JF1054: Getting Paid to Raise Capital Without Being a Broker-Dealer – With Amy Wan
A question we hear all the time, “how can I make money from connecting syndicators with high net worth individuals”? Well Amy Wan is here today to answer this question specifically. The issue is making sure you are not doing what a Broker-Dealer does. We’ll hear today how to separate yourself from looking like a Broker-Dealer. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Amy Wan Background:
-Founder & CEO of Bootstrap Legal and former partner at Crowdfunding Lawyers
-In 2014, named one of 10 women to watch in the legal tech by the American Bar Association Journal
-Formerly was General Counsel at Patch of Land, advised the company on its $23.6M Series A funding round
-Holds an LL.M. in Public International Law from the London School of Economics and Political Science
-Based in Los Angeles, California
-Say hi to her at www.bootstraplegal.com
Click here for a summary of Amy’s Best Ever advice: 4 Legal Ways to Get Paid Raising Money for Apartment Deals
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Joe Fairless: Best Ever listeners, how are you doing? 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 investing podcast. We only talk about the best advice ever, we don’t get into any fluff.
Today we are going to answer a burning question that I get so frequently because of the business that I’m in and because of the market and how much opportunity there is. Here’s the question, Best Ever listeners – we have an expert to walk us through the process of how to answer this question correctly… Here’s the scenario (and then we’ll come up with the question).
The scenario is I know people who have money. I also know people who do syndications. How can I raise money for the syndicator and get compensated for it? Basically, we’re looking for creative ways to get paid to raise money, without being a broker/deal. With us today to walk through the entire process, Amy Wan. How are you doing, Amy?
Amy Wan: I’m good. How are you, Joe?
Joe Fairless: I am doing well, and I am smiling ear to ear, because I get this question so frequently from Best Ever listeners and from people on Bigger Pockets and everywhere else… I’m really looking forward to diving in.
A little bit about your background for the Best Ever listeners, before we dive in. Amy is the founder and CEO of Bootstrap Legal; she’s also a former partner at CrowdfundingLawyers.com. She knows crowdfunding law. In 2014 she was named one of the top 10 women to watch in the legal tech field by the American Bar Association Journal. She’s based in Los Angeles, California. Say hi to her at her website, BootstrapLegal.com.
With that being said, Amy, take it away, my friend. How do we approach this topic?
Amy Wan: Sure, so there’s definitely a lot of people out there who are able to get compensated somehow for helping other people raise money, but there’s a number of different ways to do it, and there’s also a number of different things you have to look out for.
Before I launch into explaining this entire [unintelligible [00:04:30].02] of law, I just wanna put out there I’m an attorney, so I have to put out a legal disclaimer that none of this is legal advice… It’s all educational, and I’m not necessarily recommending any courses of action. Whatever you do, you should always go and talk to your attorney who’s helping you out and representing you before you launch into this, because they’re gonna be able to look at the specifics of what you’re trying to do.
Broker dealers are people who have a license and they make a lot of money to sell securities of other people. Usually, the way they do this is they’ll take a commission – like, I’ll take 7% commission for whatever capital I’ll bring in. That’s also how a lot of investment banks get paid. But the truth is being a broker dealer is really difficult, especially if you’re not really in the business of doing this every single day and you don’t wanna deal with all the compliance.
Now that we’ve talked about what a broker dealer is, I know that a lot of your listeners don’t want to be broker dealers; they just happen to see people who might have a really good network of investors or of people who have a lot of money. So let’s talk first just a little bit about what it means to be a broker dealer, just so people know whether or not they have to be one.
There’s basically about four things that the regulators look at when they are determining whether someone is engaging in unlicensed broker dealer activity. Those four things… The first thing is actually THE most important – are they taking transaction-based compensation? Transaction-based compensation is basically payments based on the transaction amount, how much money they’re bringing to the table. If you’re not bringing transaction-based compensation, it’s not to say you’re not a broker dealer, but it makes it a lot less likely. Commissions (straight up commissions) – that’s definitely transaction-based compensation.
The second thing is whether or not the person who’s helping the other person raise money – are they soliciting or going out and trying to find potential investors? The third thing is “Is that person providing advice or engaging in negotiations? Are they helping to structure this deal in any way?” [unintelligible [00:07:17].00]
Then the last one that the regulators look at is do they have previous securities deals experience or history of disciplinary action? So was this person formally a broker dealer or are they regularly involved in the sale of securities? Because if they are, they’re probably a broker dealer. If this is like a one-off thing, it makes it less likely.
Joe Fairless: So these are the four questions that are asked to determine if someone has engaged in unlicensed broker dealer activity, correct?
Amy Wan: Yes.
Joe Fairless: The first question is “Are you taking a transaction-based compensation?” Two is “Are you soliciting…” — what was that?
Amy Wan: It’s whether or not you’re soliciting potential investors.
Joe Fairless: Okay… Which you must have to do if you’re talking to people, right?
Amy Wan: Oh, there are ways to do it, Joe. [laughs]
Joe Fairless: Alright, so we’ll get to that. Okay, so “Are you soliciting potential investors?” The third is “Are you helping structure the deal?” Let’s just use a hypothetical example with something that people might come across, and that’s an apartment community deal… So that would be “Are they helping structure…” — is that the transaction of the deal itself with the seller, or is that the structure of the compensation and the waterfall stuff with investors?
Amy Wan: It’s the latter. Whenever you’re buying or selling property, that’s not necessarily a security. When we’re talking about broker dealers, we’re only talking about selling securities. That’s when you’re going out and you’re trying to find passive investors and offering them a return on investor.
We’re not talking about buyer or selling property, we’re talking about basically fundraising… That’s what all of this is.
Joe Fairless: Okay. And then the fourth is “Do they have previous securities experience?” or “Were they previously a broker dealer?” or “Did they get in trouble previously with this process?” Okay, got it.
Amy Wan: Cool. So now that we have the fundamentals down, I think what your listeners are really interested in is how do we get some form of payment while helping people bring investors or raise capital without getting in trouble and without having to become a broker dealer or some sort of other licensed person who can do this?
Joe Fairless: Do you know what it takes to become a broker dealer, what the process is and how much studying or what tests you have to take?
Amy Wan: Sure. You have to take some of the Series exams; it kind of depends on what exactly you want to be doing. A lot of people will take the Series 7, they’ll take the Series 63… Once you pass the tests, you’ve got to change your license at a broker dealer shop. Suffice to just say that basically over the last couple years it’s become a lot, lot harder a) for broker dealers to make money, and b) for broker dealers to keep up with compliance.
It’s not to say that people shouldn’t become broker dealers. There’s still a ton of them out there today, but if you’re just like one person, or a small team of people who only want to just do this one off, I would really reconsider getting into this business, because you really need to have a full-on chief compliance officer, you really should have actively [unintelligible [00:10:48].19] It’s engaging in the stuff that Wall-Street engages in, so if you’re not equipped to do that, you just need to make sure you’re not inadvertently gonna do something that’s gonna get you in trouble.
Joe Fairless: So basically the 99.99% of everyone listening would not want to become a broker dealer, I’m guessing… So now how do we get some sort of payment while helping people raise capital without being a broker dealer?
Amy Wan: Perfect. Okay, so there’s a couple of methods that I see pretty commonly — and again, whatever you do, if you’re gonna go down this road, just do me a favor and check with an attorney first.
Joe Fairless: Are you someone they can check with?
Amy Wan: I can refer them to people that they can check with.
Joe Fairless: Got it.
Amy Wan: So one of the things you might wanna consider is if you look at the definition of broker dealer, it’s someone who’s engaged in selling securities for other people. The question is “Well, what if you are not selling it for others? What if you’re selling it for yourself, the issuer?” What if you, Joe Fairless, who wants to help people raise money – what if you become a member of the management (if this is an LLC scenario) or you become part of the general partners?
If you become part of the issuer – and what that means is you’re not just raising money, you need to be doing other things that are a little bit more day to day… But if you are part of the management or the GP or whatever it is who’s the active sponsor, then suddenly you’re not selling securities for others, you’re selling securities for yourself. Issuers are allowed to sell securities for themselves generally, so what I’ll see a lot of my clients do is maybe they’re a team of two real estate syndicators, they’re working on multifamily, and “Hey, this guy happens to know a lot of people who love to invest in student housing, AND he’s a student housing expert.” If they’ll team up with him on that particular project, they’ll give him a piece of the management (or whatever it might be). So he’s a part owner, he’s part of the issuer.
Maybe the guy helps them set up their bank account, maybe he advises them on what strategies they should use for student housing, or any other area that maybe he can contribute. Maybe he’s helping out with property management, or helping with the monthly distributions… Something that’s not purely just the raising of capital. If he is involved actively in some of the day-to-day AND he’s raising capital, suddenly we’re not raising money for other people, we’re raising for the money for ourselves, and that’s okay.
Joe Fairless: Now, what if the agreement is that he will be on the GP side and he’ll advise on things and bring capital, but what if he doesn’t bring any capital? Is there are recourse for them to say “Oh, actually I don’t know… I don’t think you should be on the GP side now.” [unintelligible [00:14:05].00]
Amy Wan: Usually when I see this happening, it ends up being a very fluid process. I think this comes down to a negotiation between those parties of what role this person’s going to play. You shouldn’t really have it that black and white where “Oh, you don’t bring in money, you don’t get to be a part of it.” You really shouldn’t. You should have them doing a little bit more than that, at the very least adding value or contributing in some way. I won’t say that I haven’t seen it, but then I would say they’re a bit too close to the line.
I think law is not a black and white thing, it’s a grey spectrum. There’s things that you can do that are closer to the edge and things that are closer to safety. So that’s number one, making yourself actually part of the company, so you’re not raising money for other people.
The second thing is very closely related, where for example let’s say hypothetically they’re structuring a syndication, you have (let’s say) two classes of ownership interest. You’ve got class A, which is your investors, and class B, which goes to yourself, the manager, or whatever it might be.
Same concept, expect that this time instead of them being a part of the management, they’re not actually a part of the owner or the issuer anymore, they are a separate entity. You are giving them some of the class B shares, even though they’re not actually part of the management.
The interesting thing here is if we revisit the definition of a broker dealer, they’re looking at transaction based compensation. If you give a guy maybe 5% of whatever the class B interest is, if you make it not transaction-based compensation — maybe he gets 5% regardless of whether he brings in a million dollars or a hundred thousand, that starts looking a lot less like being a broker dealer… And then again, just as with the last example, even if they’re not a part of the management, it’d be nice if they could provide some sort of additional service. Maybe it’s them personally guaranteeing the loan. So even if they’re not bringing capital, they’re helping you get capital from the bank, because they’ve signed the loan documents.
Now, if we’re getting into more creative strategies other than that, you could charge a finder’s fee, but when you charge a finder’s fee you have to be careful about how you charge it… And remember, we don’t ever want to tie the compensation to the amount of money raised.
I see sometimes people are charging finder’s fee, but it’s a flat fee; it’s not based on how much ends up actually converting into an investment… And remember one of the things I talked about earlier, about soliciting investors. When we’re soliciting investors, what we don’t wanna do is to pre-screen or to recommend an investment or anything of the sort. But if it’s a mere (let’s say) e-mail introduction to someone who’s just interested in learning about multifamily apartments generally, and the person happens to know that this guy also happens to be interested in investing in real estate, that on its face is okay.
Now, we don’t wanna be saying “Hey, Joe has this amazing 100-unit apartment complex that he’s raising five million dollars for now… You should take a look at this” – you don’t wanna say that. We’re just doing soft introductions.
Then the last method that I see a lot – and again, we’re not tying this to the amount of money raised – is people who basically negotiate with the issuer to become their consultant. They’ll sign a consulting agreement. The consultant has to do a number of things; one of them could be going out and helping trying to raise capital or make those introductions… But it has to be that this consulting agreement is not merely for raising; what we’re paying the consultant is not based on how much capital this person brings in, and as is the general theme here, they should have some sort of other job, too. Again, whether that’s — I don’t know… If they’re a CPA, maybe they’re the chosen auditor of the books, or something like that… But it really shouldn’t just be the raising of capital.
Joe Fairless: Could that job be e-mailing their investors that they brought into the deal every month, about the status of the project?
Amy Wan: It could be, yeah. Investor relations. The latter two strategies that I talked about – the finder’s fee, the consultant fee – that usually is more so like cash payment upfront or something like that, whereas the first two I talked about it’s usually not monetary compensation upfront, but rather it ends up being that they get paid on the backend. Let’s say if it’s a multifamily syndication with a 5-7 year life or timeline. When the property is disposed of in 5-7 years and they’re selling it and paying back their investors – or honestly, even during operations, they have rental income – that’s when the person is getting paid, and they get paid just as the manager or the GP gets paid. So it’s not cash up front, it’s cash later down the line.
Joe Fairless: On option number two, give a class B interest – assuming there’s class A/class B or GP, LP – will you explain that for me one more time?
Amy Wan: Basically, I would say actually a majority of the clients that I used to work with, whenever they did a syndication, if it’s a smaller syndication and not a huge shop, they’ll choose a two LLC structure where one LLC [unintelligible [00:20:36].20] and one LLC is the manager, and the manager usually gets all the class B units.
Let’s say in the actual LLC that holds the assets 70% of the LLC is owned by investor members as class A units, and the other 30% is owned by basically the manager, affiliates of the manager or whoever’s helping out a little bit more on the management side. Of that 30%, sometimes I see people saying “Okay, so of the manager’s 30%, we will take 28% of it and 2% we’re gonna allocate to this individual for helping us on these specific things.”
Basically, option A and B are very similar, except that in the former they actually become part of the sponsor, and in the latter, they’re a little bit more removed, but are still doing things that add value.
Joe Fairless: This is crystal clear. I’m incredibly grateful, and I know a lot of the listeners are as well, because now every time I get this question I’m going to give them a link to this interview. I have a feeling this is gonna be a popular one. Anything else that we haven’t talked about as it relates to the subject of “How can we become compensated for helping people raise capital without becoming a broker dealer?”
Amy Wan: You know, what I’m about to say is a little bit more obscure, but lately I’ve actually been getting a relatively more frequent number of calls of people asking about AngelList [unintelligible [00:22:31].26] AngelList is basically a tech startup; it’s like a futuristic venture capital firm. They are not a broker dealer; I actually don’t even think they’re a registered investment advisor [unintelligible [00:22:43].15] but they make a lot of money off of helping startups get fundraising. Their founder – he’s invested in companies like Uber, and all sorts of vague unicorn startups.
The way they’re structured is really interesting… They do not make any money on the front end; what they do is they make it on the back end. They use syndicates to basically fundraise. Angel investors in their network who see a lot of deals every day will basically bring a deal to AngelList and say “Hey, I wanna invest in this deal, and on AngelList I have a lot of backers who every time I invest a certain amount of money, they will back my investment, so the investment kind of snowballs”, and it kind of helps them diversify a little bit.
What the angel syndicate gets is a carry; he gets a portion of what the end return is for the investors, for his services. He manages the investors, he manages the relationship between him and the startup, and then communicates what’s going on to the crowd of investors.
AngelList also takes a carry, which means they get paid on the backend. I think it’s like 15%-20%; I don’t know about the numbers anymore.
I’m starting to hear a lot of people who are trying to or thinking about adopting this model in real estate, because I guess a lot of investors only know how to invest in multifamilies, but they might not know how to invest in hotels, or something like that.
That’s really interesting, and it’s another way that people are looking at to be able to help people raise capital based off of their networks or someone else’s network without having to themselves become a broker dealer.
Joe Fairless: You’re gonna laugh, but can you repeat that, but dumb it down for me, exactly what you just said?
Amy Wan: Okay, so basically if people want to for example google the SEC no-action letter, that basically is another way for people to be able to utilize their network, get paid something off of the transaction without being a broker dealer. It is a little bit more complex, it is for someone who is specifically interested in making this their day-to-day job, but it’s something I think worth looking at.
Joe Fairless: There’s the takeaway – we will google “angellist SEC no-action letter”, and for anyone who wants to dig in deep, then that’s the starting place, right?
Amy Wan: Yeah.
Joe Fairless: Sweet. Alright, Amy, anything else that we haven’t mentioned that you think it’s relevant to bring up on this topic?
Amy Wan: Nothing other than before you do anything, go run it by your attorney. [laughs]
Joe Fairless: How or where should the Best Ever listeners go to get in touch with you and learn more about Bootstrap Legal?
Amy Wan: They can go to my website – it’s BoostrapLegal.com – and they can always feel free to contact me personally. My e-mail is email@example.com, or they can find me on LinkedIn.
Joe Fairless: Amy, this has been such a practical exercise… An interview for all of the Best Ever listeners who are focused on bringing in more capital into their deals or partnering with other people to do deals. The question is “How can we get some form of payment or compensation while helping people raise capital without being a broker dealer?” You gave us four options:
1) Become the issuer, so basically, be on the general partnership side. There’s a lot of disclaimers in between all of these, and I won’t say them all (there’s a transcription of this episode, fortunately).
2) Give class B interest.
3) Charge a finder’s fee, but make sure (I will mention this disclaimer) not to tie the compensation to the money raised.
4) You can negotiate with the issuer to be a consultant, and again, make sure that there is not a transaction or amount raised tied to this compensation.
Overall, if you are on the general partnership side and you’re getting compensated, make sure that you do have additional responsibilities, albeit it could be as simple as sending out a monthly e-mail to investors, so investor relations with deals.
Did I summarize that — I know I didn’t say all the disclaimers, but is that basically the gist of it?
Amy Wan: That’s it.
Joe Fairless: Okay. Amy, thanks so much for being on the show. Did I mention this was a Situation Saturday? I don’t know if I did… I hope you have a best ever Saturday, and we’ll talk to you soon.
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