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Interstate Crowdfunding: Is the Risk Worth the Reward?

Ron Fields
Instructor

In our previous newsletter regarding crowdfunding, we covered the Intrastate Crowdfunding model, and the benefits associated with raising capital and acquiring control or title using this model.  Two of the most important benefits to Intrastate Crowdfunding are, the ease of using it as it relates to regulations, and the fact that you may be able to completely bypass using lending institutions as a source for funding your projects.  For some, the greatest obstacle to using this method is approaching and asking potential funding candidates to consider participating in your offering.  The second obstacle, having the absolute desire and total commitment to make this work.

Now, let’s look ahead a year or so.  You have funded several projects for your account. or that of others.  Your confidence, along with your credibility have increased dramatically.  You are ready for the next step in your business plan.  You are about to get in the arena with the Big Dogs.  That’s right, you are ready to embark on the next level as it relates to Crowdfunding.  You literally are going to step across the line and expand your business using the Interstate Crowdfunding model. 

How to be successful with crowdfunding

Pros and Cons of Interstate Crowdfunding 

In adopting this approach, you can raise funds from potential investors that live in other states along with buying properties in different states.  This can significantly increase your ability to acquire larger properties that generate greater revenues and, therefore, the potential for greater profits.

But this all comes at a cost, a much greater cost.  The cost in your time, money, regulation compliance and risk all add to the challenge of making this endeavor profitable.  Is it worth it?  You will have to make that call.  Let’s examine each of the Interstate Crowdfunding risks separately. 

TIME 

Precious time.  Some say that this is your most valuable commodity, and I would agree.  That being the case, it is crucial you realize that with Interstate Crowdfunding you can spend considerable time doing the following:

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  1. Identifying and closing on the right deals
  2. Identifying the right funding candidates and getting funding commitments.
  3. Obtaining the information to conduct a thorough due diligence
  4. Building real estate teams in each state
  5. Coordinating with all parties involved in the transaction
  6. Record keeping for the operating company and each property
  7. Overseeing all aspects of the operation
  8. Ongoing compliance with various regulatory bodies
  9. Evaluating market conditions on an ongoing basis in the locations where you acquire or own properties.
  10. Acquiring bids, hiring a contractor(s), overseeing the contractor(s) that do any renovation after acquisition. 

MONEY – Your $’s 

  1. Operating a business of this complexity will require a strong personal financial statement. This will not be a one person operation and the cost of hiring and keeping good people could be a sizeable portion of your operating budget.  You will also have business operating costs.
  2. Due diligence costs in evaluating the property and market can add up quickly. For instance, lead based paint, title search, travel, property inspection, environmental study, survey, radon, asbestos and appraisal are just a few of the upfront fees you may have to advance without the opportunity to recover them if the project is not viable.
  3. Having a productive marketing strategy could include a website, pamphlets, brochures and advertising.
  4. Having an attorney that specializes in security issues on retainer that can guide you through all the various regulations with the Federal SEC and State Securities Divisions will certainly be a major part of you budget planning.

Underestimating the funds needed to start and maintain Interstate Crowdfunding operations could very well be the reason for failure or major setbacks. 

REGULATIONS – State and Federal                                                                     

The challenge with dealing with more than one Security Regulatory Body is that they can have different restrictions and compliance requirements for Crowdfunding.  This of course impacts both the legal and registration compliance costs, and the money needed to pay the application fees for each state and the Federal SEC.

For a complete review of the Federal General Rules and Regulations relating to Crowdfunding, go to the e-CFR – Title 17 Chapter II Part 227.  This is the electronic portal to the federal CFR (Code of Federal Regulation).  Part 227 will have sub-parts A-E.  This is not easy reading and therefore only confirms the fact that you need an experienced securities attorney to guide you through the maze of do’s and don’ts.  I would suggest that you familiarize yourself with the regulation so that you can establish some degree of credibility with the securities attorney you select before meeting them personally.  Likely, this will be the same attorney selected for your team for Intrastate crowdfunding transactions.

RISK 

In evaluating risk, we should look at it as if wearing two different hats, or from two perspectives; risk to the Investor, and risk to you as the Business Operator/Promoter. In my game book, I always place the investor’s interest of capital preservation above mine. Let’s look at each.

Investor Risk

Here is a list of some of the risks associated with being an investor in a Crowdfunding/Pooling investing strategy.

  1. Market conditions can change where property is available
  2. Interest rates could rise.
  3. Inflation could increase dramatically
  4. Having a poor property manager
  5. Rental/Credit losses – tenants don’t pay
  6. Having inadequate insurance coverage
  7. Environmental issues
  8. State or local regulatory bodies imposing new restrictions. (Zoning changes, rent control, environmental issues, and the list goes on.)
  9. Changes in the Federal or State tax code

These are some of the areas you should address in your SCOR (Small Corporate Offering Registration) or Disclosure form.  Some States will only accept SCOR form U-7, while a few require a Disclosure form.  The majority will accept either.  Consult with your securities attorney on your team.  Sample forms are available on the internet.

Business Operator/Promoter

Here are some of the challenges I see for individuals interested in pursuing Crowdfunding as a strategy to raise capital.

  1. Not having a business plan
  2. Insufficient capital/resources
  3. Underestimating the amount of time required to get up and running and sustain operations.
  4. Not having a team or wrong team members.
  5. Lack of experience/knowledge
  6. Inadequate recordkeeping
  7. Establishing credibility

These are some of the challenges facing any new business owner.  The key is to look at Crowdfunding as a new business opportunity, do your homework and decide to proceed with a 100% commitment to make it work.  If you do that, I expect that you will look back in 5 or 10 years and say, ‘this is one of the best decisions I’ve ever made,’ as it relates to building a comfortable retirement fund.  My opinion is that Crowdfunding can become a major source of funding for both large (Interstate Crowdfunding) and small (Intrastate Crowdfunding). 

Make it happen! 

Ronald Fields, CCIM

P.S.  Don’t forget about OTA Tax Pros.  Michael Atias and his staff can be an immensely valuable source for recommendations concerning entity structuring and minimizing your taxes.

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.