A finders fee is compensation paid to individuals or entities that introduce investors to real estate syndication opportunities. While it can be a valuable tool in attracting investment, it’s essential to know when, how, and to whom these fees can be paid to stay within the legal boundaries.

Recognize that the role of unlicensed finders who may assist in connecting potential investors with your real estate projects has limitations. It is imperative to understand these to ensure your syndication efforts remain compliant and legally sound per SEC regulations.

This article focuses on paying finders fees to unlicensed individuals who do not have a securities license and who refer investors to a securities offering with an exemption under federal Regulation D, Rule 506.

Issuer Exemption Under Regulation D, Rule 506

Regulation D, Rule 506 is an essential part of U.S. securities law that offers companies a streamlined way to raise capital even without Securities and Exchange Commission (SEC) registration and is the most used exemption by real estate syndicators. Rule 506 has two variations:

  1. Rule 506(b), which allows for unlimited accredited investors and a maximum of 35 non-accredited investors but does not permit general solicitation of the syndication offering.
  2. Rule 506(c), which permits general solicitation of the syndication offering but requires that all investors be accredited, with the issuer demonstrating verification of their accredited status.

Under this rule, companies or individuals can offer exempt securities, allowing them to bypass the broker-dealer registration requirement provided they follow specific SEC guidelines. It facilitates a more straightforward approach to raising capital. As the issuer, you can engage in certain activities typically reserved for registered broker-dealers, such as soliciting investors and negotiating terms.

This is particularly beneficial for real estate syndications as it allows them to focus on attracting investment without the burden of a tedious and full SEC registration. As a result, it significantly reduces costs and expedites the fundraising process.

However, this flexibility comes with the responsibility to ensure all actions remain within the legal framework established by the SEC. Missteps in compliance can jeopardize your exemption and expose you to legal risks. Therefore, a thorough understanding of what is permitted under this exemption is vital for the smooth operation of your real estate projects.

Qualifications of the Issuer in a Real Estate Syndication

Finders who assist in transactions often act as intermediaries, introducing potential investors rather than deciding on the appropriateness of investments. They are typically in a facilitative role, helping to connect possible investors with investment opportunities.

Individuals claiming the issuer exemption under Regulation D, Rule 506 must be involved in the company’s management and have substantial responsibilities beyond referring investors. Their compensation cannot be linked to the amount of money they refer as this could be seen as a commission paid to an unregistered broker.

Issuers are required to meet these three key criteria:

  1. They are not hired solely for offering or selling securities
  2. Any securities activities they conduct must be secondary to their primary non-securities-related duties
  3. Their compensation must be based only on non-securities-related duties

Compliance with regulations is crucial to ensure the legitimacy and success of your real estate syndication efforts. Failure to adhere to these guidelines can result in the individual needing to register as a dealer or agent.

Defining Unlicensed Finders in a Real Estate Syndication

Securities offerings under Regulation D, Rule 506 can be sold by the issuer in any state without being registered with the SEC or state as a broker or dealer. Individuals can also sell their own real estate without a license (FSBO—for sale by owner). 

However, any other individual compensated for selling securities on the issuer’s behalf or someone else’s real estate must still adhere to registration requirements and possess a real estate broker or sales agent license.

Unlicensed finders are individuals who leverage personal networks to help connect potential investors with real estate opportunities even though they are not formally part of a registered firm or registered as broker-dealers. While this practice is a violation of broker-dealer laws, it can be tempting for real estate syndicators looking to expand their investor base quickly.

You should recognize the potential legal pitfalls of such activities that don’t operate within the bounds of the law. By working with unlicensed finders, you run the risk of non-compliance with federal securities regulations, which can have serious repercussions for your business.

Legal Implications of Paying Unlicensed Finders

Securities regulators view payment based on transactions as a strong indication that someone is involved in the securities business and is required to register as a broker-dealer. This is significant because broker-dealer registration is designed to protect investors by acting as a gatekeeper in the market.

Violating these rules by paying unlicensed finders can jeopardize the legal status of your exemption. Additionally, failing to comply with securities laws is a risky move that could threaten the compliance of your real estate syndication and lead to these serious consequences:

  • The Securities Exchange Act of 1934, Section 15(a)(1) prohibits unregistered individuals from facilitating a securities transaction or attempting to sell a security. This means that unlicensed finders who engage in such activities are breaking federal law and could face hefty fines as well as civil or criminal charges.
  • The Exchange Act, Section 29(b), states that contracts breaching the broker-dealer registration requirements are considered void. It nullifies agreements made with investors, potentially leading to costly legal battles and the loss of invested capital.
  • Most states acknowledge the Regulation D, Rule 506 exemption, provided they receive notice within 15 days of the sale and/or offer of a security, and no unregistered individuals are paid for selling it. Otherwise, the state could prosecute or impose penalties.

Non-compliance can also result in damage to your reputation and business relationships. Given these potential repercussions, it’s vital to ensure that all aspects of your real estate syndication comply with federal and state securities laws.

The Bottom Line: Compliance in Paying Finders Fees

Navigating SEC guidelines is a critical aspect of safeguarding your exemption status. However, the commission defines rules on broker-dealer definitions broadly and exceptions narrowly. Private securities offerings are self-policing, with minimal likelihood of an audit for securities violations—until an issue arises. Thus, even well-intentioned efforts to reward unlicensed finders can result in severe consequences if not handled correctly.

To mitigate risks, consider engaging experienced real estate securities and syndication legal counsel who can provide tailored advice based on the specifics of your situation. An experienced syndication lawyer familiar with these regulations can help you understand the complexities of federal and state securities laws. They will ensure all aspects of your real estate syndication are compliant.

Staying informed about regulatory updates and industry best practices is another crucial step. Although the rules discussed above are generally applicable across the U.S., variations may exist for individual states or other exemptions under state or federal securities laws. Therefore, regularly reviewing your procedures and policies to align with the latest legal requirements can help prevent inadvertent violations.

By prioritizing compliance, you not only protect your business from legal repercussions but also build a reputation for reliability and integrity in the market. Taking these proactive steps will support the long-term success and sustainability of your real estate ventures.

Unsure about paying finders fees in your real estate syndication? Consult an expert attorney! Shams Merchant is one of the top-ranked real estate private equity and syndication lawyers in the country, representing clients in award-winning real estate projects across the nation. Shams is one of the few attorneys who specialize in real estate syndications, fund formations, securities law, and private placements for commercial property investments and development, Shams has been featured in publications like Law360, the Austin Business Journal, BisNow, and The Real Deal.