Be Prepared When You Show Up to Investors:
The Legal and Financial Tools and Team You Need to Raise Capital
Have you ever wondered what’s involved in raising capital to buy real estate? Well, I recently had a former client and friend reach out with that very question. They’re embarking on a capital-raising journey for their new real estate project and wanted some feedback. Before diving into the details, I find it helpful to start these conversations by providing some foundational background information. This way, we’re both on the same page when it comes to the essential elements required for successfully raising capital. Below is the guidance I shared, covering the critical legal and financial tools, as well as the team structure necessary to attract serious investors.
Raising Capital for Real Estate Ventures: The Essential Legal and Financial Documents You Need
Raising capital for real estate investments is a complex, yet it can be a rewarding endeavor that requires thorough preparation, professionalism, and the right legal and financial infrastructure in place. Investors—particularly accredited ones—expect transparency, clean financial reporting, and well-structured legal agreements before they commit any meaningful investments to your project. Whether you're new to capital raising or experienced but looking to refine your approach, understanding the necessary legal documents and how to present your business plan is crucial to attracting the right investors and scaling successfully.
Downtown Dallas Museum Tower - Early Days of Development Resolution with Investor(s) - Photo by: Rachel C. Ybarra
Legal Documentation For Your Capital Raising Strategy
There are three key legal documents that should be in place whenever you are raising capital: the Operating Agreement, Subscription Agreement, and Private Placement Memorandum (PPM). Each serves a distinct purpose, and together, they form the backbone of your legal strategy.
1. Operating Agreement
An Operating Agreement defines the governance structure of your real estate project. It outlines the roles and responsibilities of the General Partner (GP) and Limited Partners (LPs). This agreement covers critical aspects such as:
Decision-Making Authority: Who has the final say on important matters like property acquisitions, selling assets, or taking on additional debt? This needs to be explicitly outlined.
Compensation and Profit Distribution: How will profits be distributed? What are the conditions under which General Partners or key personnel will be compensated?
Roles and Responsibilities: Clearly define the day-to-day responsibilities of all parties, ensuring there's no ambiguity about who is responsible for managing the property, overseeing renovations, or handling investor relations.
Exit Strategy: What happens if an investor or partner wants to exit the agreement? Will there be buyout provisions? Are there timelines that must be adhered to?
The Operating Agreement ensures that everyone involved understands their role and how key decisions will be made throughout the project’s lifecycle.
2. Subscription Agreement
The Subscription Agreement is a legally binding document between you and your investors. It outlines the financial commitments of the investors and sets clear expectations regarding their stake in the project. Key elements of a subscription agreement include:
Investor Contributions: How much is each investor contributing, and in exchange for what percentage of ownership?
Ownership Stakes: What is the structure of ownership in the project? Are there different classes of shares or levels of investment?
Compensation Terms: How and when will investors be compensated? Are there preferred returns, or will it be a straightforward profit split?
Exit Strategies: Similar to the Operating Agreement, this document should detail how investors can exit the project and under what terms.
A well-crafted Subscription Agreement sets the financial terms of the investment and ensures that both you and your investors are on the same page regarding ownership.
3. Private Placement Memorandum (PPM)
The Private Placement Memorandum (PPM) is required any time you're fundraising from investors. This document serves multiple purposes:
Risk Disclosures: The PPM must include a comprehensive list of all the potential risks associated with the project. This is not just for transparency but also for legal protection. It’s essential that all parties understand the inherent risks of investing in your real estate project, such as market volatility, property depreciation, or unforeseen maintenance costs.
Legal Requirements: Similar to the regulations required of publicly traded companies, the PPM must meet certain legal standards. It ensures compliance with securities laws and includes attestations that the investors are accredited.
Accreditation Documentation: As part of the PPM, investors will need to provide proof that they meet the criteria for accredited investors. This includes attestations about their income, net worth, and investment experience.
Detailed Business Information: The PPM will also include a summary of the business plan, outlining the project’s goals, market strategy, and potential returns.
The PPM is essential for compliance with legal standards and for protecting both you and your investors. It’s a crucial document that ensures all parties are fully aware of the risks and opportunities involved in the deal.
4. Business Plan: The Key to Differentiating Your Investment Opportunity
While the legal documents set the foundation for your investor relationships, your business plan is what will sell your vision. A well-structured business plan not only outlines the market opportunity but also emphasizes what makes your project unique and worth investing in.
Your business plan should include:
Market Opportunity: Clearly define the market opportunity you’re addressing. Whether it’s undervalued properties, a growing real estate sector, or a niche investment category, you need to demonstrate why this is the right market to be in.
Competitive Advantage: This is crucial. What makes your project stand out from other real estate deals? Do you have a unique funnel for acquiring properties, a well-oiled operational team, or proprietary technology that optimizes for efficiency? You need to articulate why investors should choose your project over others.
Team Experience: Highlight the strengths of your team. If your team has deep experience in real estate, technology, or operations, emphasize that. If you're working full-time on another job, you’ll need to address how you plan to overcome the perception of divided attention. Investors may view this as a risk, and it’s important to mitigate that concern.
Competitive Landscape: You’re not just competing with other real estate deals; you’re also competing with alternative investments, real estate investment trusts (REITs), and other publicly traded liquid investment opportunities that are becoming increasingly accessible. How does your project stand out in a crowded market? Why should an investor choose an illiquid real estate deal over a highly liquid publicly traded REIT or other online investment platforms?
Preparing for Success: Final Thoughts
If you’re serious about raising capital for real estate investments, you need to be prepared with the right legal and financial infrastructure in place. Investors expect professionalism, transparency, and a well-structured approach to business operations.
When assembling your legal team, ensure they have experience with real estate deals and can help you put together an Operating Agreement, Subscription Agreement, Private Placement Memorandum (PPM), and Business Plan that reflect the high standards investors are looking for. These documents don’t just protect you and your investors—they also signal to investors that you are serious about the deal and have thought through the risks and rewards.
Inside tip: when preparing a PPM and you are looking to share all the possible risk to the plan, consider looking at publicly traded companies filings for companies in the industry and sector you will be competing in. In these documents you will find a holistic list of risks to their business that might also apply to you. Create your PPM in the same caliber that a publicly traded company would.
The financial infrastructure is just as critical as your legal team and documents. You’ll need a good real estate tax partner, fractional CFO, certified bookkeeper, and reliable accounting and reporting systems in place to manage day-to-day operations and provide accurate monthly and quarterly reports to investors.
Capital raising is competitive, and with new alternative investments emerging regularly, it’s more important than ever to differentiate your real estate project by presenting a comprehensive, well-thought-out plan with a unique opportunity that is not necessarily available elsewhere.
There are competing factors you will have to overcome including opportunity costs, liquidity, access to equity, and meaningful cash flow from competing investments. Investors will be more open to your opportunity and possibly commit capital if they see that you have the right team, systems, and vision in place. Expect it will take a bit of time to raise funds and expect a whole lot of “no’s” before you get your first “yes.”
Investor Selection
To save for another time, however if you do decide to take on investors, you too want to be selective about which investors you bring on. What you want to consider is when things get tough in the business, how will that investor show up during those difficult moments? Every entrepreneur you meet will tell you they have been close to business death in the past or many have experienced it. You will want good and solid investors by your side, willing to ride out the horrible storms. I have witnessed really good ones on a cap table, which I admire.
Being an investor and entrepreneur are very tough businesses. Welcome to the arena. Be Prepared.
Until next time, keep building so you can embrace any future that comes your way!
Disclaimer:
This newsletter and podcast are not financial advice. Rather this is educational information as you build your financials skills to be a better sovereign of your own finances.
Share With Others
If you are a mentor working with your mentees to improve their career possibilities, having financial strength is key. People are more apt to take on greater career prospects if they currently have financial security and financial knowledge. Feel free to share so others can know and grow.
Note: Thanks to AI for helping scribe and edit my dictation on this subject, which is based on my experience as an investor and author of such documents, and my experience working with fractional CFOs, certified bookkeepers, tax partners, and business and M&A attorneys.