Crowdfunding Lawyers

Finance and Use of Proceeds: Two Critical Parts of Your Operating Documents

July 14, 2023
Finance and Use of Proceeds: Two Critical Parts of Your Operating Documents

From your employer identification number (EIN) to your articles of organization, dealing with operating documents can be challenging. However, getting it right is critical to your success. Errors in your documents could mean major delays in getting your deal off the ground, which could have devastating repercussions, including missing out on the asset you want to purchase in the first place.

In this post, we will discuss two often-overlooked parts of your operating documents – finance and use of proceeds.

Finance

You may have figured it out, you may not have it figured out, or you may have some ideas, but if you know where you’ll get your financing, it becomes a material part of the investors’ returns. It must be disclosed with other pertinent information designed to cover you in case of errors or omissions.

To fill in this portion of your operating documents, ask yourself: where do I expect to obtain financing? Getting the financing and working with lenders is the most challenging part of closing these deals. Getting ahead of the game means making sure you’re talking to loan brokers and mortgage reps, and ensuring you have a good idea of where you’re going to get finance figured out as early as possible.

Your attorney can be an invaluable asset during this process. They may be able to offer referrals to mortgage companies, brokers, or finance professionals that would be happy to work with you on the deal. Getting loans closed is one of the most difficult things today compared to in the past; lenders continually come back and try to retrain and renegotiate. So having a good lender on your side is of utmost importance.

Use of Proceeds

As part of all these operating documents, you also have the use of proceeds. It’s always complex, and one of the most challenging things to define. For instance, suppose you’re raising a million dollars. How are you going to spend that money? The reality is, who knows?

Here is a simple solution when it comes to real estate. In real estate, you will always have a pro forma that says the purchase price. Here’s how much additional capital we expect, capital expenditures, carrying costs, or working capital reserves in the unknowns. Add those at the top, and then subtract the costs in line items and the cost of putting the deal together. Then include the capital stack defining how much is from debt and how much is from equity from this syndication. If there are other capital partners, preferred equity, hard money, or mezzanine lenders, all of that is explained in the general use of proceeds.

Avoid the temptation to get bogged down in the minutia. You don’t need to explain how you’ll get from A to B to C to D, etc. If you’re raising $1 million but spending $4 million, just explain how you’ll spend the $4 million and then define the capital stack.

When speaking of subtracting the cost of doing the deal, we’re referring to raising capital. You’re buying the asset. You have the costs of purchase. These additional costs must be separate line items from the cost of doing the deal. That’s if you’re paying broker-dealers or have finders fees, which are different from a commission so that we can keep all legal and aboveboard. However, any sort of CPA expenses, like an audit or other legal expenses, securities filings, and such go on a single line item in your use of proceeds.

Speaking of broker-dealers and others involved in the process, let’s divert the discussion for a moment. You need to have your team, although the makeup depends on whether you’re using broker-dealers or if you’ve been doing this a while and you have multiple syndications. It may make sense to have a compliance consultant who’s available on request and will refer out to securities consultants for clients that have lots of projects or ongoing projects because they will generally be cheaper than hiring an attorney every time you encounter minor needs.

A broker-dealer is like an investment bank that goes out to raise capital. Nowadays, the process hinges more on investment portals, funding portals, and online technology where you can direct investors to process their investments. Rather than broker-dealers, today’s deals rely on marketing and online marketing agencies to drive traffic to your opportunity. This allows you to avoid the huge commissions broker-dealers once charged. Of course, you’re replacing those costs with marketing agency fees, the pay-per-click fees, and the different ways they’re driving traffic to your opportunity.

In Conclusion

Your operating documents are critical to get right from the very beginning. Mistakes and omissions here could mean major problems down the road, up to and including being unable to purchase the asset in question. For help with your operating documents, as well as all the other minutia involved in getting a deal off the ground, contact Crowdfunding Lawyers and schedule your free consultation.

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