Raising capital can be a crucial step in growing your private lending business and expanding your lending operations.

Although this is written by a lawyer, it should not be construed as legal advice. Every situation is differently nuanced, and your facts could result in different advice. Always seek competent counsel to advise you of your specific situation.

One way to raise capital is to seek it from third-party providers such as institutional investors or high net worth individuals. However, before embarking on this path, it is important to understand the securities laws and regulations that apply to the offering and sale of securities, as well as common objections and exemptions.

This article will provide a primer on these topics and discuss mortgage fund structures, SEC Rule 506, and reporting requirements.

Securities Laws and Regulations

Securities laws and regulations are designed to protect investors and ensure they have access to accurate and complete information when making investment decisions. The primary federal securities laws that govern the offering and sale of securities are the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).

The Securities Act requires that all securities offered for sale to the public be registered with the Securities and Exchange Commission (SEC) unless an exemption from registration is available. One such exemption is Regulation D, which provides exemptions for certain private offerings of securities. These offerings are not required to be registered with the SEC, but they are subject to certain disclosure and filing requirements.

One of the most commonly used exemptions under Regulation D is Rule 506. There are two common Rule 506 structures. Rule 506(b) allows for the sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors, provided that certain conditions are met. One of these conditions is that the issuer must not use general solicitation or advertising to offer the securities. Rule 506(c) allows for general solicitation and advertising, but you may not have any non-accredited investors in the fund.

A note on general solicitation or advertising: At its base level, this is advertising the securities to people you do not have a preexisting relationship with. Although this is prohibited by 506(b), it is allowed under 506(c). The most common example is if you’re speaking at a conference and talk about your fund and how to invest in it. Unless you have a preexisting relationship with everyone who is listening to you, that would be generally soliciting to the audience. This particular area is very nuanced. Reach out to your counsel to discuss and get an opinion on what you’re doing.

Common Objections from Investors

One of the most common objections private money lenders may encounter when seeking capital from third-party providers is the lack of liquidity in their investments. Investors may be hesitant to invest in private lending funds because they cannot easily sell their investments on a secondary market. To address this objection, lenders can explain that private lending funds are typically structured as long-term investments and that investors should be prepared to hold their investments for an extended period. Further, investors are being compensated with a higher yield than they generally can find elsewhere.

Another common objection is the lack of transparency in private lending funds. Investors may be concerned they do not have access to the same level of information they would have if they were investing in a publicly traded company. To address this objection, lenders can provide detailed reports on their lending operations and performance, including information on the types of loans they make, the terms of those loans, and the loan-to-value ratios.

Exemptions to Securities Laws

Exemptions to securities laws and regulations can also help private money lenders overcome common objections. For example, the SEC’s Regulation A+ provides an exemption for certain securities offerings of up to $50 million. This exemption allows for general solicitation and advertising, which can help private money lenders reach a larger pool of potential investors. Further, Regulation A+ allows for a smaller net worth and income of accredited investors.

Mortgage Fund Structures

An important consideration for private money lenders is the structure of their mortgage funds. Several different structures can be used, including:

• A standalone mortgage fund. This structure involves creating a separate entity that is responsible for issuing and managing the loans. Larger private lending firms typically use this structure.
• A pooled fund structure. This structure involves multiple investors pooling their funds to make loans. Smaller private lending firms typically use this structure.
• A fund-of-funds structure. This structure involves investors investing in a fund that, in turn, invests in other funds. Larger private lending firms typically use this structure.

Debt Structures

Raising capital using debt instruments, also known as debt financing, is a common way for private money lenders to obtain additional funding for their business. Debt financing involves borrowing money from investors or lending institutions and agreeing to pay back the borrowed amount plus interest over a specified period of time.

One of the benefits of debt financing is that it allows private money lenders to retain ownership and control of their business. Unlike equity financing, where investors receive a stake in the business in exchange for their investment, debt financing does not dilute the ownership of the existing shareholders. Additionally, the interest payments on the debt are tax-deductible, which can help to lower the overall cost of borrowing.

Private money lenders can use several types of debt instruments to raise capital, including:

• Bonds. Bonds are a type of debt instrument involving the issuance of a bond by the lender, which is then sold to investors. Bondholders are entitled to receive regular interest payments and the return of their principal investment when the bond matures.
• Loans. Loans can be obtained from banks, credit unions, or other lending institutions. Private money lenders can also obtain loans from individuals or groups of individuals, known as private investors.
• Lines of credit. A line of credit is a type of revolving credit that allows the borrower to draw on the line as needed, up to a certain limit. Interest is paid only on the amount borrowed.

When raising capital using debt instruments, private money lenders should be aware of the terms and conditions of the debt (e.g., the interest rate, repayment schedule, and any covenants or restrictions that may be placed on the lender’s operations). It’s also important to consider the lender’s ability to repay the debt as well as the overall impact on the lender’s financial position.

SEC Rule 506 and Reporting Requirements

As mentioned earlier, Rules 506(b) and 506(c) of Regulation D are commonly used exemptions for private offerings of securities. Under 506(b), private money lenders can raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 non-accredited investors. Under 506(c), private money lenders can raise an unlimited amount of capital from accredited investors. However, with both, there are certain disclosure and filing requirements that must be met.

One of the key requirements of Rule 506 is the issuer must provide certain disclosures to potential investors, such as financial statements and information about the management team. The issuer must also file a Form D with the SEC, which includes information about the offering and the issuer.

In addition to the requirements of Rule 506, private money lenders must also comply with the reporting requirements or rely on an exemption of the Exchange Act. These requirements include filing periodic reports, such as annual and quarterly reports, and providing information about material events that may affect the value of the securities.

Most private money lenders will fall under a federal exemption of the Exchange Act, but they may need to register with their state.

Raising capital from third-party providers can be a valuable way for private money lenders to grow their business and expand their lending operations. However, it is important to understand the securities laws and regulations that apply to the offering and sale of securities, as well as common objections and exemptions. By structuring their mortgage funds appropriately, complying with SEC Rule 506 and reporting requirements, and providing detailed information to potential investors, private money lenders can increase their chances of successfully raising capital from third-party providers.