Today my guest is Gene Trowbridge is a commercial real estate broker, CCIM, syndicator. An author, he wrote the book, it’s a whole new business. He’s a speaker, a real estate attorney, and a founding partner at the corporate securities law firm Trowbridge, Sidoti LLP, and an expert in real estate syndication. And in just a minute, we’re going to speak with Jean about syndication law, and the issues with regulation, the private placement. But first, a quick reminder, if you like the show, CR e pn radio, please let us know you can like, share and subscribe. And as always, you can leave a comment we’d love to hear from our listeners. Also, if you’d like to see how handsome our guests are, be sure to check out our YouTube channel. And that’s commercial real estate pro network. With that, I want to Welcome my guest, Jean, welcome to see our CREPN Radio.
Gene Trowbridge 1:05
Thanks, Darrin. I’m happy to be here.
J Darrin Gross 1:08
I’m so glad you were able to join us today. And before we jump into our conversation, if you could take just a minute, and share with the listeners a little bit about your background.
Gene Trowbridge 1:21
All right, well, I really had three, three careers. And that that’s amazing given I’m only 27. But I’ve had death. Three careers. I had a career as a commercial real estate broker. I had a career as a real estate syndicator, where I put together syndications, concentrating primarily and building self storage facilities here in Southern California. And then when I was 45, I went to law school. And my third career now is being an attorney. And my practice is really specialized in commercial real estate securities. And that would be my third career. And I’m still working on my fourth one. I’m going to keep that a secret.
J Darrin Gross 2:10
Oh, yeah. Got a surprise. Is it gonna? Is it something real estate related?
Gene Trowbridge 2:15
You know, I don’t even know. So it’s a secret to me but you know it’s
it’s a it’s it’s it’s a
it’s a shame if you don’t try new things once in a while.
J Darrin Gross 2:25
I love it. A seeker constantly seeking good stuff. Gene I’m just curious based on your experience, and you know, having been a broker and also a syndicator. And now, being a part of a law firm that specializes in syndications. have you kept count, you have any sense of how many syndications you’ve you’ve been a part of in one way or another?
Gene Trowbridge 2:56
Totally No, but Since 2014, since the the formation of this law firm, we do keep track of that. And we have about all 550 clients, individual clients, we have almost 900 offerings. And we’re over the $4 billion mark in dollars raised in our offerings, not the value of the real estate, but the dollars raised. So for a bowtique firm, right now, we have five attorneys. That’s a pretty strong, pretty strong record.
J Darrin Gross 3:42
Definitely does sound like you’re just trying to figure it out. We’ve kind of worked out some of the kinks, I suppose. Hmm.
Gene Trowbridge 3:48
Yeah, that’s right.
J Darrin Gross 3:49
So for the uninitiated, could you define for us what syndication is
Gene Trowbridge 3:57
That’s Very good question because that’s one of the most common questions I get someone’s calls me in the off on the phone and says Jean, I want to put four or five people together, we want to buy a piece of real estate, but I don’t want it to be a syndication.
Well, that’s the wrong question.
A syndication is anytime two or more people combine their money and their expertise to do something. Some of the examples of syndication that you see are when you go to the movies. At the beginning of the movie, it probably talks about three or four different companies who have come come together to make the movie. I talk about
long term health care insurance for an old guy like me, that’s really a syndication. We all pool our small amounts of money and then the big pile of money will take care of us hopefully. Other syndications are when you fly an airplane, you don’t have a plane. You don’t have that. management expertise, you 140 of your best friends climb into the, what I call the flying petri dish. And, and fly somewhere. That’s a syndication. So simply, a syndication is when you and other investors get together to buy some real estate. Now, that’s not a legal entity. That’s not an anything. It’s just a definition. The real question is, is it a security? That’s the issue because when people say I don’t want to do a syndication, they’re asking the wrong question. They’re using the wrong language. They’re saying, I want to put these people together and buy something, but I don’t want it to be a security. Because with the security, you work, you walk into a whole different world. And you know, that’s the title of my book. It’s a Whole New Business. The securities world is totally different than the real estate world. Okay, it’s different. So that’s That’s my long winded answer to that question, Darrin?
J Darrin Gross 6:03
No, it’s a it’s a perfect starting point, I think for today. And you mentioned that it’s not an entity, but it’s more of a kind of a coming together. And actually, it’s a security to that kind of the distinction as opposed
Gene Trowbridge 6:18
to syndication. And the question is, Is someone going to manage the money? For the other people? Are there going to be passive investors? And in there, is there going to be an active investor. So the government has an interest in protecting these passive investors. So the government long time ago set rules that apply to the syndicator, who’s going to take the money from the passives and run it I mean, the definition of a security Darren is if there’s an investment of money in a common enterprise, the investors expect to profit what’s Someone else is doing the work. So you’ve got passive investors, and you’ve got the syndicator. And there’s a reason for the government to regulate what the syndicator does to protect the passive investors. So you can have a, you can have a group who come together in a syndication three or four people and go out and buy something. And they all decide that they will all be active managers, and that they will all vote unanimously on the big decisions. And I’d call that a member managed something or other probably an LLC. And if it’s just member managed, then one of the four parts of the definition falls apart. The fourth prong is managed by someone else, what’s not managed by someone else, it’s managed by them. So there’s no one in charge of the passage money. In fact, there are no past All the investors are active. So that’s not a security and we don’t need to regulate that. But the minute they put Darrin Gross in charge of the money,
it’s a security. Right.
J Darrin Gross 8:14
Gotcha. I appreciate you making that distinction, because I think sometimes people, you know, speak of more like a joint venture or some sort of little partnership where there’s, you know, the, everybody’s active, like you said, and just the distinction there seems too straightforward.
Gene Trowbridge 8:31
Well, that’s the hot topic, one of the hot topics today, and I’ve heard some united troll alive lot of podcasts and I listen to a lot of other people’s podcasts. And I always hear this well, gee, you can do a joint venture and you don’t need to make it a syndication. Well, once again, that’s the wrong use of the word. A joint venture would be two people or three people or a number of people getting together to do something. Well, that in itself is indication, but a joint Venture isn’t a legal entity. It’s just an explanation of how people are coming together, you drive downtown, and you see a big hole in the ground downtown and you see a fence all around it. And you see First National Bank is providing the construction financing. Some big companies is funding the permanent financing. And ABC contracting company is doing the building the contracting company as the bulldozers, the permanent financing as the permanent financing and First National Bank as the construction lending expertise, and they call it a joint venture.
Well, that’s not how it’s owned.
It’s probably owned in a general partnership. There’s no entity. There’s nothing in a joint venture that takes title. That’s just a description of how the people who take title aren’t coming together to do the work and if it’s a true joint venture Everyone is making all the decisions are made unanimously. Okay, you could say it’s a joint venture, but if it’s actually an LLC with 10 people, then you’re managing member. It’s a security.
J Darrin Gross 10:16
So, I mean, it becomes a I think at some point, just physically impossible for the like said everybody coming to the same decision and stuff as a matter of just efficiency and moving forward. Just as a matter of if you have more than X number of people, I would think that, you know, syndication would be the natural way just based on just efficiency that not
Gene Trowbridge 10:39
Well, that’s right. For the last podcast, I heard the first question that was presented to the attorney like me who is speaking is how many people does it take before you haven’t syndication? Well, wrong question. The answers two.
That wasn’t the answer that was given, but that’s the answer. It’s two. And then the question is, well, how many new people would have to take before it becomes a security and and you hit it right on the head. I don’t know how you’re making, how will you make a decision? How many people is too many to have unanimous votes on decisions, and the minute one person takes control. Let’s say we put together an LLC and the members can vote on all the day to day stuff, and it’s all unanimous voting, but gene Trowbridge can make a decision when you sell the property, or gene Trowbridge can make a decision when you refinance the property. You’ve got yourself a security
J Darrin Gross 11:37
Got it. That the decision making and like I said, the somebody else’s trusting or that I am placing my money with you and I’m trusting and have an expectation of some sort of economic gain.
Gene Trowbridge 11:54
Well, yes in the world in the law and securities without getting too deep as it is If gene Trowbridge is a sponsor, Gene Trowbridge has to give all the investors all the material information they need to make an informed decision before they vote. And that’s a securities law issue.
And so that’s to protect the investors. Right? Then there are other rules in the securities, which, you know, maybe we go into or maybe not, how much money can be raised, how many investors can there be? And all those are ways that the federal government is regulating risk.
You know, if we say that there can only be so many people in a deal well, there, that’s their attempt to regulate risk. Right? If we say there can be as many people in the deal as you want, they’re probably going to come back and say, well, that’s going to be people who come who are smart, and who are rich, who can make their own decision and maybe we don’t need to predict them.
J Darrin Gross 12:59
Okay. Right. So, just for clarity here that so you stated that the syndication is not an entity itself, is that correct?
Gene Trowbridge 13:09
No, because the syndication could be, it could be today almost everything is a limited liability company. It could be a limited partnership. It could be a corporation. You know, Google, everything on the New York Stock exchange’s is a syndication Tesla’s a syndication Tesla with their thousand dollar a share stock Can you believe it? Is is a syndication the legal entity isn’t the issue. The issue is is the investor investing money expecting to make a profit and someone else is running it? Got it. And and again just Is it the syndication is the you know, what it represents? Is it more of like a definition of how the entity is operating or Really a definition that two or more people are combining their management expertise and their money. Okay, that’s what it is. And then the question is, what entity if there is going to be an entity and you could have, you could have a syndication with two individuals taking title, individually tenant in common. Okay, you’re gonna buy 50% with your money and I’m gonna buy 50% with my money. We’re tenants in common as individuals, we own the property. That’s the ownership entity tenant in common.
That’s a syndication.
And more than likely, that’s not a security with just two of us. But the five of us do it somewhere along the line, someone’s going to start making decisions and write in a raise it to us and security.
J Darrin Gross 14:46
Right. I know there’s different versions of syndications. And I believe, is this all under the regulation D is that where the syndication Law?
Gene Trowbridge 15:00
Regulation D. That’s an important I’m glad you brought that up when they wrote the syndication rules and the syndication rules we work under now really come from 1933 in 1934 and have changed. But over time of the syndication and the securities laws have matured to where there’s really a dichotomy.
Does the syndication law need to be applied to protect those people who are rich and smart? Does it need to be applied to protect people who aren’t rich and smart? And the answer keeps coming down to we don’t need laws to protect the rich and smart people for the most part, but we do need laws to protect those who aren’t rich and smart and a 1981. regulation D that had been around for a long time, was really modified and codified to say that in a private placement, you can have as many rich and smart people as you want. And then they applied the accredited investor definition to rich and smart.
But you can only have 35 non rich and smart people, call them sophisticated. And that’s to limit the risk. How many people can lose their money in this deal? How many people who aren’t rich and smart 35
And you can’t advertise? So 1981 that was the big, the big rule. And I said this dichotomy keeps going. The jobs act that came out in 2012 2013 really said okay, there’s a lot of rich and smart people who will We’ll never know about Gene Trowbridge his offerings, BECAUSE Gene doesn’t know them.
why shouldn’t they know about Gene’s offerings? And there are a lot of rich and smart people that Gene doesn’t know.
So let’s let Gene advertised all the rich and smart people there are. And let’s let all the rich and smart people find out about Gene’s offerings, and why would you do that to promote capital formation. And so they came out with 506 C, which simply was, hey, the rich and smart people all along, haven’t needed our protection. We’re going to expand it. And we’re going to let gene build the database of rich and smart people that he might not know and try to sell them, his offerings. And then rich and smart people can go online when they can Moment night and have a glass of a port and smoke a cigar and search the web for offerings offered by people like Jean and see if there’s something they want to invest in. So that’s been the trend is moving away from protection for the rich and smart people, but beefing up the protection from thought for those who aren’t.
J Darrin Gross 18:24
Got it. So in going back to essentially 81 kind of the rules there was that when the relationship was critical to this, and in order to participate, you there had to be a relationship or does that.
Gene Trowbridge 18:41
That still is that still is the case. And I’m going to I’m going to explain it like this. If the SEC came to you and said, you know, you were advertising, weren’t you? You were advertising you were soliciting when you took those people in and That’s a problem because if you’re going to do that you can only have accredited investors. And you have to have some third party verification of your advertising. And you say, No, I’m not advertising. This is family and friends and bla bla bla bla bla.
Your defense against advertising is number one, you had a pre existing relationship with the investor. And number two simultaneously, you had a substantive relationship with that investor. Those words go together pre existing and substitute. So in order to defend yourself against a claim of advertising, you have to be able to show that all your investors had a relationship with you before your offering came out. My firm The date is when you sign the fee agreement with me to do your offering. I think I think up to that point, you really don’t know what you’re doing, you might have a letter of intent. You’re just negotiating. You might even have a purchase and sale agreement. You might be wholesaling. You might be buying it yourself. I don’t know. But when you hire me to do your offering documents, I think it’s pretty clear cut, you’re looking to do an offering. And at that time, if you would, your database kind of freezes. Everyone who’s in your database up to that time would be pre existing.
Now, the question is, are they pre existing and substantive? Or did you just download some, some list of data, you know, I love that now that’s okay. If they’re all accredited. If they’re all accredited and you go do an advertising a 506 C, you can sell to people you don’t know you don’t need a pre existing relationship. You don’t need a substitute relationship. All you need to do is have some third party verification that the people you’re taking are granted. Yeah.
J Darrin Gross 21:09
So substantive. Is there any kind of a timeline or a knowledge base? Or is there a measure for defining that?
Gene Trowbridge 21:18
No. You’d think wouldn’t it be nice if we had four bullet points, but but we don’t. And over the years, there have been things called no action letters that the SEC issues when people want to define substitutive. And they’ve never really done it. The broad definition is, you as the syndicator know enough about the investor to know if the risk in the offering is something that they can handle and through their education, and their advisors, they can make a determination for themselves, that it’s okay and at the same time, the investor knows It’s enough about you to want to know about your offerings and hear about it, and go ahead and invest. That’s, that’s about it. There’s no bright line on that. I’m sure if I looked it up, I could read you the definition. I don’t have it right here. But that’s, that’s my plain English definition.
J Darrin Gross 22:18
Gotcha. So basically we’ve got a coming together of, of like minded known people or accredited people looking for, to to profit, your investment. It as far as the the, the benefits, I guess, of syndication is basically a means of raising capital so we can all do something greater than we could. On our own is that
Gene Trowbridge 22:53
Well, if you think about the examples of syndication I gave it gave it the beginning. If Just one person was going to make the movie. Or if you had a single passage xenos home movies. Yeah. So it really doesn’t work. But I think the reason, Darrin is that the investor public as a whole, for the most part doesn’t have enough money to buy a piece of real estate themselves doesn’t have the education and the training to understand a real estate investment by themselves doesn’t have the time and energy to do the management. And if we put a syndication together, we provide all those things for an investor, combine their their money, provide them professional management, and professional property management things that they couldn’t do.
So that’s why that’s what you’re looking for in your syndication if you’re going to be a syndication investor. A lot of people who say, my broker, friends, my real estate, commercial broker, friends say, well, I’ve had a lot of clients over the years, and I’ve bought a lot of properties. I think I’m going to do some syndication. And a lot of that fails, because the people who have the money and the time and the energy will continue to stick with their own property. But how many people is that? You know, there’s, there’s huge I, I think I think I saw somewhere along the line that they’re 38 or 40,000 accredited investor households in the United States. And a lot of them don’t want to buy real estate, but they’d love to invest in yours because the friends own real estate and their friends have made a lot of money in real estate. So they probably know you.
There’s all sorts of people Darrin that you know, who you’ve never asked to invest with you, who would love to invest with you You just never asked them. Right. My best story is Dan, the dry cleaner man. And for years I went in to see to Dan and today’s so does my dry cleaning. My girls had their first jobs with him. It was just amazing. And here I am a big money raiser big syndicator. In one day, he asked me what I did. Shame on me. And I told him that I was putting together syndications to buy us selves to build self storage in Southern California. And he said, Well, is that something I can invest in? Okay, so my job as a syndicator is to build my database of investors. And he asks me, okay, right. I said, Sure. You can. So he he threw $300,000 at a deal.
He did that 10 times.
J Darrin Gross 25:55
It’s pretty good dry cleaning business.
Gene Trowbridge 25:56
Pretty good dry cleaning business, but because I didn’t know That he inherited 36 dry cleaning companies when his dad died, and the only reason I knew him is the one that was close to my house was close to his house. And that’s where he came every day. But I never asked, okay, and so here’s someone who is too busy to buy real estate, had some money, didn’t know who to trust, didn’t know what to do. And that’s what the syndicators job is gotten from those people and give them the opportunity you don’t sell a syndication to someone, you give someone the opportunity to invest with you.
J Darrin Gross 26:38
Appreciate you, you know, making the distinction of what the job is, you know, finding the the potential investors and in fact, I wonder if you could take a minute and just define who the members of the syndication are the person that’s leading the or the call them the sponsor or the general partner or how do you need to find them?
Gene Trowbridge 27:00
If it’s an LLC, we have members members invest their money in the LLC that buys the property is the borrower. But someone needs to run that LLC. So we have a managing member. In my world, the managing member is also an LLC, made up of more than one person. So we have continuity. Because we need to make sure that, you know if there’s 3430 or 40 investors in the deal, we need to make sure that the member the managing member is always there. A single member LLC Upon the death of them of that member dissolves. Now who’s going to run? Who’s going to run all this? What’s the bank and say, we recently in the company had a situation where a fella was 56 years old, and he came to us and he wanted to do a big mobile home park development in Louisiana. Anna, and I said we’ve got to find you got to find a second person.
So someone in his office who was in his late 20s became a 10%. Owner in the manager LLC. Two years later, the 56 year old guy’s dead. Who would have thought, that pneumonia and died in four weeks? Oh,
What do you do? Well, luckily, we’ve got the 10% owner who just picks up and goes right to work. We don’t have to go out to the investors and figure out which one do you want to run this and all that we just we just carry on. So the lender is interested in continuity, your investors are interested in continuity.
J Darrin Gross 28:49
Know that continuity is definitely what keeps it going. Right.
Gene Trowbridge 28:54
Well, really, I think that that an investor should ask these four questions of a syndicator. And then the syndicator should have an answer. So this these questions go out to everyone. The first, the first question is, Darren, if I invest with you, what happens if something happens to you? And, Darrin, if you can answer that question, you’re not going to get my money. Period. Okay. So there’s the continuity, so we can solve that.
The second question and investors should ask is Darrin, have you done this before?
And I will tell you, Darrin, that every single one of us has had to say no, to that question the first time. So you got to go out and get your first deal done. And hopefully you’ve had some real estate experience that is maybe different than syndication. No, I haven’t done syndication but I’ve owned five properties myself, and I’m a CCI I am and I got an MBA and construction management or whatever it is, you know, You have to overcome that question,or they’re not going to give you their money.
The third question and investors should ask is, if this deal is so good, Darrin, are you going to invest any money in it? The old skin in the game question there.
And get Yeah, that’s where all the money is made is from the investors. So you should have some money. A lot of the deals we’re doing today, the minimum investment is 50, or $100,000. And I don’t suggest that the sponsor the syndicator, invest 50 or 100, in every deal, because pretty soon you run out of money. I think that you should invest something. And as core kind of a marketing issue is how much is enough? If it’s 100,000, minimum, and you can put in 40, does that satisfy the investors? I don’t know. You have to ask the investors. So that’s the third question. And then the fourth question is comes from the investor The investor says, well, Darrin, what happens if something happens to me?
Is this liquid? What’s the plan?
How do I get my money out of it? And that answer is, well, we have a well developed, drafted operating agreement that gives you the rules, and I’d be glad to have you look at it. And we take care of all the different ways that can happen. And I think you’ll be satisfied.
J Darrin Gross 31:29
I appreciate you sharing those. I was gonna ask you if we didn’t cover it. Before the end. They’re just kind of some questions that should be asked when somebody is considering getting into syndication. And those all definitely seemed like some primary points of concern and the answer should be available or near.
Gene Trowbridge 31:49
Darrin, I asked, I asked my clients those question if a first time client calls me, says they want to do a deal. They want to do a syndication. I’m gonna ask them those questions. If I were an investor and I had these four questions, how would you answer them? But the best thing I do is when the passive investor who’s invested in and literally that happens 25 30 other deals that other people have run, making a lot of money. They come to me and say, Gene, I want to be a syndicator. My best question is why?
Why would you want to do that? Being a passive investor is working for you. Why would you want to take on the issue of, of being a syndicator we have to have a heart to heart talk there in somewhere, we’ll probably talk about risk right? And we need to we need to talk about that because this is not a risk free, nothing down. Job.
This is a tough job.
J Darrin Gross 32:56
Want to ask you a little bit about the general partnership and raising money. Because I think I think one of the things I saw on one of your online, there was a video I think I saw you put together a while back. And it was speaking about this notion of the general partner and raising money and who can be on the general partnership and and in that, can you speak a little bit to that as far as
Gene Trowbridge 33:28
Sure. Let’s, let’s use the analogy to start with. For Sale By Owner. Okay. From the real estate world. The real estate world has licensing of people. You can sell your own property without a real estate license. But you can’t sell mine unless you have a real estate license. Bring that analogy right over to the securities world where there’s a licensing format. You can sell your own security.
But you can’t sell mine.
I can sell the securities I issue, but I can’t sell yours. And it’s called the issuer exemption. It’s not the for sale by owner exemption in the securities world. If you’re the issuer, you can sell the securities. So where do the issuers sit, they sit inside the managing member LLC. Members of the managing member LLC are issuers and they can sell the securities you’re offering.
Anyone outside of that group would need a securities license to sell those securities. And one of the things we see in the world today is syndicators and people are on the podium. Talking to big groups of people violate that rule all the time by saying or anyone in the audience who wants to put together a group of investors and come in and invest in my deal. And I’ll pay you a commission. That’s just totally illegal. Because the SEC would say, Well, if you’re selling someone else’s security, you better have a securities license. You don’t, you’re an unregistered securities broker. And there’s huge penalties for that. So you don’t want to, you don’t want to do that. One last thing about this Darren is inside the managing member group. Even though you’re issuers and even though you can sell the securities, you can not get paid a commission.
In order to collect a commission, you have to have a securities license.
You don’t have to have a securities license to be an issuer and sell your own stock, your own shares your own interest. But you can’t have anyone in there paid commission. There are a lot of ways we can compensate them. We can share all sorts of fees and everything, but it can’t be tied to what you raise $500,000 therefore you get x can’t do that.
J Darrin Gross 36:18
Gene Trowbridge 36:19
That’s news to a lot of people who are going to be listening to this.
J Darrin Gross 36:23
Now I and I swear that, you know, I, I, I hear kind of what you hinted at some of the notions of, you know, yeah, raise some money for me, you you should do it, you know, right. And when you get into the details, so I don’t know, and I haven’t pressed on it, but I know I’ve been, I’ve been asked a number of times, yeah, you should raise some money for us. And the, you know, sometimes it seems kind of fast and loose. And, you know,
Gene Trowbridge 36:55
Tell you how you can do it. Put together your own offering of investors Bring them together in your own LLC. Have your own operating agreement. It’s your own securities offering. And then that LLC goes into Jean Trowbridge is LLC. As an investor. That works, you’re your own issuer. Okay? You can bring your own people together. And let’s say it’s Darrin Gross fund one.
After you raise that money, you can come in and invest in Trowbridge equity group, fund one. When the end of the year comes, I give you a K1. You go to your accountant and they break all that down into individual k ones for all your investors. And I give you a check. You put it in the bank, and then you write individual checks for all your investors. That works. You’re the issuer of your own securities, and we actually do quite a few projects. We’ll be four or five a year of something I would call a fund of funds, where someone comes to us and they syndicate money to invest in other people’s funds example. There are a couple big funds out there that have a million dollar minimum for an individual investment investor, and everyone has to be accredited. Well, not everyone has a million dollars.
But if you put together a fund and let’s say you raise $5 million $200,000 at a time, from accredited investors, you could take a share of this million dollar big fund. And you could take a share of this other million dollar big Fund and the people who invest with you who could never get into those funds, take advantage of pooling their resources and then diversifying into those into those big funds. We call that a fund to funds and totally, totally legal and totally done.
J Darrin Gross 39:06
Right? And then that point you’re, you’re following the rules and you’re, you’re structured properly and and you basically have capital, meaning if you’re raising the capital and you can deploy it and participate in these, these other investment opportunities is, are you would you essentially become in, if the Darrin Gross fund was participating with the Gene Trowbridge fund would that be would would I be or my fund be a limited partner in yours? Or would it come in as a general or as
Gene Trowbridge 39:37
You’d come in as a member? Yeah, I don’t want you in my managing member entity because that puts risk on you.
J Darrin Gross 39:48
Gene Trowbridge 39:49
We don’t want the risk. We just want to you just want we just want your money, right? We don’t want you to share in management and sharing our risk .
J Darrin Gross 39:59
Right? Right. No, it’s again, I appreciate you kind of distinguishing that because it’s, it’s always seems a little bit fast and loose. And I’ve gotten into a few of these conversations.
Gene Trowbridge 40:10
But the things I see that are wrong in the marketplace today is, people saying you can do joint ventures and it’s not a security. I think they’re loose with those facts. So you have to look at that. People saying you can raise money for me, and I’ll pay for you pay you for that. I think that is that is fast and loose. And another one we haven’t talked about, which is maybe too deep is something called a side letter, where you take 20 investors in under a certain set of rules. And I take Darrin in, and I say no matter what I’m doing for the other investors, I’m going to pay you twice as much of a yield.
Okay, well, that’s okay. But I better tell all the other investors
J Darrin Gross 41:00
Gene Trowbridge 41:00
You know, because you know, all the material facts has to be disclosed, or sometimes Darrin’s going to come in with a big amount of money. And Darrin is going to want more access to the books and the records and the decision making than the other members. So we better tell the other members that because maybe what’s in the best interest of Darrin isn’t in the best interest of the other members, and maybe we should all be alerted to that something that could happen.
J Darrin Gross 41:32
Yep, full disclosure, and that is, right.
Hey, we’ve been talking a lot about kind of the, the come together of a syndication and essentially to buy a property or invest in property and, and, you know, once it’s acquired, it’s operated and, and assumably. The property is profitable, and there’s distributions and and those all follow per the operating agreement. Everybody’s going to be paid. Can you talk a little bit about the liquidation and how a syndication treats it and if there’s any kind of an opportunity to take advantage of like a 1031 exchange or, or you know what the options are there.
Gene Trowbridge 42:20
So we’ve owned this property and we’ve gone full cycle and now it’s time to do something. Okay? There’s there’s going to be a capital event happening. And one of the capital events could be a refinance.
So what we do is we put a new loan on the property, generate new cash and give it back to the investors. That’s the return of their capital. The property’s gone up in value. They have equity, we refinance it, give them their money back and continue to own that property. Sometimes we take the money that we earned from the refinance and go out and buy another property. Now we own two properties. So there’s a lot of situations that are possible in a refinance.
The other thing, of course, is just the sale, we sell the property. We pay off all the debt and there’s all that money sitting there in the bank. We’re giving people their equity back. So it’s a return of capital. We pay them all off and they go away. The Smart syndicator has another offering ready at that time, Darren, we’re gonna sell this property you’re 100,000 is now 300,000. And by the time we get the sale or that ready, I’m going to have a new offering and I’d like to have you consider investing some of your money in that. That’s what the smart investment smart syndicator does.
And then the exchange. Okay. The LLC that owns the property Darrin has a deed to that property. The exchange rules simply say, you can exchange your deed and the equity represented by your deed for another deed on another property, moving your equity without it being diluted by income taxes reporting game. Okay, so we have this property, we took our $500,000 investment it’s worth, we now have a million and a half, we can take that million and a half and go over and buy a $5 million property. The LLC itself is the LLC that buys. Nothing changes.
The money just transfers, simple. Just like you doing an exchange on your own property. You own it in your name. You sell it, the money goes to the account. After you buy another property in your name, it’s a 1031 exchange. Same thing. LLC buys on the property. The issue becomes when someone wants out.
J Darrin Gross 45:14
I was gonna ask.
Gene Trowbridge 45:16
That that’s smooth, but the problem is, the first deal was 10 years ago. And now I’m 72 I don’t want to get in another 10 year deal. I want my money. Okay. So how it’s very simple what you do, you survey your investors, and you know, what your investors want to do, how many are going to go with you in the same LLC? How many are going to want their money? So what you do is in the escrow instructions, at the time of the sale, you set up two escrows one escrow is for the money that needs to go to Gene Trowbridge because Gene is going to leave. And the other escrow is from The money that’s going to stay with the LLC, that’s going to buy the new property. So when the closing happens, the cash goes into the correct escrow. I get my money, taxable, okay. All these other people accomplish a tax deferral in their 1031 exchange because they never got anything. They just transfer their equity from one property to another property, and that’s not taxable.
J Darrin Gross 46:33
And is there any number of of partners or members that need to go to the second deal to retain that?
Gene Trowbridge 46:44
No the number isn’t the issue. There are a couple issues that can happen number one, some of the states have rules that if the membership An LLC changes by more than 50%. The LLC is dissolved. That’s a problem because you got to take title in the same LLC. So you have to worry about that. Number two. The rules in a 1031 exchange is that what you have to acquire is a property at least of equal value with the loan, at least the same as the loan you gave up? Well, if too many people leave and take their money, maybe you’re not gonna be able to do that. Right?
So that’s just an issue of balancing equity and balancing loans now. What if too many people leave and you can’t buy all of this new property with who’s left? You can buy part of it. You can change into a tenant in common interest This new property and raise money from new investors who will buy the other tenant in common interests. So we can still solve the exchange for the equity we’re bringing over here. And then we can give new people some of whom may also have exchange money can come in as a tenant in common. So all this gets involved with the, the exchange accommodator and with the CPA for the LLC, and any new investors, their tax advisor in their accommodator but we see that quite a bit where we are today in the marketplace is anyone who bought a property 2012 1314 who still owns it has a lot of equity. And they’re all interested in how do we how do we move the equity without paying tax?
J Darrin Gross 48:53
How do we keep it?
Gene Trowbridge 48:55
Or or keep it. You know you want because no one The problem is if you pay taxes, your equity goes down. Down to buy another property and, and with the tax last day, if you just keep your property until you die, given the right size of your estate, you never do pay taxes on it. So.
J Darrin Gross 49:14
Right, right. I appreciate you you walking through that because I think that’s always been kind of I’d say some of the newer real estate investors that I’ve talked with that that are kind of in and out of something really fast or have maybe been used to kind of a stock market. In and out the taxing never doesn’t faze them. But if you’ve been in in a property for any length of time, and you’ve experienced some significant appreciation, and maybe you’ve depreciated the property down salutely, then you’ve got a whole different kettle of fish there that
Gene Trowbridge 49:51
Another question that comes up Darrin in that same issue and I get this call periodically. One of my clients will call me and we’ll say, Hey, I’m Raising money. I’ve found someone who’s got $500,000 sitting in an accommodators account. Can they invest in my syndication? The answer’s no. Because what the syndication is, what you’re buying in an LLC, is personal property. You don’t get titled to real estate. You buy shares or interest in an LLC, someone coming out of a property and wanting to accomplish a 1031 exchange needs to get title to real estate.
J Darrin Gross 50:36
Gotcha. And that’s why the TIC works.
Gene Trowbridge 50:39
J Darrin Gross 50:40
Because you’re on on title and
Gene Trowbridge 50:45
We’re covering a lot of stuff.
J Darrin Gross 50:47
No, it will use a wealth of information and it is nice to be able to speak with somebody that has you know, the the clarity and understanding and knowledge of all this. I got to ask you a question. And this was something I thought of just based on a a an insurance related topic protection. What kind of protection? Does the syndication provide the general partner? Or the limited partners based on the contract or is or you speak to that?
Gene Trowbridge 51:21
It’s based on state law. Okay, if you form and you use the words limited partner in general partner, which means you’re using a limited partnership, okay? If you form a limited partnership, the limited partners have absolute protection. Their only liability is what they have invested, or any promises they make to invest more money. I’ve invested $100,000 That’s it. That’s all I’m liable for, or I’ve invested 100 now and then signed a note to investment 102 years from now, when we do construction, well, I’m liable for that note, okay. But that’s all I’m liable for.
The general partner is liable for everything has unlimited liability. That’s why 99% of everything is done in an LLC. Because in an LLC, the members have the same limited liability they have in a limited partnership, but they can also vote, which they cannot do. As a limited partner, they can have any share in the management, or they’re deemed to be general partners, and then they lose their limited liability. So the limited the members in a limited liability company have total protection based on the state law. And the manager has total protection way back in the 80s when limited liability companies weren’t in existence.
The State of Wyoming was having some trouble because they’re, they’re drilling in oil and gas and all that industry. You know, we had quite a meltdown in the economy in 1981. And their industry died and what the problem was is the the wildcatters the guys who had gone out to raise the money and do all this, as limit general partners finally learned what unlimited liability meant, and they just got crucified. And the investors who are limited partners who couldn’t vote couldn’t really do anything to help save their money.
So Wyoming actually was the first state to develop a Limited Liability Company, which solved two things. It gave the wildcatters a new name, managing member and gave them limited liability. And it gave the investor a new name members and gave them while keeping the right to limited liability, gave them the right to vote. So itself to have the problems, the manager was willing to go out and take the risk, because now they were shielded with limited liability, and the investors were ready to come back in the marketplace. Because if anything went wrong, they could vote me thought at least that they could correct things. So there we are 1981. And all of a sudden, all the other states created their own individual limited liability company. So to answer your question, each state has their own rule, but generally, the manager is protected and the members are protected. doesn’t help the manager if the manager goes off and signs a recourse mortgage.
J Darrin Gross 54:50
Right. Okay. That’s That’s you. Sign up. I appreciate you you explaining that. You know, it’s funny how Much of law or you know, policy is reactive to events and get a little bit of a history there on
Gene Trowbridge 55:08
J Darrin Gross 55:09
How it came about there. So that’s great. Hey, Gene, before we started recording, I mentioned to you that by day, I’m an insurance broker. And as such, in insurance, we try and manage risk with our clients. And there’s a couple different strategies we typically consider. And then
The first is we ask, can we avoid the risk? If we can’t avoid it, and we look to see if there’s a way we can minimize the risk. And then if there’s not a way to avoid or minimize, we look to see if there’s a way to transfer the risk. And that’s essentially what an insurance policy is. And I’ve been asking all my guests, and I’d like to see what if you would take up the cause, but if they could consider or take a look and consider what they see to be the biggest risk. And just for clarification, I’m not necessarily looking for an insurance related answer a risk is certainly more broad than that. But if your game, I’d like to ask you, Gene Trowbridge. What is the BIGGEST RISK?
Gene Trowbridge 56:18
Okay, well, you talked about avoiding minimizing and transferring. Okay? So avoiding the risk. In my best legal language; Don’t do this! That’s how you avoid the risk of being a syndicator. Just don’t do it. And what is the biggest risk, the biggest risk is really, the investors. Never the property properties will get empty and go into foreclosure and all that you can always deal with that. Excuse me, but you can’t deal with the investor whose life changes in the middle of a project.
That’s really the BIGGEST RISK.
So simply how to avoid the risk is to don’t do it. Well, if you’re going to do it, then the question is how do you minimize it? Okay, you might minimize it by the investors you choose. You could have a strategy of only dealing with accredited investors who are rich and smart, who have enough money where they can handle the risk of your investment. That might be a good one. Another way to minimize it is make sure your manager LLC is free form correctly so that people can’t get at you. If there’s trouble, and maybe two, this is kind of an asset protection answer. Maybe you want to be an LLC yourself, and then that LLC becomes the member of your manager LLC. So they really have to go through multiple loops.
Every once in a while, I think asset protection gets a little carried away, you can have two very too many of these LLCs and tax returns and all that stuff. But that’s not uncommon for the manager to be an LLC and have the member of the manager be LLCs the one thing you don’t want to be, is an individual manager. Yet 30 investors up there, and Gene Trowbridge is the individual manager. There’s no protection for Gene Trowbridge from those 30 investors. I’m in the LLC with all the other investors are kind of protected from the outside world. But any investor can go after me for everything I have. So we want the manager to be have the layer of protection the LLC.
When I did it, it was a sub s corporation. Same protection, but today different issues that I was trying to deal with insurance and employees and all that stuff. But today almost everyone is ais aan LLC.
And then the last one How do you transfer the risk?
I don’t know if you do.
I don’t know if you do I think one thing I would say is the manager LLC is constructed in such a way that it has no assets. All you want you don’t want your let’s say there’s a commercial real estate broker listen to us and he has an office with 20 salespeople and own some buildings. That’s not going to be the managing member. We’re going to form a brand new entity that’s clean. And the only thing the managing member actually ever gets his some cash distribution for the fees and some stuff subordinated interest that might occur in the future. Okay?
So there’s nothing in there. Okay? So don’t syndicate.
Minimize your risk by having limited liability protection around you at least one or two layers. And then make sure that nothing in your syndication world, really at any time has any value. Now I do get I do get asked this question, should we buy directors insurance?
J Darrin Gross 1:00:35
I was gonna ask you that.
Gene Trowbridge 1:00:36
Yeah. I thought you should ask me that.
Our clients ask us that. And we’ve researched a lot of it. It’s very expensive, simple answer, very expensive, and doesn’t cover the crap that you do. The fraud that you do, the stealing money that you do all the stuff that managers get in trouble, doesn’t Anyhow, so don’t waste your money.
J Darrin Gross 1:01:02
Yeah, the exclusions.
Gene Trowbridge 1:01:04
Lloyds of London? Yeah, that’s where we’ve had some people who have big, big funds. And they’ll buy it. And very, very expensive. And I don’t know really what it protects.
J Darrin Gross 1:01:18
Yeah, no, I have a couple of underwriters about this. And, you know, I think that the, I think where the exposure I would think that exists or where it may be more applicable would be in a very large fund with you know, large money and the potential for a suit come from one of your investors for a quote mismanagement or something like that, but, but just like you said, if you take the money or you’re if you’re stealing, you know, crime is not a covered panel there, but, but the kind of the defense of have any kind of a mismanagement kind of thing is more of the I think the nature of the coverage.
Gene Trowbridge 1:02:02
I’ll tell you another thing that that that I just thought of the operating agreement of the company can also be a protection for the manager. In our operating agreement, we have a pretty well worked out dispute resolution provision, which is designed, I’m not going to go into all the details. It’s designed to keep you out of court. It takes you through mediation, it takes you through arbitration. And then it has some pretty strict rules like number one, no attorneys fee provision for the person who’s bringing the lawsuit that usually stops a lot of stuff.
And number two, the only remedy is your original investment. No damages. Now, I don’t know if all that’s legal, but that’s what we put in there. It’s never been challenged. And the deals that we’ve had where there have been disputes have always been resolved before we go to court.
J Darrin Gross 1:03:01
Right. Well, it’s certainly a better starting point than nothing written and no guidelines and you can test it all in court and and paying all the attorney fees and time. Gene This is this has been exactly everything. I’d hoped it would be in more. And before we wrap up, Where can the listeners go if they would like to connect, or learn more?
Gene Trowbridge 1:03:27
All right, well, our website is www.crowdfundinglawyers.net. And it’s a great website. We have all sorts of things on we have a YouTube channel, we have all sorts of stuff. You can reach me at Gene@crowdfundinglawyers.net. That’s probably the best way to work with me. I typically use my emails like a telephone. If you send me an email, and it’s an important question, I’ll just call you. So if you’re going to send me an email, and you want We do call you make sure you put your phone number in there. And then other than that, I have to send you an email and say, hey, I want to talk to you about this, but I can’t, because I don’t have your phone number. So the best thing to do would be Gene@crowdfundinglawyers.net. or just go to our website and if you want a if you want a consultation with me, you can sign up at the website for a 15 minute or a half hour consultation with me and that works also Darrin
J Darrin Gross 1:04:27
Awesome. Well, Gene, again, I cannot say thanks enough for taking the time. have enjoyed it immensely. learned a lot and I hope we can do it again soon.
Gene Trowbridge 1:04:38
Okay, thanks, Darrin. Appreciate it.
J Darrin Gross 1:04:40
All right. For our listeners. If you liked this episode, don’t forget to like, share and subscribe. Remember, the more you know, the more you grow? That’s all we’ve got this week. Until next time, thanks for listening to Commercial Real Estate Pro Networks. C R E P N Radio