While real estate crowdfunding has made it possible for virtually anyone to begin enjoying the world of property investment, that doesn’t mean there aren’t some obstacles you need to know about. Let’s look at one right now.

The 100 Investor Rule

This 100 investor rule has emerged time and time again as an annoyance for those in the crowdfunding world. One of the most frustrating things about it is simply that the rule comes from the Investment Act of 1940. Yet, 75 years later, it’s still enforced.

The basics of this rule are fairly simple. First, a company that invests in securities will be treated as an “investment company”, making it subject to all kinds of burdensome regulations from the Act of 1940.

Any special purpose vehicle created by a portal for the purpose of investing in a portfolio company is also seen as engaging in securities investments.

However, there’s an exception. If the special purpose vehicle has no more than 100 investors, then it won’t get treated as an investment company.

As you can imagine, there’s a lot more to this rule than just this. For our purposes, though, the above summary should be sufficient.

What This Means for Real Estate Crowdfunding

The 100 investor rule comes up enough that it annoys many, but there are also plenty of deals that get made every day where this is never an issue. Fortunately, this is usually the case with real estate crowdfunding. Most deals don’t go over $2 million and remain relatively small, with fewer than 100 people investing. As you probably know, $5 million is the limit for nonaccredited investors, so this makes sense.

As deals get bigger, though, you start running into a problem. Special purpose vehicles are no longer available, for one thing, as we start getting into pools of assets instead of those from individuals. You already can’t use them for Regulation A+ deals.

What will most likely happen eventually is that more and more crowdfunding deals will run into this problem. We’ve already seen large properties go through real estate crowdfunding like the Hard Rock Hotel. You can expect that this kind of thing will continue into the future with even larger properties that demand more and more investors. This is when the 100 investor rule will become a real problem.

Subsidiaries Can Function as a Workaround

Now, you’ll want to consult with an attorney in your state before following this advice, but with that disclaimer aside, there’s reason to believe that subsidies may provide you with a solid workaround.

Here’s how this could work. Let’s say you’re given an opportunity to join 1,000 other investors in acquiring 10 properties. There are a few reasons to put each of these properties in a separate subsidiary.

For one thing, it could be beneficial to finance each of them individually. You also wouldn’t want any liabilities stemming from one property to end up leaking over into another.

The good news is that not only can you do this, but you would also no longer have to worry about the 100 investor rule. In application, you ignore any securities that have been issued by a company your investors control. As long as the company you’re acting through isn’t actually an investment company, you’re just fine.

Most likely, this company of yours will put every property in its own limited liability company (LLC).

Choosing Sound Platforms to Handle This Problem

If the above reads like Greek, you’re not alone. Although this is a relatively straightforward problem, most investors flocking to real estate crowdfunding don’t have any background with it.

This is why you need to be so careful about investing through platforms that enjoy a solid reputation. While you can consult an attorney to ensure you’re acting on the right side of the law, a good platform should be doing the same. Those in charge of it will know all about the 100 investor rule and check to confirm you’re not in violation.

People have accidentally violated the rule because they became part of an investment company and just didn’t know it. The authorities don’t make exceptions for these kinds of mistakes when they hand out punishments though. This is not something to take lightly.

Keeping Deals Smaller

Of course, the easiest way around this entire issue is just to keep investment deals small. Obviously, if you don’t go over 100 people, there’s no reason to mess around with subsidiaries in the first place and you don’t have to be concerned about the law.

Still, don’t let this become a reason to get tempted into investing more than you can afford. If you have to take on that kind of risk, just to keep your investors below 100, the deal isn’t worth it. There are always more out there.

For the vast majority of us, being nonaccredited investors means we have to keep deals small anyways. This isn’t such a bad way to go, though, at least at the very beginning of your real estate crowdfunding investment career, because it means you can’t lose that much money either.

The Problem for Bigger Deals

Let’s say you are an accredited investor though or you hope to work your way up to that level in the future. Now, you’re still going to have a problem with the 100 investor rule. For example, let’s say you want to invest in a $50 million property. Well, you still can’t go over those 100 investors. That’s going to be half-a-million dollars apiece or some of you will really need to put a lot of money in the pot.

If you’re considered a qualified purchaser under the law, that means you have at least $5 million in net worth and 500 of you are allowed to go in on a deal together. Still, though, do you think someone looking for investments is going to look for dozens of “little guys” at that point or just go with a fund?

The 100 investors rule is definitely annoying and poses unnecessary challenges like we just discussed. Still, it shouldn’t keep you from enjoying the many benefits of real estate crowdfunding.

Matthew Sullivan

@thecrowdventure

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