The Legal Docs Checklist I Use Before Every Syndication Investment | Ep 85

James: At the end of the day, no matter how good a pitch deck looks, all that really matters are the legal documents. And so that's what we're gonna talk about today on the Furlough Capital Real Estate Podcast. Where we dive into the intricacies of passive real estate investing and our mission is to equip investors to invest wisely, especially on the legal side.

Um, so that in

Jessi: both properties Yes. And residents

James: in both properties and residents and the legal documents, so that together we can build wealth while improving housing. I'm James, and this is my wife, Jesse.

Jessi: I have discovered this. Uh, has nothing to do with anything except maybe I want to take my dog to court.

You wanna take a dog to court? Yes. I've discovered he does not just like water. He also likes mud. Oh, he does love mud. It drives me insane. It does drive you insane. It makes me very happy. 'cause he's very happy when he finds mud.

James: Oh my gosh. Yes.

Jessi: But it's real bad. He just starts digging and gets all over his paw.

Oh yeah. Mouth all over his face. All over his belly. It's. Everywhere. Yes. And it is not like, I mean, yeah, I, I must have given him like three baths in a row. Was still finding like dirt coming off of him. Oh,

James: amazing.

Jessi: And was like, ah. And we have a, we have a doggie door situation. So it was like,

James: so he can get in without being clean.

Right. We were, yeah. We had one where, I think it was the very first time that he got muddy. He, like, you were trying to bathe him and it was like half working. And at one point in time he took off, I was in the garage and all of a sudden I heard him jet out and I just saw him and went, oh man. I was like, I dunno what to do.

And he started going towards the, the kitchen Oh. Which has another doggy door. And I, and I grabbed his, his doggy blanket and just like, just threw it on top of him. Yeah. I'm so glad you caught him. Then scoop him up 'cause

Jessi: Wow.

James: And so he didn't make it any further than the, than the kitchen. Thankfully we just put that

Jessi: whole thing, the blanket, the dog, the money mess.

All in the bathtub. Yep. And just, and, and I gave him a for realsy bath. Oh

James: man, I remember that. That was pretty intense. Uh, it's fun. Oh yeah. That's, that's is what

Jessi: we are navigating right now. Yeah. Which, you know what, you know, it's all good. That's probably more fun than legal issues, so maybe that's why you should read legal different legal documents.

James: Yes, yes. It is important to know what someone find that fun, I guess, navigating what you're signing. Totally. So this is part eight of. Doing due diligence. We kind of took a

Jessi: Of how many parts?

James: Yeah, of eight parts. So this is it. This is it. Yeah. I took my sweet time to kinda get through 'em. That's all right.

So they're all scattered throughout, so you really gotta hunt and peck to find them. Yeah. I mean, you could make a little playlist or something. This is, I could, there's one on YouTube I guess, but yeah, no, this is it. Talking about, uh, the legal side of it. And so part eight. So the first one you're talking about the sponsor, and that's really important that you understand who that is, who you're investing with.

At the end of the day, the, and these are all parts of, totally just moved that camera. Um, hey, quit speaking of dogs. Quit chewing. Um, can you stop him? Alright. So while she's fixing that, um, this is, uh. The first one's all about the sponsor and how you, like, you wanna make sure that you're investing wisely with that person because at the end of the day, you're giving that person the money.

Uh, the second one is about the property manager. This is really important for long-term holds. You then are gonna care about the market, right? What's the context in which this investment is happening? You're gonna care about the property itself, like the physical thing. What does it look like? You then are going to care about the.

The business plan itself, what are we planning to do with this property? Mm-hmm. Related to that, if there's a big value add, like what's the construction plan, how's the money gonna be spent to do that? Some have less of that. Uh, you then are going to care about the financing side of it, the numbers. Right.

And now finally, boom. Got 'em all. You like that? That was pretty good. Legal documents. I don't think I

Jessi: could have pulled that out.

James: Yeah, that was pretty

Jessi: good.

James: So, uh, so that's what, um, so that's what this is. And all

Jessi: of these are parts of. Bigger document.

James: Correct. Called good deals Only. 'cause the idea is we want you to only invest in Well, good deals only.

Yeah. And yeah, there's 196 questions. And so these are, this is the, the final, the final set, I dunno, set. Yeah, yeah, yeah. 20 or so of questions. Yeah. So it finishes with the legal part, which it's interesting and I, and I tease this at the beginning, uh, all the other stuff, it kind of doesn't matter. Hmm. This.

The legal documents are the only thing that matters at the end of the day, and

Jessi: well, like why, you know, that sponsor

James: itself. But

Jessi: is that just, that's the fine print, that's what you're actually signing and what is gonna be recorded? Yep. That's the thing you're committing to. Yep. So,

James: yeah, so, uh, I, I've got questions that you should ask around it, but kinda let me give you a, uh, like a, the high level.

View, I guess Sure. Of what it's gonna be. So it depends on the deal, right? Is it a long term equity deal or is it a short term, like you're given a loan type of deal? Mm-hmm. Well, it depend on the stuff. So let's do the long term equity one. Okay. Because it's a little more complicated. So on that one, you are actually buying shares of a company.

Jessi: Okay.

James: And so you, uh, things are on that. You are, uh, when you form an LLC, it has what's called an operating agreement. Mm-hmm. That's part of it. You know, you get a name and then you make an operating agreement. And the operating agreement spells out, here's how this company works. Um, it says, who's getting voting rights?

Who's in charge? What do you do for disagreements? Like. All the things. Yeah, all the things. And it's usually, you know, it could be somewhere between 10 to 30 pages, depending on what it is. You then have what's called a PPM or a private placement memorandum. Now that document is a very long way, typically of saying.

Your money is at risk. There's no guarantee you could ever get it. Oh, it could be gone. Interesting. And, and the way that they do it is very lawyerly where essentially it repeats a lot of the stuff that's in the operating agreement. Mm-hmm. Um, but couches it all with, with risk stuff. Hmm. Um, so it says here are the different risk factors.

It talks about the major sponsors. So it would like talk about me and it talks again about, uh, here's the property itself, here's the market. Here's what's good, here's what's bad. It's, it's a very lawyerly, it almost ing replicates interest, the pitch deck, or in my case, the pitch website. Sure. But all in, in a legal format, legal terms documents.

So, because what happens is with certain investments, you don't, uh, they're exempt from submitting them to the SEC. Mm-hmm. And instead what you have is this document in place. And so this is kind of the full disclosure, Hey, Mr. Investor or Mrs. Investor. This is what you're getting into that document.

Interesting. Um, the most recent one that I did, he's totally causing a problem. Uh, the most recent one that I did was 45 pages long. And, um, and it had, yeah, it had all the different stuff and it, it had to break down of like, here's the expected return, here's the breakdown. Like all the math, again, it's as if it's like a legal, it's like a loyalty version of.

Pitch deck. Wow.

Jessi: How many pages did you say it was? Uh,

James: mine was 45.

Jessi: Oh gosh. So yeah, me as the investor.

James: Yeah, yeah, yeah.

Jessi: Um, are, am I expected to like read those 45 pages? Ooh, that's a a good question. I mean, okay. Okay. You have like given me the pitch deck. I've read that by the way. There've one more, but keep going.

And I've eye roll and, and I've asked you questions and I've clarified, so I've, I've done due diligence. Yeah. Would you still recommend that I go through. Each of those two areas and this other third one that you haven't told me about, like with a fine tooth comb and like read through them.

James: Hmm.

Jessi: Um, because I mean like, am I even gonna understand it?

I

James: think it comes back to do you trust the sponsor?

Jessi: Yeah.

James: And if the answer is yes, uh, you know, you should read it and understand it. Sure. There's certain parts of that are boil it plate, there's an entire section that just talks about how taxes, like tax rates,

Jessi: and that's the same for every single document.

James: You could skip that. Yeah, you could skip through that part. I think it'd be good to read, like there's an investment summary. Typically I would read that, I would read the risk section, which is like super pessimistic. Um, I would read the part about who are the, who are the sponsors if you don't already know about them.

Okay. Um, which is probably the main, you should, I would read about the, the financial, like how to returns done. Mm-hmm. Which is also gonna be in the operating agreement. Um, the operating agreement's gonna have, so there's certain sections I would hunt and peck. I may not necessarily. Read every single line with a fine tooth comb, but I would, there's certain sections where you go, Ooh, this seems important, and we're gonna help kind of guide you do that.

The last, so what was,

Jessi: what was that? First,

James: the operating agreement. There's

Jessi: an operating agreement.

James: There's a private placement. A

Jessi: private placement, Memor memorandum Meum, so an

James: OA and a PPM.

Jessi: And then this third thing

James: is called a subscription agreement. Wow. That is the document that you actually sign.

Jessi: Okay.

That's the one saying, I promise to blah, blah, blah, blah, blah. Give you money and then you'll pay me back. Yeah. You know, just ran outta

James: that one. I am buying shares of this company at this such and such a rate for these many shares and given all the information to register it.

Jessi: Okay.

James: And shocker, they repeat some of the other stuff in that one as well.

Sure. So like the most recent one I did. I think it was 10 or 11 pages.

Jessi: Okay.

James: Again, that's one you probably like, you don't have to read as much. That one's more go through and fill it out. Uh, you do have to do a W nine, but that's like totally normal.

Jessi: Right? Well, you're gonna get paid some money in. Yeah. So you gonna have that claim it and all the good things.

That's the fourth

James: one. So those are like high level. Okay. So that's if you're doing a long-term investment. Yeah,

Jessi: that's what I was gonna say. That was for the long term investment. Because you're buying equity in this property. Yes. In a, in a company essentially. Kind of,

James: yep. Mm-hmm. Which seems weird to me.

Mm-hmm. Mm-hmm.

Jessi: Okay. Let's say this is short term. Well,

James: you're buying, you're buying. Shares of a company that then is buying a piece of real estate and the company owns the piece of real estate and then you own a

Jessi: company. Do you have to do that for every single piece of real estate?

James: Just the big ones.

Jessi: Interesting. What counts as big?

James: I dunno, it's up to you to define it over a million dollars, I'd say.

Jessi: So if you were just buying like a single family house, you probably wouldn't do something like that. Me?

James: Uh, let me, let, let me ask, answer that more precisely. I would do it for any situ any time you are selling.

Shares of a company to buy a property. Each one of those is going to be an individual one. Now, typically it only makes sense to do that on larger properties. Uh, you may not be able to hear this, but our dog is clearly getting into something and it is agitating Jesse, but we're gonna soldier on. And not worry about it.

So, uh, if you are doing a loan, which is a different type of structure, you don't have any ownership. Mm-hmm. The paperwork's actually a lot more straightforward. There's only two documents that you care about. There's the promissory note. This is the agreement saying, Hey, thank you for letting me borrow money.

Here are the terms at which I am borrowing said funds. Mm-hmm. And then the other one is, and it depends on the state you live in, in Oregon, it's called a trust deed. And it is essentially the thing that is saying, and here's the collateral. Which is usually the house for that loan.

Jessi: Okay.

James: That's it,

Jessi: huh? So that's a lot more simplified then.

Yeah. And the trustee, all those other documents is

James: like, it's a standard document. Honestly, you don't even need to read it outside of just making sure it has the right address and the right names and all, everything that's spelled correctly. Like that's all you need to check. That's like, it's such a standard form.

Interesting. Uh, the promissory note, ours is only page long. Okay. I'm sure that. Um, it could be more complicated, but it could be a lot more complicated. Probably should be a lot more complicated. Mm-hmm. Um, but, um, like I, I like ours 'cause it spells it out pretty favorably. Like it spells it out very simply so that a normal person can understand it.

And honestly, I'm like, yeah, it's just a loan man. Like, we got money. I'm gonna pay you back no matter what. Right. So if you're gonna, if it's a I'll pay you back no matter what. I really don't feel like you need to get complicated about that since it's no matter what

Jessi: is there. I mean, this is. Kind of related, but outside of, okay.

Diving into the legal documents, which we're gonna do in just a second, but, uh, is there a better, like, investment or, I guess what I'm saying is like, if I'm the investor, like which one, is there one that's more risky or less risky? Oh, you know, if I'm like, oh, I'm buying into this equity, it's a bigger investment.

There's a lot of people buying into it versus I'm. Paying into this loan that you're gonna pay me back for. I mean, structurally they're very different,

James: but I would say categorically no one is not necessarily better than the other. There's just different pluses and minuses to each,

Jessi: and really you should understand.

Like the, and, and both the legality or the nuances of each of those, regardless of which one you're, which are going

James: to be influenced by those seven other categories. Sure. Right. Who is the sponsor? Who's doing it? Yeah. What is the property? Where are they doing it? What's the project they plan to do with it?

What are their debt is held on it? Like all of that other stuff. That all makes sense. It it, it kind of builds into does this investment make sense for me? Sure. Now the legal documents is kind of the, all that other, it's checked all the other boxes. Now we're just making sure that the legal documents match.

What was said and everything else and what I know about this person. Okay.

Jessi: So theoretically it should be straightforward to read through the legal documents if you have. It should be learned about everything already. Yep. Alright. Yeah, so,

James: so there we go. There's a little bit of background.

Jessi: Yeah, no, that legal doc that is helpful about like what would be included in legal, legal documents so that when you're holding them, you're not just like, I have no idea what this, oh, what I do is like, what am I reading?

Um, so. Here's some high level questions that you kind of included in this list. Yes. That I think are great to focus on. So, um, the first one is, what is the legal structure of the offering? Which is kind of what you. Just mentioned, but really it's things like, um, what are the sources of the funds? Is that clearly outlined?

How will payback happen? Is there co-investing? Yeah. You know, what is all the legality of who is going to be involved? Yeah. Am I

James: buying equity? Am I giving a loan? Yeah. If it's a loan, is it, will it be payments during the hold period or will it be a lump sum? If it is, uh, equity, it's, you know. When do I get paid?

Who gets paid before me? Who gets paid after me? All that stuff.

Jessi: Sure. And, and, um, I'm just gonna

James: let him chew your boot. Yeah. So

Jessi: I, yeah, there's, there's another one in there too that I think is important where, and you didn't quite mention it in the other areas, not necessarily, but it's, what are the reporting re requirements?

Oh, yeah. Mm-hmm. Mm-hmm. It's kind of like, as an investor, what can I expect? To get from you, correct? As far as like, yes. What are you gonna tell me? Are you gonna disclose all the information or just a little bit? Yeah. At what rate and what are you gonna tell me and, yeah.

James: Yeah. Uh, yeah. It's good to see that, that it's written down.

Sure. It should say somewhere in the operating agreement. Sure. What that report cadence is and what the expectations are and how often you should hear back from them.

Jessi: Okay. Um, and then this one I find very interesting. Under what circumstances do, do the investors get a vote? Yep. In all of the decision making.

James: Yeah. So, uh, to be clear, if you're alone, you get no votes if, um, if you're buying into equity, there are limited times when you get a vote. Mm-hmm. But usually it's whoever the sponsor is, they're the managing partner. Yeah. Um, they make all of the day-to-day decisions. Now, that might, and that would

Jessi: be outlined

James: in the operating agreement in these legal

Jessi: documents.

Okay.

James: Yep. It'll definitely say it in the operating agreement. And that's kind of like the operating agreement. Is the winner. Yeah. The PPM, if there's a disagreement between the two operator agreement is the one that you go with. Mm-hmm. And, um, and then the subscription agreement, there's less of an overlap.

Um, but, but yeah. Uh, it will tell you, Hey, here's the time that you can vote. Um, like if there's a, like sometimes it might be, Hey, we're making a decision on a really big, um, capital decision, or will we sell or refinance or keep it, like that's a big decision. Sometimes you get to vote on that one, sometimes you don't.

Um. If, uh, if something happens to the sponsor, oh, and you gotta find someone new, or the sponsor stops, you know, isn't doing what they said they were gonna do. Mm-hmm. That's when you can come together and vote 'em out. Interesting. Essentially. And, and

Jessi: then hire you hire someone else, be in charge. Yeah.

Usually

James: it will spell out what that process is. Wow. To hire a manager to come in and run it. Interesting. Yeah. So

Jessi: in every set of legal documents it has that outline of it

James: should,

Jessi: what comes next

James: if you're buying equity. Yeah.

Jessi: Interesting. I had no idea that that was in there every single time. Yep. Uh, so here's another possible scenario that you bring up in here is, uh, let's say additional capital needs to be raised.

Oh yeah. Capital. How are you gonna address that? You know, and are they gonna come back to me and ask for more? Is it gonna be spread evenly? Like who's gonna come up with that?

James: Yeah, it will say that. And also in the operating agreement, I think it also says in the PPM, if I remember correctly, um, and, uh, yeah, what you wanna know is, am I required to do it?

And if I don't, what happens? Right?

Jessi: Yeah. Well, I to it, do I just get, which typically the answer is thought out or,

James: yes, you're required, but if you can't, uh, other people can. Do your part for you. Interesting. No, it's usually no one new, but existing people can cover for you and then they get a little bit more equity.

They get some of your equity, you know, it's all proportional.

Jessi: Which makes sense. 'cause I mean, yeah,

James: it will also spell out how much advanced notice you need to get.

Jessi: Mm-hmm.

James: Like is it 10 days? Is it 30 days? Is it 90 days? Like Sure. Yeah.

Jessi: Um. And then there's, there's some other things in here that I feel like are worth revisiting.

I, I, I feel like we talked about them before. Yeah. But within the legal documents, revisiting like. The payment structure. Mm. So a waterfall payment and like preferred returns. Yeah. How do you, like, as an investor, how do I wrap my head around how to read those things and know what I can expect?

James: Yeah. And honestly, that's the one where it's like you go with the pitch deck or my case pitch website.

Yeah. Um, 'cause it's usually gonna be visual on how shows it, that's more straightforward

Jessi: than the legal.

James: And then the legal's gonna have, there's by, there's usually like three or four places where it says. Here's how it works. Okay. And depending on how complicated the waterfall is, will depend on how complicated, uh, the paragraphs are.

Sure. Um, do the

Jessi: legal documents ever take, you know, visuals and information from the pitch deck and put them in there?

James: Uh, no, not really. They all, I lawyer it, it super annoying and no, I usually hand boring hand. I give my attorney the pitch deck so he can see it all. And then so as he's writing up burns in the words

Jessi: the documents, it matches.

James: Yeah. Yeah, yeah.

Jessi: Huh.

James: And the first time I had to, I actually had to teach my guy the first time around about preferred returns and how I wanted that structured and done. 'cause he was like, I've never seen this. Okay, so

Jessi: give me like the 32nd. Description of waterfall and preferred returns.

James: So we got a whole podcast episode about us.

You can listen to it if you're interested. Uh, but no, uh, so Waterfall is the, the way in which people are getting paid. You know, if, imagine you have a bucket of money that you're pouring mm-hmm. And like, where does it first go? So, um, a very simple structure, which is one I've recently done is 20% goes to the manager, 80% goes to the passive investors.

Super easy waterfall. You can imagine just two. Yeah. Uh, it can get a lot more complicated where you might say, Hey, you know what the F. All the money is going to go to the investors until they reach some internal rate of return. Let's just call it 8%. Once that's done, then we're gonna switch over to a 70 30 split.

Now the manager's gonna get paid 30%. The investors will get paid 70 until the investors hit the next IRRR hurdle, let's call it 15%.

Jessi: Mm-hmm.

James: Once that's hit. Then it switches to a 50 50 split between the manager and the investors. Okay. That works really well if it's like a, so it can get

Jessi: pretty complicated.

James: Yeah, and that's gonna be all spelled out in a bunch of paragraphs or sentences at least. That works our how that our sponsors

Jessi: typically pretty well. Okay. I could ask about you 'cause you don't know what most sponsors, but if someone were to come to you and be like, I do not understand this payout structure, would you take the time to kind of break it down?

A hundred percent. Yeah. Yeah. Let them know like, okay, if I put in this amount. When can I expect returns? How much, what are you getting paid? All those. Yeah. On my pitch check, I

James: actually, I have a visual where I show like, here's how, here's how the money flows. Sure. And then I have a nice little chart that actually shows, here's my, here's the projections.

Cool. Every year. Just so you can actually see that amount. Have you ever

Jessi: had someone I'm, this is. Related to the legal documents. Have you ever had someone look through the legal, legal documents and go, this doesn't make sense, or this is a typo, or, you know, like,

James: oh, um, I was reading

Jessi: this and this doesn't seem right.

Not

James: yet.

Jessi: That's good.

James: Yeah, it's

Jessi: probably good.

James: Not yet.

Jessi: I either people aren't reading them or they are and everything's great.

James: Well, I think, again, like, I think what a lot of people do is they're looking through the. Marketing materials. Sure. And if the legal documents match what's in the marketing materials, they go, yeah, it makes sense.

I feel pretty good about this. Sure. And they,

Jessi: yeah. You're not gonna read over it and use a red pen to highlight all the ins and outs of it.

James: Yeah. Correct. Correct. Yeah.

Jessi: You might do that as a sponsor.

James: Yeah. Oh, I do. Definitely. Before I hand it off, like the lawyer and I Yeah. Help say, no, no, no, I mean this, it should be this, or blah, blah, blah.

Jessi: Yeah. So. Um, there's one more small section in here kind of related to the preferred returns, but um, I think it all kind of falls under what we've talked about. Okay. And really just, um, looking at the nuances of what is included in those Okay. Legal documents as far as like the financial returns? Yeah. The outline of the property, who's investing, how that's structured.

So you, did your job align? Yeah. Honestly, in a cheat. Do is

James: take those PDFs. Toss 'em in a chat, GPT, ask it questions. That's interesting. I wonder if you could even, I haven't, I've never tried this, but throw the pitch deck in as well and just be like, Hey, compare and contrast these. That would be an

Jessi: interesting experiment.

Yeah. To, to add the pitch deck and add the legal documents without reading them. Maybe With reading 'em. Yeah. But just see what it comes up with.

James: Yeah. Yeah. So that's another thing that you could do at least get you kicked off. Sure. On where to focus, right. Maybe which areas to read more closely. What areas, yeah.

Hey, I'm looking at these documents. Yeah, exactly. Where should I focus? Gimme page, paragraph numbers and, and kinda help you. But honestly, you should at least skim the entire thing. And then actually read the sections that look interesting to you and follow up on those questions. Cool. So there you go.

That's the legal documents. Woo-hoo. It really is. It's the last one, but it's also like the official one. Which is super

Jessi: interesting.

James: Yeah. Yeah. Because

Jessi: there's so many ins and outs to investments and thinking through like, okay, well what area do I wanna be in and who do I wanna be working with? But really, you're right.

When it comes down to it, this is the document that's gonna, you know? Yep. Spell out everything that you're signing your money to and your time to. Yeah. It's.

James: Pretty unregulated. So if you hit the wrong person or the wrong investment, like you could lose everything.

Jessi: So all of those other sections do matter.

James: Yes, they do. They build up to this last thing. It comes up to. Yep, yep. So there you go. That's, uh, those are the legal documents. Again, if you would like to see all 196 questions that deal with all of 'em, you can download good deals only from my website, furlough.com. At that same place, you can also learn just more about investing with us and what it's like.

Us as sponsors in our track record and um, I think we do a pretty good job of, um, passing those questions there. Sure. So yeah, that's what we got for you. Thanks for listening. Have a great day.