JF1023: The 4-Prong Test to Raise Money LEGALLY and Avoid Fines!
She’s an investor and securities attorney, it’s safe to say she knows a thing or two about legal ramifications when your business isn’t setup correctly. She has a four prong test for determining if you need to follow securities laws and file with the SEC. Jillian also explains why the SEC may not be your biggest problem if you’re not fully protected.
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Jillian Sidoti Real Estate Background:
-Partner at Trowbridge Sidoti, LLP
-Expert on money raising techniques for real estate companies
-Speaks at seminars educating real estate investors on how to legally raise capital for investment projects
-Prior to her legal career, Jillian owned and operated a record label enabling her to tour worldwide with artists
-Based in Los Angeles, California
-Say hi to her at http://www.crowdfundinglawyers.net
-Best Ever Book: How to Win Friends and Influence People
Click here for a summary of Jillian’s Best Ever advice: The 4-Pronged Test to Raise Money Legally and Avoid Fines, Lawsuits, and Jail Time
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Joe Fairless: Best Ever listeners, welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate podcast. We only talk about the best advice ever, we don’t get into any fluff. With us today, Jillian Sidoti. How are you doing, Jillian?
Jillian Sidoti: I’m doing great, thanks for having me. I can’t believe it’s the BEST EVER…!
Joe Fairless: I know! I love to under-promise and over-deliver… [laughs] Setting expectations really high right out of the gate, but that’s okay…
Jillian Sidoti: I love it, I love it!
Joe Fairless: I have heard a lot of good things… As I was mentioning before we started recording, I’ve heard a lot of good things about you in particular — I don’t remember from who, but I’m pretty sure it was multiple people. Again, we are setting the bar really high for our conversation…
Jillian Sidoti: [laughs] I’m the best ever interviewee!
Joe Fairless: Yeah, there we go! So a little bit about Jillian… She’s a partner at Trowbridge Sidoti, LLP. She’s an expert on money-raising techniques for real estate companies; she speaks at seminars, educating investors on how to legally raise capital for investment projects. Prior to her legal career she owned and operated a record label, enabling her to tour worldwide with artists – what an eclectic background!
She is based in Los Angeles, California. With that being said, Jillian, do you want to give the Best Ever listeners a little bit more about your background and your current focus?
Jillian Sidoti: Sure, absolutely. As a matter of fact, what I always love to tell people who I meet for the first time is that I was in their position once, where I was trying to raise money for my commercial real estate deals. That was actually before I started practicing law. I did condo conversions down in San Diego, and I literally didn’t know how to get any more money.
We had leveraged all of our properties to the hills and we needed more money to get more deals done. So I am speaking from not just an attorney’s point of view, but also from a real estate developer/investor’s point of view. I get it, and I get the struggles with raising money and how it’s sometimes easier/cheaper/faster to not do it legally correctly, but it’s also way, way, WAY riskier. And at the end of the day, if you take shortcuts with money and going around the law, you’re only going to realize that it’s not easier/cheaper/faster, but actually more expensive, slower and harder.
Joe Fairless: Let’s talk about taking shortcuts around the SEC guidelines, because this is really rarely talked about. What are the legal ramifications in terms of jail time or fees or whatever else that I’m not thinking of?
Jillian Sidoti: The biggest thing that I think most people have to worry about isn’t so much the jail time, because jail time — you really have to commit a crime to go to jail, which means you have to commit fraud, and you have to have the intent to commit fraud, the intent to steal (if you will) and take money from people, and that’s very hard for the government to prove. We see it happen all the time, but it’s hard to prove.
Most of the people who come to me or I run into have no intention whatsoever of committing fraud or stealing from anybody. They just want to run their real estate business and make money doing real estate.
Where I see the shortcuts being taken is with the actual paperwork. What ends up happening is really two things. One, the state and the SEC catch up with you and they run on fines; that’s how they make money, that’s how they justify their existence, by generating revenue through fines. They’re looking for people who are not following the rules, and in recent history you may or may not know that the [unintelligible [00:06:01].09] changed it so the rules are a little looser. This doesn’t mean that regulators stop regulating; they’re just gonna look harder for people who are violating those rules, so that they can raise money for their coffers.
So the fines is the big thing, but I think that the real threat is actually not the government itself, but your investors… Because if you don’t do right by your investors, that not doing right by your investors, not following the law in the first place is going to be exhibit A against you in the trial against you when your investors come to see you. And nothing necessarily even has to go wrong, it just could be you have a falling out with an investor, or an investor needs their money back in the middle of the project; well, how are they gonna get it back if you’re not very willing to give it to them? They’re gonna sue you and they’re gonna use all of this as evidence against you in order to get their money back.
Joe Fairless: Let’s talk about the most common legal mistakes that you’ve seen that investors make when raising money.
Jillian Sidoti: The absolute biggest one is when people don’t understand what a security is, because that sets them up for failure. I’ll use joint venture agreements as an example. I often hear people say to me “Well, if I just use a joint venture agreement or call it a joint venture, then that’s not securities and I’m in the clear”, but that’s not necessarily true. And by the way, I feel for real estate entrepreneurs and investors who are out there trying to do these types of technique to avoid securities laws because there’s a lot of bad information out there.
I’ve sat in seminar myself where people say “If you just use a joint venture agreement then you don’t have to worry about any of these securities laws and you can do whatever you want”, and that is simply not true. If you don’t mind, I’ll just real quick give everybody the tests you can use to know if securities laws apply to you.
Joe Fairless: Can I guess what it is?
Jillian Sidoti: Yeah, do it! This is gonna be good!
Joe Fairless: Is it if they are passive and expecting your expertise to generate a profit for them, then it’s a security.
Jillian Sidoti: That’s very close – the 4-Prong test. Investment in money – that’s kind of implied in what you said. They have an expectation of profit – absolutely; there’s more than one investor, and one investor doesn’t mean one investor in the deal, it means one investor and you become the common enterprise. Several states have rules that say “Look, you can have one investor per property, but if you have more than one investor period, you’re the common enterprise.”
And the fourth one you got, which was that through the efforts of a promoter, meaning that you’re doing all the work, and the implication is that your investor is expecting for you to make money work, not the other way around.
Joe Fairless: I know we probably shouldn’t think this way, but it’s probably something that some listeners are thinking… What is the bare bones…? if we wanna say, “Boy, this security stuff… A lot of paperwork. I’d rather do a joint venture.” What’s the bare bones minimum to qualify as a joint venture where you’re skirting the line, but you’re on the joint venture side of the line?
Jillian Sidoti: That’s a great question. I get this all the time. It doesn’t help me to take somebody’s last dollar to do legal documents for them. One of the things that always makes me cringe is that attorneys get paid and then everybody else is left empty-pocketed, if that’s even a phrase; maybe I just made that up.
Joe Fairless: Is that why you all don’t charge a fee and you just do equity ownership in every deal?
Jillian Sidoti: That’s exactly what we do! [laughter] I’m so wealthy right now because of all the money I made on equity ownership… [laughter] No, a lot of the times — I feel for people like this who are trying to do their first deal and they want their first joint venture partner and they don’t know what to do. So I have a solution to the problem, but I wanna tell people how to solve the problem and solve it without necessarily coming to me…
What you wanna make sure you do with your investors is not just simply have a joint venture agreement, but tell them all the risks associated with investing. Tell them the who, what, where, when, how, how much and why… Like how much money do they need to invest, how are you going to use the money, who are you – you have to disclose who you are, not just do a handshake and expect everything to be okay, because if they find out you filed for bankruptcy five years ago and you didn’t tell them, that is a material fact that could have influenced their decision to invest… And that’s the test right there on what is it that you need to tell the investor – it’s what material facts would influence an investor’s decision to invest, and that’s what you wanna disclose to your investors… So that’s how you can do it yourself.
Joe Fairless: Is there a template? Is there somewhere we can go and just like — okay, you just rattled off five or six questions, which is great… Is there somewhere we can go and be like “Okay, we’re gonna make sure we address these things, and here’s the copy for it”, or do we have to go to the attorney for that?
Jillian Sidoti: That’s my solution, actually. So by end of April — there is no worldwide template you can just google search for, that I know of… You very well could, and I just don’t know about it, but I do happen to know everything, so… There’s that. [laughter]
But we do have a software that’s gonna come out. It’s gonna be a per-use software that you can go on… You literally put in all the information, you put your partner’s information in and it will spit those documents out for you and it will be much less expensive than using an attorney. It’s kind of like legal zoom for the securities industry.
So hopefully by the end of April we’ll have that launched and I’ll let you and all your listeners know about it.
Joe Fairless: Outstanding. Where can they go to stay updated? They just go to your website, CrowdfundingLawyers.net and look for that?
Jillian Sidoti: Yeah, that would be perfect right now; they can just go to CrowdfundingLawyers.net. We haven’t built out the site yet because we’re kind of hemming and hawing on what to name it… Because there’s a couple of groups out there, real estate educators if you will, who all want this software for their own platform. So you’ll be able to find it in a couple of different places, and I’ll let you know all those places where you’ll be able to find it in the future.
Joe Fairless: But as far as where do they go, they can go to CrowdfundingLawyers.net and they’ll get more information on it, right?
Jillian Sidoti: Yeah, I wanna encourage people to e-mail me at Jillian@CrowdfundingLawyers.net and we’ll add you to the list when it all comes out, too.
Joe Fairless: Alright, sweet. There we go. So what other legal mistakes have you seen investors make that you’ve had to clean up?
Jillian Sidoti: The big one is people who start funds and then don’t file Form D’s. Form D is a really simple form that gets filed with the Securities Exchange Commission and the state’s securities boards. It gets filed in the states where you have investors. For example, you guys are in Colorado. In Colorado it’s actually really simple to file that Form D; you just send it in and it’s a $75 fee there. It’s not expensive at all.
There’s other states that are much more expensive. For example, the state of Texas is $500, the state of Pennsylvania is $525. So there’s some states that are really expensive, and then there’s some states that are not expensive at all. For example, the state of Florida is free.
But one of the first things a state securities regulator will go to when realizing that perhaps something is wrong is they’ll look to see if you filed the Form D. In certain states they’re very rigid about this. For example the state of Arkansas – if you don’t file your Form D in a timely fashion, they charge you I believe $500/investor in the state of Arkansas.
Joe Fairless: Ouch!
Jillian Sidoti: It’s expensive, it can get costly.
Joe Fairless: You only have to file in the states where you have investors?
Jillian Sidoti: That’s absolutely correct. And honestly, if you haven’t done it before and you’re not sure about it, I strongly encourage you to call somebody like myself to help out with that, because there is a learning curve on how to file them. It’s a simple form, but some of the states take it electronically, some take the paper; the SEC only takes it electronically… So you wanna kind of figure out how to do that, and there’s a process.
Joe Fairless: Do people actually file actual syndicators without lawyers, file their own funds?
Jillian Sidoti: You’re gonna laugh at this… I had this group call me and ask if I would fund for them, and I said “Sure, I’d be happy to.” I don’t hear from them for a while; I hear from the again and they go, “So we did our funds, but we want you to take a look at it. We want you to do the next one… We had to get the last one done in a hurry… Blah-blah-blah-blah-blah.”
So I said, “Okay, that’s fine. Why don’t you send me your old fund, so I can take a look at it?” and it was funny, because they sent me my own paperwork. They had gotten a copy of paperwork I had created before and reverse-engineered it and put their own information into it and called it a day… [laughter] And I don’t think they realized that it was our firm’s paperwork…
But I see that all the time, and I knew the answer I was gonna get when I asked them “Did you file your Form D’s and where did you file them?” The answer was pretty much, “Um, what’s that?” It happens all the time.
Joe Fairless: I don’t understand that… I don’t understand, and this really is nor here, nor there; I just don’t understand why a group would take it upon themselves to file the fund… You have to file it through the SEC, right?
Jillian Sidoti: Yeah. So the thing is all you’re filing is the Form D. The fund itself is your own documentation. So all you’re filing is a five-page Form D with the Securities Exchange Commission. The Securities Exchange Commission, nor the states review your actual offering documents. All we’re saying in the Form D is that “We’re using this exemption; we’re letting you know we’re using this exemption”, and that’s it.
It’s the drafting of the paperwork by the attorney that’s vital, and you wanna make sure that it’s correct, and you wanna make sure it’s as tight as a drum as you can possibly get. I mean, there’s always holes you can poke in something, but that’s why you wanna use a securities attorney. I’m an attorney, so it’s hard for me to say “Don’t use an attorney”, but I feel like it’s kind of foolish to not use an attorney when you’re doing this type of stuff. It’s just so risky…
Joe Fairless: I agree, yeah. It makes a lot of sense. I can tell you one thing I’m guilty of, and it’s along these lines, so I don’t wanna act like I’m purely innocent of bypassing all the processes with an attorney… One of the things I’m guilty of – after three or four syndications and seeing the PPM, my partner and I realized “Hey, there’s some redundancies, or there’s a path that seems similar every time with the updates that the attorney is doing.” So what we did in order to save time and money, we made the updates track the changes and sent it to the attorney, and then they updated it. That saved us time and money. What are your thoughts on that?
Jillian Sidoti: I don’t have a problem with that per se. We generally speaking don’t send Word documents to our clients, but sometimes if a client is so “Hey look, this is the way we wanna do it”, I am happy to comply with that. It’s more for their protection than mine, being a control freak. I’m not a control freak, so I don’t mind if you wanna change your own documents, but it’s really just for your protection more than anything else.
Joe Fairless: Anything else come to mind as far as common mistakes? You mentioned not knowing what a security is and talking about securities versus a joint venture; you were also mentioning filing Form D… Anything else come to mind?
Jillian Sidoti: So the biggest mistake I think people make beyond all this — because all of this is irrelevant if you’re not raising any money. The biggest mistake I see people make in raising money actually isn’t a legal thing, but a marketing thing. That marketing thing is that they’re not consistent with the marketing message at all. You’ve gotta pick a marketing message and then stick to it.
I’ll be honest with you, Joe – you’re a perfect example of this. You have this “Best Ever” moniker… Or tagline, or I don’t know what you would name it – branding… And you stick with that throughout your branding. I think that’s really key to giving the same message so somebody knows exactly who you are and what you’re doing and what tone they can expect from you going forward.
It reminds me of one of my toddlers… I have three boys, and one of them when he was a toddler, he would try something for like 30 seconds, and then go “Oh, I can’t do it… Too hard, too hard.” And that’s kind of what I feel like with real estate entrepreneurs – when they go out to start raising capital, they try (say) a Facebook ad campaign, and after a week they give up because they’re not getting any traction… Yeah, because you have to have a consistent marketing message going forward.
Joe Fairless: Only if it’s 506(c) they do a Facebook advertising campaign, right?
Jillian Sidoti: Correct! But the thing is it’s not just 506(c), because people were raising money for their deals before 506(c) ever existed, and what were they doing? Well, their consistent marketing message just wasn’t about raising money, it was about the company itself.
Joe Fairless: Right, right.
Jillian Sidoti: For example, I won’t even use a real estate company, I’ll use Apple as an example. Apple never went out at a shareholder meeting and said “Hey everybody, buy our stock. We think it’s gonna go up.” Steve Jobs would come out with all this bravado and talk about “Look, I just created this iPod and it can hold a thousand songs, and there’s nothing else like it on the market.” And the market recognized that, and then reacted to that. They didn’t recognize that Apple needed shareholders, they recognized that this iPod was an amazing invention that they could capitalize on, and it’s the same with real estate.
“I invest in apartment buildings in Texas, and here are some of our apartment buildings that have done really well. We’re really excited to make this acquisition in Houston”, and just to always have that consistent marketing message. It doesn’t need to be about “Hey, everybody… I’m looking for investors.”
As a matter of fact, I think the education-based push/pull strategy is way better than a push strategy of saying “Earn 15% on your money. Act today!”
Joe Fairless: I agree, by the way. My background is in marketing and I embrace everything you’ve just said about that. Based on your experience, what is your best real estate investing advice ever for investors?
Jillian Sidoti: My best ever real estate investing advice — my investing advice might be different than somebody else’s because I’ve learned very much the hard way that I’m a much better passive investor than I am an active investor. So I really do rely on others for great real estate opportunities. Right now personally I’m pulling out of all single-family. I might be a little premature in that, and everybody’s telling me I’m a little premature in that from what I can hear, but I’d rather be premature than too late. So that’s what I’m doing right now, and I’m trying to get into more self-storage and some value-add opportunities.
I’ve invested in some apartment buildings, I just haven’t seen anything in recent history that I’ve been super comfortable with investing in. I have invested in some office buildings as of late, but that can be scary, because if the residential industry in a certain marketplace [unintelligible [00:21:17].03] office building goes down, the office space is certainly going to take a hit… So I’m not the best person to ask for that. [laughter]
Joe Fairless: Well, that’s good, you’ve given some incredible advice from a legal standpoint and that’s really the focus of our conversation today. Are you ready for the Best Ever Lightning Round?
Jillian Sidoti: Oh, yes! Okay, let’s do it!
Joe Fairless: Doesn’t that sound like fun?
Jillian Sidoti: That sound exciting!
Joe Fairless: [laughs] First, a quick word from our Best Ever partners.
Joe Fairless: Alright, what’s the best ever book you’ve read?
Jillian Sidoti: I think How To Win Friends And Influence People. That’s probably it.
Joe Fairless: What’s the best ever deal you’ve done, knowing that you also are an investor?
Jillian Sidoti: Oh, the best ever deal I’ve done… I think the best ever deal I’ve done is actually a biotech firm if I’m gonna be fair, but the best ever real estate deal I’ve ever done was I invested in an apartment building in Kansas City and they refinanced the apartment building and they paid all the investors back, and yet we’re still owners in the building… So that’s gotta be a great deal, because I got all my money back and I’m still making money from it.
Joe Fairless: Absolutely. What is the best every way you like to give back?
Jillian Sidoti: I have a couple things I do. I’m actually the CFO – which is glorified bookkeeper – for a nonprofit that tries to prevent human trafficking. That’s the biggest thing I donate to. Actually, one of my goals is to give $100,000 away in a year, so I’m working on that now.
Joe Fairless: What would you say is the biggest mistake – or any mistake that comes to mind – on a deal or a transaction that you’ve done?
Jillian Sidoti: Not necessarily in real estate but in life in general is not looking into more carefully the partners that you partner with. I’ve gotten into some pretty terrible business relationships and I think at the end of the day at least one of them could have been solved with a quick couple of phone calls to a quick couple of references.
Joe Fairless: Any particular question that you’d make sure that you asked during those reference calls?
Jillian Sidoti: Basically how did they handle conflicts? How did they work under pressure?
Joe Fairless: What is the best place the Best Ever listeners can get in touch with you?
Jillian Sidoti: Probably e-mail Jillian@CrowdfundingLawyers.net. Also, find me on Facebook, Jillian Ivey Sidot is my full name. You can friend me, I don’t bite. [laughter] If we don’t have a lot of friends in common, just make sure you write me a little note so I know to accept your friend request and that you’re not some weird person fishing from Nigeria, or something like that. [laughter]
Joe Fairless: Well, Jillian, I really enjoyed this educational conversation, that’s for sure… And the most common legal mistakes that you’ve come across as it relates to raising money, not knowing what a security is – we have that 4-Prong test… Investment of money, expectation of profits, more than one investor and they’re passive.
The other takeaway is people who file on their own for whatever reason – I don’t know why – but not filing a Form D, just make sure you work with a securities attorney on that; that’s an easy one. And then the third is not necessarily a legal, but more of a success mistake (or lack thereof) is not having consistent marketing messaging throughout your entire presentation or your business approach.
Then also talking about the ramifications of what happens when you don’t follow the rules, and you talked through that at the very beginning of our conversation.
Thanks so much for being on the show. I hope you have a Best Ever day, and we’ll talk to you soon.
Jillian Sidoti: Thanks!
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