When I was getting my real estate education and started to learn about using private lenders, ALL of my instructors left out a HUGE piece of the equation. It was the part about being in compliance with the SEC and their regulations.
I realized recently that there is a basic item that you need when borrowing money from Private Lenders that some of you might overlook. It is a DISCLOSURE DOCUMENT and every one of your lenders should get it. This is such an important item I thought I would dedicate this investing article to covering as much as can – so here we go…
Private Borrowing & Lending Rules:
- A promissory note is a security.
- If you want to advertise, or pool money you had better have ‘registered' with your states SEC.
- Don't pay commissions to find private lenders unless it is to a licensed broker.
- Don't use the word ‘guarantee' in your advertising. Or anytime.
- Every lender should get your disclosure document.
What Is A Disclosure Document?
Whether you have no private lenders yet or a bunch of them, you must have a disclosure document. This is a “no option item”. When you are looking to get a new private lender, the first thing you hand them is a disclosure document.
You see all investments are risky. Therefore you have to tell your private lenders that in your disclosure document. If you are ever asked by the SEC to show them yours, you had better be able to produce it and prove that every lender got a copy of it. If you don't have one, then you need to start immediately on creating one. Then I'd run it by a SEC attorney to see if it is good enough. They are roughly 10 pages long for a basic one.
When you are offering private lenders the opportunity to work with you, you must be sure to disclose to them the risks and rewards of the business. You should prepare a disclosure document. A disclosure document has legal consequences. If a private lender is not given sufficient, material information and suffers a loss, he may have a claim against you and your business. The information you give private lenders must be accurate and not misleading. The key test is if you have given private lenders all “material” (significant) information about your business at the time the investment was made. It is therefore important to follow the SEC's disclosure regulations in your document.
What Are The Guidelines For Creating a Disclosure Statement?
In general a disclosure statement should have at least the following included information:
The Business of the Company – This information generally includes a description of your private lending business, location of the company's facilities, trends in the industry, and the company's marketing strategies.
An example would be…
“Integrity Home Buyers, Inc. is a real estate investment company. We work with private lenders and put their funds to use in residential property investments that are secured by mortgages. These transactions are done in compliance with relevant laws and regulations and in compliance with appropriate securities registrations or exemptions in every state in which we do business…”
Risk Factors – These factors vary depending upon the company and the nature of its business. They may include cash flow difficulties, market competition, inexperience of management, and dependence upon an unproven product, absence of operating history or profitable operations. The real estate industry is particularly sensitive to economic downturns. The value of securities of issuers in the real estate industry can be affected by changes in real estate values and rental income, property taxes, interest rates, and tax and regulatory requirements.
Use of Proceeds – The use of the funds to be received from the offering should be set forth with a high degree of specificity. Categories of expenditures may include such items as leases, rent, utilities, payroll, and purchase of equipment, payment of notes, advertising costs, insurance, supplies, and payments to be made immediately to officers.
Key Personnel and Shareholders – Individuals who direct the company's operations or who make significant contributions to the business of the company as employees, independent contractors, consultants, or otherwise are identified and important background information such as education, age, and business experience of these persons is disclosed. Principal shareholders of the company are
identified with a description of the number and percentage of shares beneficially owned.
Financial Statements – Financial information, such as balance sheets and statements of income and cash flows that accurately describes the financial condition of the company, is typically provided. In some circumstances, these financial statements must either be audited or reviewed by a Certified Public Accountant.
Other key points – This is where you should give people access to information about your business. If you're new to this business, give people some projections of what you hope to do with the business that is reasonable and conservative. It's good business to under-promise and over-deliver.
You should distinguish between facts and beliefs in your disclosure. Restrained language should be used throughout the text. At the practical level, many investors are accustomed to reading carefully worded disclosures and they are suspicious of broad, unqualified claims. An understated, factual disclosure can deliver a powerful message to private lenders.
Avoid arcane jargon and technical terms. Provide definitions for terms that might not be easily understood. Don't make private lenders learn a new language if they want to understand your disclosure document.
Private Lending Lesson Conclusion – The All Important Disclosure Statement
The bottom line… by giving your lender a disclosure document, it shows the lender exactly what is going on with their loan. You will have a meeting of the minds and everything is on the table. You will be a huge step forward by being professional and in avoiding potential problems in the future. Besides, it's required in every state.
I now see it as my goal to make sure real estate investors are aware that when they borrow money from private individuals, it is not the Wild West. There are rules that come into play. The rules are there to protect the lender and the rules are good rules. The above guidelines were compiled through my SEC attorney.