Are you a private lender? Non-conventional lender? Mortgage broker? Is your capital sourced from private investors (friends and family included)? If so, this article is for you.
MYTH #1: Brokering loans to investors does not constitute a security. FALSE. The SEC and every state securities regulator has made it a point that Promissory Notes are almost always a security. The broad test often referred to as the “HOWEY TEST” will result in whole notes, fractional interests in notes, unsecured notes, lines of credit, stock, membership interests or LP interests in an LLC as a security.
MYTH #2: I don’t need to comply with securities regulations – I’m just raising money from friends and family. FALSE. First, cousin Bob can become plaintiff Bob before you know it. Second, the SEC and state regulators are interested in protecting investors, regardless of the existence of any personal relationship between the investor and the sponsor.
Now, here are the Top 3 Regulations that lenders use to raise money legally.
- REGULATION D RULE 506b/506c
Regulation D is a federal securities “safe harbor” that establishes that if an “Issuer” (i.e. someone who offers and sells securities to investors) relies on its requirements, it is exempt from registration with the SEC.
For clients who operate national fractionalized loan offerings, debt offerings, and debt funds – 99% will utilize Regulation D’s Rule 506B or 506C.
Here are some key features of both regulations:
| Rule 506(B) | Rule 506(C) | |
| Maximum Offering Limit | NONE | NONE |
| Federal Preemption | YES | YES |
| Advertising & General Solicitation | NO | YES |
| Non-Accredited Investors Permitted? | Yes. Up to 35 Max | No. Verified Accredited Investors ONLY. |
| Liquidity Restrictions? | Yes. Minimum 1 year | Yes. Minimum 1 year. |
| Compliance Requirements | Form D with SEC & States | Form D with SEC & States |
- REGULATION A
Regulation A was amended and significantly expanded in 2014 as part of the JOBS Act. This amendment essentially opened the door to true “Crowdfunding” – in the sense that it permits issuers to raise capital from the public (in a limited fashion). In many ways, Regulation A can be viewed as a “semi-public” offering.
Regulation A is comprised of 2 tiers, each with its own unique restrictions. Notably, Tier 2 is significantly more popular because it does not require state-by-state qualification. Here are some key features of both tiers of Reg A:
| Reg A Tier 1 | Reg A Tier 2 | |
| Offering Limit | $20,000,000 every 12 mo. | $50,000,000 every 12 mo. |
| Government Qualification | State and Federal (SEC) | Federal only (SEC) |
| Advertising & General Solicitation | YES | YES |
| Non-Accredited Investors Permitted? | Yes – max 500. | Yes. Investment limited to 10% of net worth. |
| Audited Financials Required | NO | YES |
| Periodic Reporting Required | NO | YES. Annual, Semi-Annual, Current Event. |
- LOCAL SECURITIES REGULATIONS
For lenders who raise capital from one state only, state securities regulations can be immensely useful. Many states have variations of the federal securities exemptions set forth above. For example, California has California Corporations Code 25102(f) which is essentially identical to Rule 506(B) of Regulation D but limited to California only.
These regulations are highly effective for raising capital in a single state, but to truly scale and raise money nationally, the federal options above are recommended.
Today, non-conventional lenders, debt funds and mortgage brokers nationwide have a broader means to raise investor capital at the private level thanks to the JOBS Act. However, selecting the right option can often be a challenge.
Our recommendation is to rely on Regulation D’s Rule 506(B) or 506(C) to establish your initial capital raise, whether it be friends and family or high net worth investors. From there, a determination can be made – remain within the same investor class or expand to the general public. Thanks to Regulation A, the path to a public offering is much less burdensome.
