Raising Capital in a Partnership LLC or Joint Venture

We’ve all heard the buzz words of crowdfunding, PPMs, and IPOs, but there are less complicated ways to raise money and start a business and one of the most reliable and most used methods is that of partnership LLCs or joint ventures.

If you ‘re raising money from others in an LLC, partnership, or joint venture, you must take specific precautions in structuring your documents so that the investment of money from any member, partner, or joint venturer does not constitute a violation of federal or state securities laws. Failure to comply with the securities laws can result in civil and criminal penalties. Many real estate investments and emerging companies rely on numerous strategies to raising capital that are outside of publicly traded stock and that do not require registration with a state securities division or the federal Securities and Exchange Commission. This article addresses those strategies and outlines some of the key issues to consider when raising funds through an LLC, partnership, or joint venture arrangement.

IS THE LLC MEMBER, PARTNER, OR JOINT VENTURER CONTRIBUTING MORE THAN JUST MONEY?

The courts have widely held that an investment in an LLC, joint venture, or partnership is a security when the investor is investing solely cash and has no involvement, vote, or say in the investment. In these instances where the cash partner just puts in cash (sometimes called “silent cash partner” arrangements), the investment will likely be deemed a security. In a famous securities law case called Williamson, the Fifth Circuit Court of Appeals held that a joint venture contract investment is a security if the investor has little say or voting power, no involvement in the business or investment, and no experience that would provide any benefit to the business or investment. Williamson, 645 F.2d 424. As a result, to avoid triggering these factors and having your investment or business deemed a security we strongly recommend that all cash partners, whether individuals or self-directed IRAs, in Joint Venture agreements, LLCs, or partnerships have voting rights and that they participate in the key decision-making functions of the investment or business. Cash partners do not have to be part of the management team but they do need to have voting rights and need to have real opportunities to use those voting rights. For example, they could have voting rights on incurring additional debt, on management compensation, and/or on buying or selling property.

DON’T GIVE YOURSELF UNLIMITED CONTROL AS MANAGER

In most LLCs with cash partners, the person organizing the investment and running the operations is often the manager of the LLC, partnership, or joint venture and has the ability to bind the company or partnership. When making this selection as the manager, it is key that you do not give yourself unlimited control and authority. If you do give yourself unlimited control as manager, your investors may be deemed to have purchased a security since their voting rights will have been extinguished by placing to much control and power in the manager/management. What is recommended is that the members have the ability to remove the manager by majority vote and that the manager may only make key decisions (e.g. incurring debt, selling an asset, setting management salaries, etc.) upon the agreement and majority vote of the investors. While key decisions and issues should be left to the members, day to day decisions can be handled by the manager without a vote of the members/investors.

DON’T COMBINE TOO MANY PEOPLE INTO ONE LLC, JV, OR PARTNERSHIP

The Courts have consistently held that even if a cash partner is given voting rights and has an opportunity to vote on company matters that the cash partners interest can be deemed a security if there are too many other cash partners involved in the LLC, JV, or Partnership. Holden, 978 F.2d 1120. As a general rule of advice, you should only structure investments and partnerships that include 5 or less cash partners as the securities laws and the involvement of more individuals than this could potentially cause the investment to be deemed a security. When there are more than 10 cash partners it is critical for clients to consider structuring the investment as a Regulation D Offering and that they complete offering documents and memorandums and make a notice filings to the SEC. Many people refer to this type of investment structure as a PPM.  When there are a lot of investors involved, a Regulation D Offering provides the person organizing the investment with exemptions from the securities laws and can allow someone to raise an unlimited amount of money from an un-limited amount of investors.

In sum, there are many factors and issues to consider when raising money from others in an LLC, JV, or partnership and it is crucial that you properly structure and document these investments so that they can withstand these challenges of securities law violations. For help in structuring your partnership LLCs and joint ventures please contact the law firm at 602-761-9798.

ADVERTISING NOW ALLOWED IN RAISING CAPITAL

The SEC’s final regulations implementing the JOBS Act  and allowing advertising in the raising of capital went into effect last week on September 23, 2013. This is a significant change in the laws relating to the raising of capital and is one that has been discussed and written about extensively. Prior to last week all raising of capital by real estate investors or small business owners needed to consist of private methods whereby the person raising capital could only talk to persons whom they knew or had a prior relationship with. They could not make a “solicitation” for investment from anyone else without having to go and do an extensive and costly public SEC Offering.

Under the new rules in effect last week, those raising capital may now make public solicitations to anyone and may make presentations at meetings or seminars, on websites, or through social media and they don’t have to work with people they know or have a prior existing relationship with.

In order to comply with the new rule, known as Rule 506 (c), those raising capital must create offering memorandum and legal documents in accordance with the new rules and must make a notice filing to the SEC to claim compliance with the new law. Additionally, the new advertising rules will only allow those raising  capital to accept funds from accredited investors. Accredited investors are those who have $1M net worth (excluding equity in residence) or $200K annual income single or $300K income married. The person raising capital must take steps to verify an accredited investors status and can’t just rely on the investor stating that they are accredited. While some offerings do allow for up to 35 unaccredited investors, the rule allowing for unaccredited investors cannot be applied when advertising has been used in the offering and as a result is not available under the new rule.