes back to what I mentioned earlier.

Do it right whether the sponsor or an investor use the right attorney.

So thanks for listening to this episode or watching.

If you want in the comments, put Cheat Sheet and I will send you an infographic and put it in the show notes to outline everything we talked about today with kind of a nice chart of where each type of raise fits in.

And if you want help structuring your next raise, feel free to reach out.

I'm always happy to share my experience and and talk to you about not only what we think we did right, but some of the mistakes we made along the way.

So thank you for listening to this episode of the Paper Trail.

Make sure to subscribe, leave a review, and share this episode with someone who is planning their next raise.