Partnering v. Syndications Part 1


This 2-part blog is going to cover the differences between partnering with others to engage in real estate investing versus putting together a syndication. These two techniques may be similar—and often confused—but they are very different! And you need to understand each as a separate investing strategy.

NOTE: There can be some subtle legal nuances to the discussion below. It’s meant as information and educational. content only. If you even think the SEC rules may apply to your deal, you should seek legal counsel to make a determination before proceeding.

Not only is it important to understand the difference from a structural standpoint, but also from an SEC compliance standpoint. True “partnerships” do not need to be registered with the Securities and Exchange Commission or other state securities office. While a syndication (almost certainly) will need to jump through SEC filing hoops. Because failing to register a project with the SEC can create very serious financial and criminal consequences, we’ll cover the SEC portion in this blog and the structural differences in the next blog.

All offerings of securities must be registered with the SEC. Private offerings, like the ones you’ll see in real estate investing, have exemptions from the complicated and expensive filings that companies going “public” face. But even with private offerings, there are still forms that must be submitted to the SEC and to every state (along with state fees) in which you are raising money. Failing to provide these forms can lead to prosecution by the SEC.

What is a security offering? Pretty much any time you give something of value (think money) in exchange for ownership in something else, you have a security exchange. So, offering to sell membership in an LLC for cash is a security offering. Even looking for lenders, debt financing, can be considered a security offering (it depends on how the loan is structured). Think of it this way, if you are looking to “raise funds” from “other people or entities” to do a real estate investment deal in exchange for giving those investors a share of the deal, you’re in SEC territory.

What isn’t a security offering? A true “hard money” loan where the loan is secured by a trust deed or mortgage on actual real estate is not a security. If an LLC gets a loan that isn’t secured by a mortgage, that can certainly be considered an offering and you should review your deal by an SEC attorney for compliance issues.

Raising money from people (or other entities) by “selling” membership in the LLC that will own the property is a security offering. I’ve heard people say, “But I’m only raising this money from ‘friends and family’ so the SEC doesn’t apply.” That is not true! When raising funds in exchange for ownership, it’s always a security offering regardless of WHO those investors are. They can be your own parents, and you still have a security offering.

So, what is the “friends and family” exception you’ve heard about in these kinds of deals? Once you have a security offering (see, above), depending on which exemption you’re filing under, there are rules about “to whom” and “how” you advertise your offering. Sometimes, you cannot market at all to the general public. But, there is an exception to that prohibition on marketing in certain cases for friends and family, who aren’t considered the general public. But this is just marketing your deal IF the SEC regulations apply. It is not a determination of whether the regulations apply in the first place.

Another way to think about it is to define what a true partnership is. A “true” partnership does not need to worry about the SEC. A partnership is when multiple people come together to achieve a business pursuit. They want to combine resources and talents to make money. In a true partnership, all the partners are actively pursuing that goal—they are “actively” working for the partnership. So, if all the people involved in the deal are doing some kind of regular work on behalf of the company in exchange for their ownership, then it’s just a partnership.

What if you have a partnership with two people, one with money and one with time & talent to do the work? This situation looks like the money person isn’t actively working to achieve the goal. This is gray area, and the SEC would certainly take a close look. Being just 2 people, and especially if they do this repeatedly, putting up funds could be considered an “active” involvement in the business pursuit and it will be deemed a partnership. Now let’s say there are two, unrelated people contributing cash funds? This now looks more like you are “raising” funds rather than “partnering” with someone that has funds. That is not to say that 1 cash investor is fine and 2 is definitely in SEC territory. This is an area that can come down to your communications, other relationships and documentation while obtaining the funds.

In most true “syndications” there is a person or group of people putting the deal together (doing all the work) and then offering ownership in exchange for cash funds to the project. The people in the group would be a partnership. But once they “offer” something in exchange for something, they’ve turned the partnership into a syndication and have to jump through the SEC’s hoops.

So, once you have an “offering” (and that term is defined very, very broadly!), you need to comply with all SEC regulations for the kind of offering you’re engaged in (yes, there are a few different types of offerings). My suggestion is that if you even “think” you might be offering a syndication, to run exactly what you’re doing and how you’re looking for partners in the deal past a qualified SEC attorney.

In the next blog, I’ll cover the structural differences between a partnership and a syndication.

Jeffrey S. Breglio, Esq.
Breglio Law Office and REI Mastery U
(801) 560-2180

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