In the world of crowdfunded real estate, many investors feel lucky to get an offer for sponsorship at all. Some get so excited that they overlook details that may later come back to eat into their profits. The reality is that you do you have the luxury of being picky about your sponsors. In fact, you have to be. Not everyone is an angel investor out to selflessly help you get a leg up in the world. Sponsors, of course, must have something to gain from the transaction. This is only natural and fair, but some purporting to help you may be using dirty tricks for their own selfish ends without your knowledge. This article is here to let you know about some of the most common traps investors fall into so that you can avoid becoming the next sucker.
Today, we are going to talk about three major dealbreakers that you should watch out for when seeking sponsors for your next real estate deal. We will also give you some tips to avoid dishonest deals, and more information on how to protect yourself as a crowdfunded real estate investor.
Let’s dive right in.
Dealbreaker #1: Capital Calls After The Initial Investment
A capital call is basically the right to demand money from you. While these are a normal part of crowdfunded investing, legitimate deals will not come with repeated capital calls. This principle applies whether you’re dealing with a peer sponsor or a crowdfunding platform.
Demands for money that just don’t seem right are a sign that the sponsor intends to make money off of you as well (or instead) of the investment. Just say no.
None of this information should scare you off of crowdfunding online. Check out Adam’s article on the best ways to raise capital online for more information on safer, smarter ways to get the funds you need.
Dealbreaker #2: Lack of Transparency
You don’t want to deal with anyone who has something to hide. There are two issues you must be crystal clear on with any deal:
- Right to Inspect Books. As a business partner, you have the right to review the records of your business. Most states have enshrined this into law. However, some shady “sponsors” may attempt to have you sign a waiver of these rights. Don’t do it. If you’re even presented with such a waiver, the potential sponsor deserves a hard pass. Think about it: what possible motivation could a sponsor have for not wanting you to be able to see the books on your own investment? I can think of many, but none of them are good.
- Membership Rights. You need to clearly understand the rights you have on your investment. A sponsor who is cagey on this matter is likely angling for an unfair split. This problem can be easily resolved with an ironclad Partnership or Operating Agreement. I tell my clients to form an LLC, then help them craft the perfect Operating Agreement for their needs.A sponsor who is willing to sit down with you and an attorney to create an Operating Agreement is a good sign. They are showing you a willingness to collaborate–an important quality in a business partner. The opposite is also true. Anyone resisting a transparent agreement spelling out membership rights should be regarded with suspicion.
Dealbreaker #3: Unclear or Excessively Wordy Contracts and Offers
If your potential sponsor gives you an offer that is indecipherable, this can be a red flag. Whether it’s an offer filled with legalese a Supreme Court Justice would need a dictionary for, or simply worded in a way you can’t understand, this can turn into a big problem.
How You Can Protect Yourself
A bad contract doesn’t necessarily mean the sponsor is duplicitous. There are a broad range of reasons why an offer may be unclear (we’re looking at you, free Google contracts). So before you bail, try the following strategies.
- Ask for clarification. You will want to pay special attention to membership rights. If you can’t make heads or tails of your rights regarding your crowdfunded property, you could end up on the losing end of profit division.
- Never sign anything you don’t understand. Once you sign any legally-binding document, you’re locked in.
- Have an attorney review your document. It’s always a good idea to have a qualified attorney on your real estate dream team. Ideally, you want someone who has extensive experience in real estate law. If the attorney is an investor themselves, that’s even better. Your attorney will be able to quickly decipher the legalese and let you know if the offer really benefits you.
- Suggest using a single-purpose LLC instead. A single-purpose LLC is an LLC that you form with your investor and any partners for a one-time deal. Smart investors have been using them for joint ventures for decades. This strategy will protect you because you will create an Operating Agreement for your LLC. The Operating Agreement will clearly spell out essential things like which membership rights each party has, how profits and losses will be divided, and what happens when the deal is over.
Do Your Homework on Potential Sponsors
If you’ve ever wanted to play detective, now is the time. Here are some tips for researching your potential sponsor.
Look at Their Record
Never take someone’s word that their ventures are always successful. Research the person offering to sponsor your investment thoroughly. You can get started yourself by reviewing their online presence. Social media, reviews of companies the sponsor owns, and a quick public records search of their name and companies they claim to own. At a minimum, you are checking to see that they are who they claim to be.
Connecting with your local investment community can also give you more insight into your potential sponsor. Ask around among other investors to get an idea of the person’s reputation. You may hear some gossip, so take that with a grain of salt. But if you can find someone who has actually dealt with your potential sponsor before, that individual could give you a very clear idea of what it’s like to do business with the sponsor.
Finally, you can directly ask your sponsor about previous deals, then fact check their claims. An attorney can be a huge help here. For instance, if your sponsor claims to own something, your attorney can investigate these more thoroughly than you can. A good attorney can do things like check tax returns to verify whether the sponsor’s previous investments were as profitable as claimed.
Don’t rely on a single piece of information. Take everything you learn as a whole to get a good idea of whether your potential sponsor is the kind of person you want to deal with.
Successful real estate investors ask questions. Lots of questions. If this feels rude to you, allow me to be blunt: get over it. Actively investigating potential investments and those offering to sponsor them is vital to ensuring your deal goes through the way you want it to. In addition to knowing what you should ask about potential investments, it’s also critical to know how to handle potential sponsors.
It’s best to be direct with your questions. Dancing around the subject in an effort to be polite is a waste of everyone’s (possibly very expensive) time.
It’s important to note that how a sponsor reacts to questions can tell you a lot about their motivations and character. If a sponsor is evasive or vague when you ask questions, then it may be time to move on. If a sponsor gets aggressive or defensive when questioned tactfully, get out. Even if they aren’t trying to hide anything, you don’t want to be stuck in a business relationship with someone who flies off the handle in a normal conversation.
If a person can’t handle the pressure of an ordinary business conversation, odds are good they will react even worse to the inevitable stresses of managing real estate investments. Move on to someone with a cooler head, if only to guarantee smoother, more pleasant interactions.
Bottom Line: Be Willing to Walk Away From a Bad Sponsor
When you’re looking for someone to sponsor your investment, the search can feel desperate. This is particularly true if you are new to crowd funded real estate, or even real estate in general. You may even perceive that you’re in a position of no power. But this simply isn’t true. You always have the power to walk away. And if you detect any of the red flags mentioned above, you likely should.
Unscrupulous people can smell desperation like sharks can smell blood in water. Even if you have yet to make your first investment, patience and thorough investigation of potential sponsors will pay off in the long run. No sponsor at all is better than a dishonest or questionable sponsor.
If you still have questions, or want to learn more about protecting your assets as a crowdfunded real estate investor, schedule your consultation with Scott Smith, Esq. here.