If you follow my work, you know I often talk about the "sweet spot" for Regulation A+ (companies that are too mature for venture capital but too small for a traditional IPO). Usually, we talk about tech startups or biotech. But recently, a fascinating use case came across my desk that I think is a game changer for successful private mortgage lenders.
I was discussing a scenario with a colleague about an entrepreneur (let’s call him "Mr. B.") who has built a personal portfolio of about $7 million in mortgages. He is a disciplined operator, generating roughly $1 million a year in personal income by focusing on second mortgages where he doesn’t have to compete with big banks.
Mr. B’s problem isn't finding deals; he says he could easily place $100 million a year because he knows his market so well. His problem is capital. He is limited by his own personal liquidity. He wants to build a legacy business that outlasts him, and he wants to scale.
The question he asked is one I hear often: "Can a lending business use Reg A+ to raise capital from the public, or is that reserved only for companies that own and manage properties?".
The short answer is: Yes, absolutely.
But, as always, the devil is in the details. If you are a private lender looking to scale, you need to understand the Real Estate Fund Exception to the Investment Company Act of 1940.
The Hurdle: Avoiding the "Mutual Fund" Trap
When you raise money from the public to invest in assets, the SEC might look at you and say, "You look like a mutual fund." If they classify you as an "Investment Company" under the Investment Company Act of 1940, you are suddenly subject to a massive amount of regulation that makes running a simple lending business almost impossible.
This is where the Real Estate Fund Exception (specifically Section 3(c)(5)(C)) saves the day.
Our securities attorney recently gave us the "green light" on this specific structure. The Act provides a carve out for funds that are primarily engaged in "purchasing or otherwise acquiring mortgages and other liens on and interests in real estate".
In plain English? If your business is lending money secured by real estate, you can likely be exempt from the heavy regulations of being an investment company.
The Rules of the Road: The 55% and 80% Tests
To stay on the right side of this exception, you generally need to meet two portfolio tests, which legal experts outline as follows:
- The 55% Test: At least 55% of your fund's assets must be "mortgages and other liens on and interests in real estate".
- The 80% Test: At least 80% of your portfolio must be invested in real estate and real estate related assets.
- This ensures that your fund’s primary focus remains on real estate, distinguishing it from a general securities fund. For a lender like Mr. B, whose entire business is writing mortgages secured by property, this is a natural fit.
Why This Model Works Beautifully for Reg A+
From a strategic perspective, I love this model for Regulation A+. Here is why:
1. Immediate Capital Deployment (and Dividends): One of the biggest challenges in Reg A+ is "cash drag" (raising money and having it sit in the bank while you wait for a permit or a product launch). In the lending model, that money goes to work immediately. You close the raise, you fund the mortgage, and the interest clock starts ticking. This allows the company to potentially pay a continuous dividend to shareholders very early on. Investors love yield, especially in this market.
2. Efficiency and Focus: You don't need to be a developer. You don't need to manage construction crews. You can build an organization focused entirely on operational excellence: transaction recruitment, legal documentation, and collections. It is a scalable, disciplined machine.
3. The Legacy Factor: For someone like Mr. B, this transforms a "side business" into a public company. By retaining sizable ownership in the public entity, he creates a legacy asset for his family, rather than just a portfolio that liquidates when he stops working.
A Critical "Rod Style" Warning
Now, I have to give you some pragmatic advice. There is a trap here that you must avoid.
In my experience, companies get into trouble when they try to get too creative with how they structure the loans.
If you invest in other LLCs or intermediaries, the SEC may define those interests as "securities," not real estate. If you hold too many "securities," you lose your exemption, and you are back to being an investment company. You need to keep it clean: make the primary use of capital direct lending secured by the asset.
Is This Right For You?
If you are a lender with a proven track record, very good accounting records (audits are required for Reg A+), and a desire to scale beyond your personal balance sheet, Regulation A+ is a powerful tool.
It allows you to market your offering online to millions of main street investors, not just the wealthy. But remember, there are no magic shortcuts. You need a great marketing partner, a solid audit, and the right legal structure to ensure you qualify for the exemptions we discussed.
If this sounds like the path you want to take, let’s talk. We can help you evaluate if your lending model fits the mold, and we can help you succeed in raising the capital, cost effectively.
To get started or learn more about how we can assist you with your capital raising needs, please email [email protected].
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Rod Turner
Rod Turner is the founder and CEO of Manhattan Street Capital, the #1 Growth Capital service for mature startups and mid-sized companies to raise capital using Regulation A+. Turner has played a key role in building successful companies including Symantec/Norton (SYMC), Ashton Tate, MicroPort, Knowledge Adventure, and more. He is an experienced investor who has built a Venture Capital business (Irvine Ventures) and has made angel and mezzanine investments in companies such as Bloom, Amyris (AMRS), Ask Jeeves, and eASIC.
www.ManhattanStreetCapital.com
Manhattan Street Capital, 5694 Mission Center Rd, Suite 602-468, San Diego, CA 92108.
