At WealthForge, we see investors of all types—from individuals, to trusts, to other companies. Over time, we’ve noticed that when the investor is an entity that is closely tied to an individual, there are many possible mistakes to be made.
Below we discuss 5 pitfalls we have seen when investing as an entity.
Funds from a Different Account
One of the most common mistakes made by entities, particularly LLCs and trusts, in attempting to invest in a private placement, is funding the investment from an account not associated with the entity. What this normally looks like is the funds coming from an individual associated with the entity, such as a member or manager of an LLC or a trustee of a trust. With the exception of a few specific circumstances, this will lead to the funds being returned and a request that funds be provided from an account associated with the investing entity, which may require actually opening such an account. The reason for this is that when the funds come from a source other than the investor, there is a potential Anti-Money Laundering concern. In our experience, often the person controlling the entity does not understand that the entity is a separate person than himself, or is just trying create a short cut by sending the funds directly into the investment instead of funding the entity and then having the entity invest. The key takeaway here is that if you are investing through an entity, you should have a separate bank account for that entity and the investment should be funded from that account.
As part of WealthForge’s KYC process, we request copies of the entities’ formation documents. Often, we discover issues within these documents, which slow down the processing of the investment due additional follow up being required to gain further information or clarification. An example of this is in the area of authority. More often than one would think, we will look at an LLC or Partnership agreement and discover that the individual signing for the entity does not have the position or authority they claim. This can often be cleared up by a corporate resolution, or similar document, where that individual is granted authority.
A sub-category of document issues we see regularly is missing signatures. The most common situation where this occurs is with trusts and investments via IRA accounts. Using the trust example, we often see trust investors where the document is signed by only one trustee. We then review the trust agreement and find that it is a form agreement where it states something like, “John and Jane Doe are named Trustee for the Doe Family Trust….Trustee shall have the power to make investments…” So the question becomes can John alone invest on behalf of the trust or do John and Jane have to act in concert as the Trustee? If the trust agreement does not state that one trustee can bind the trust, or vice versa, then we have to go look at the specific state’s rules, which often leads to the other trustee having to sign.
Obviously there are a few ways to avoid this problem. First, use an attorney to create your trust. A good attorney will be sure to clarify what signatures are needed for what actions. If you plan to use a form trust agreement, be sure the authority is clear on the form you use. Second, if you currently have a trust document that is ambiguous, you can either amend it or execute some other document clearly granting authority to one trustee to bind the trust.
While rare, we have occasionally encountered entities trying to invest that are delinquent on their state filing fees and are thus inactive. This results in the investment being delayed until the entity pays its fees, which can be painful for everyone involved. The moral of the story here is to keep current on fees.
It is important when investing through an entity to ensure that the individual signing for the entity answers the suitability questions for the entity and not himself. Again, failure to properly fill out the suitability questionnaire causes delays and leads to additional follow up being necessary.
Additionally, it is important to ensure that for 506(c) offerings, the entity is providing evidence that it is accredited, not the individual who is signing for the entity. Rule 501 of Regulation D defines what makes an individual or entity accredited. Some entities, such as banks or broker-dealers, are accredited merely on the basis of the type of business they perform and the fact they are registered. Other entities, such as certain retirement funds, corporations, or partnerships, are accredited only if they have more than $5,000,000 in assets. Then there are trusts. A trust can either be accredited on the basis of having more than $5,000,000, or, if it is a grantor revocable trust (or an irrevocable trust that meets a host of requirements), it can be accredited on the basis that the grantor is accredited. This mirrors one of the most common methods of accreditation for entities we see — accrediting on the basis that all of the equity owners are accredited.
Investing through an entity is common way to make an investment into a private placement, but there are many mistakes that one can make that can affect the investment. The bottom line is that an individual investing through an entity should always keep in mind that the entity, which is separate from the individual, is the investor. As a result, there are different rules and formalities that should be followed.
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Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.