Crowdfunding Lawyers

Regulations and Market Movements: Navigating a Fluctuating Market

March 3, 2023
Regulations and Market Movements: Navigating a Fluctuating Market

“May you live in interesting times” is an ancient Chinese curse that feels applicable today. Everywhere we look, we see change. Rising inflation, political tensions, and changes to regulations that govern who, when, where, and who can make deals all add complexity.

For the unwary, those “interesting” shifts can mean lost profit and missed opportunities. In a worst-case scenario, they could mean legal problems and even jail time. The best defense is to understand changes to regulations and the pronounced trends within the markets. In this post, we will explore what you need to know about keeping up with the evolution of regulations and changes to the markets.

 

Regulation Updates Are More Frequent Than You Know

For anyone outside of the financial markets, news about regulation changes is probably infrequent. Only major shifts make news, but the truth is that regulations change almost constantly. The SEC continually refines and redefines the rules that govern deals, and it’s your responsibility to be aware of the current iteration of any rules that apply to your deals.

How do you keep up with those shifts while still focusing on building a successful business, though? The answer is simple: work with a securities attorney who keeps tabs on new comments, rules, and things the SEC is contemplating, and who knows your deal and its inner workings. That will help ensure that you have the information necessary to make informed decisions and comply with SEC guidance.

Another way to stay abreast of regulation evolution is with funding portals. Most of them work with FINRA, which means that confidentiality and security are always essential. That’s not to say that all funding portals are on the up and up. Shady practices happen. Work with your securities attorney to identify compliant portals and then use those to build your business.

 

Market Fluctuations: Changes to Note

Deal governance changes. What you’re allowed to do and what’s prohibited can shift very quickly. It pays major dividends to keep up with those fluctuations so you can focus your energy on activities that move the needle for your investors, rather than wasting time and money.

Syndicated Conservation Easements – Once, you could buy a piece of land and then give it away as a conservation easement. That allowed you to write off the investment multiple times, ensuring you could hedge your bets. Today, that’s not possible, at least within a syndicate. You cannot pull investor money to buy land and convert and conserve it. It’s still possible for wealthy individuals, but not for the investor pool.

Opportunity Zones – Opportunity Zones were big news several years ago, although it took investors some time to truly appreciate what was possible with them. However, things are changing now. Many of the benefits investors came to value are falling away. Yes, you can still get the 10 years of no capital gains, but there is no longer a step-up basis.

Note that this does not materially diminish tax-free growth after 10 years, which is still a major benefit. All growth after the initial 10-year period is tax-free, but they’re taxed if you take distributions before that point.

We’re also nearing the finish line on the lifespan set for opportunity zone investments. So far, Congress has not acted to reset or renew it. If left unaddressed, it will only allow you to defer until 2026. However, it is within the legislature’s power to extend that timeline.

What’s Hot and What’s Not – Real estate cap rates have been problematic, but many areas are still “hot”. Some of those that offer the best growth potential include:

  • Storage
  • Manufactured housing
  • RV parks
  • Triple-net lease arrangements with 1031 deals

However, those who’ve been eyeing multifamily deals should understand that things are beginning to slow down because of rising interest rates. Not long ago, interest for a ground-up construction loan was 4.5% just a few months ago. Today it’s 9%. It makes it difficult to create good opportunities with potential for profitability.

Banks Changing Terms Mid-Deal – Not very long ago, loan commitment from a bank meant you were very close to finalizing your deal. Today, that’s not necessarily the case. Banks backing out of previous commitments or demanding additional equity is a growing trend.

When banks change their equity requirements or move the goalposts in other ways, it affects the entire deal. Many deals are forced to retreat entirely simply because they can’t provide more equity or meet the new requirements. Others decrease their purchase prices, or the principals decide to mothball the project until rates decrease. There’s a definite chilling effect, with growth slowing down across all industries.

With that said, it doesn’t mean that now isn’t a good time to launch a deal. Projects of all sizes see capitalization across the board. Rising interest rates simply make things more difficult. This is particularly true for projects within Opportunity Zones.

 

Understanding Special Purpose Vehicles

With increasing regulatory complexity, more and more sponsors seek a way to cut through the red tape. A special purpose vehicle (SPV) could be just what you need. They’re usually attached to Regulation CF offerings and are independently managed vehicles frequently used to pass through regulations. Crowdfunding investors love them, and all funds go into the sponsoring company, not into the SPV.

SPVs are subsidiary companies formed for a specific purpose, or to undertake a particular activity. You’ll find them used frequently in structured finance applications like securitizing assets, within joint ventures, and in property deals. They can also be used to isolate parent company assets or reduce risks to the parent company.

The SPV buys assets from the parent company’s balance sheet and acts as an affiliate. Then, by attracting investors to purchase debt obligations, the SPV becomes an indirect source of financing. That capital can then be used to help shore up other deals within the parent organization, such as meeting new equity requirements to encourage a bank to commit to a loan.

 

Broker-Dealers and Finders: Should You Pay to Play?

We’ve discussed broker-dealers many times. They’re the only viable solution if you want to pay people to raise capital for you. However, if you aren’t required to work with a broker-dealer and have no need to pay anyone to raise capital for you, you can omit them from your team-building efforts.

What about so-called “finders”? For those not acquainted with the idea, finders are people tasked with identifying potential investors and introducing them to the company (you). Finders are legal to use, but they’re often questionable. If you choose to use them, be prepared for scrutiny from regulators.

The SEC has discussed creating a “finder’s exemption”, but that rule has not been passed at the time of this writing. Some states have passed similar rules, though.

For instance, Texas says that finders are exempt from registration and can be paid a “nominal” fee. However, that fee is directly related to introductions and cannot be paid for anything else. They cannot bring paperwork to the conversation, and they’re not allowed to discuss the deal with potential investors, either. All they’re allowed to do is make an introduction.

From a practical standpoint, if that introduction results in a sale and the finder receives a fee, regulators will begin analyzing actions. Is this genuinely a finder? Or is it an unregistered person earning a commission for sales?

If you choose to use finders, ask: are we calling this a finder’s fee to get around acknowledging that it was a commission? Is this genuinely a “nominal” fee? While there’s no real definition of what nominal means, because it will vary drastically from deal to deal, understand that sizeable sums exchanged only when an investment is made don’t fall into the category of finders’ fees.

With true finders, you’re paying for introductions. To put it another way, you are purchasing leads. So long as the payment to the finder isn’t contingent on the outcome of that introduction and the amount doesn’t raise eyebrows with regulators, you should be fine.

Today’s finders act more like marketing agencies than traditional finders. Marketing agencies are also making inroads into the industry and are a viable alternative to broker-dealers and they help you avoid potential problems with “finders”.

With a marketing agency, you’re paying them a fee for their marketing services. You’re not paying a percentage of capital, nor are you paying them for success based on their actions. Many sponsors today choose to work with marketing agencies, some of which have registered salespeople on staff, which makes the agencies broker-dealers. However, unlike other organizations, marketing agencies can also help build your audience through social media, content marketing, and other methods to expand your reach.

 

In Conclusion

Rules and regulations change with surprising regularity. It’s your responsibility to keep up to date with those but doing that while running a growing business can be incredibly challenging. You have a few options here, such as using a reputable online portal. However, a better option is hiring a securities attorney that regularly alerts you to changes that may affect your deals.

It’s also important to realize that while the market is cooling and getting deals off the ground is more difficult than it was, things aren’t impossible. It’s not necessarily a bad time to launch a deal – rising interest rates and stiffer bank requirements might just mean using tools like special-purpose vehicles to build the additional capital needed.

Finally, understand that broker-dealers and finders are not the same, and they’re not your only options when it comes to expanding your reach. Many marketing agencies today can act as broker-dealers and have registered salespeople, which protects you from regulators. However, they also have very deep marketing toolboxes that ensure you’re able to build as wide a funnel as possible (legally).

Interested in what a securities attorney can bring to your team? Get in touch with us to schedule a free consultation with the experts at Crowdfunding Lawyers.

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