Can you get around the SEC with joint ventures?

As real estate investors, we are trained to be creative. We try to find different ways to make the deal work. And, if not, we go back to the drawing board and try again until all options are evaluated. It’s no wonder, then, that some people get creative when it comes to securities laws.

I hate the word “enforcement” as much as you probably do – it reminds me of a CIA/government training program from a TV show or movie. But, until the laws change (not likely), we have to make sure we operate under SEC guidelines to raise money. It becomes much easier when you learn how to do it.

It’s not a good idea to be creative in trying to avoid completing offering documents or filing forms with the federal SEC or state securities regulator. In the long run, it will trip you up. One way real estate investors get creative is to raise private money from individuals and call it a ‘joint venture’. The scenario basically breaks down like this: You have deals. Your investor has the money.

You bring your investor as a full partner in your business. The premise of this is that you are bringing in an ‘active’ partner (could be an LLC member/manager etc.) who technically isn’t offering a security because the person is active (although not actually active – they don’t participate in management, rehabilitation, etc.) unlike a passive investor. This assumes, then, that the securities laws only apply to passive investors.

This is not true.

Take a quick look at the ‘Howey Test’ (Supreme Court case that laid the groundwork for what is considered to be offering a guarantee).

An investment contract under the Howey Test was defined as follows:

1. an investment of money due to

2. an expectation of gains derived from

3. a common company

4. Relies solely on the efforts of a promoter or a third party

Clause #4 gets to the heart of the ‘joint venture’ issue. Because you are offering someone the opportunity to profit by doing business with you and those profit efforts are solely up to you, therefore you are offering security and have to deal with securities law disclosures and any SEC filings you may have to make. .

Along these same lines, the actual meaning of ‘joint venture’ is defined as “A joint venture (often abbreviated JV) is an entity formed between two or more parties to undertake economic activities together. The parties agree to create a new entity for both contributing capital, and then share revenue, expenses, and control of the business (definition courtesy of Wikipedia).

A true joint venture could involve you raising private money to purchase a property and then partnering with a contractor to commit the resources and funds for rehabilitation and then splitting the proceeds and/or cash flows. You can also form a joint venture where you take the deal to an investor who will acquire it and you retain a small equity stake or receive a fee.

There are many ways to be creative in real estate, and you should never stop thinking about the possibilities. But, when it comes to raising money, if you promote the deal and your investor brings in the cash to get a return on your money, you want to quickly call your securities attorney and have everything locked up on your end. It doesn’t take a lot of time or money compared to not doing things the right way. Credibility and integrity are the cornerstones of raising money.