Avoid These Common Pitfalls During a Capital Raise: A Cautionary Guide

When raising capital, it’s essential to recognize and avoid common pitfalls that can jeopardize the process. Certain topics, if discussed inappropriately, can lead to significant complications. This guide outlines critical areas to be cautious about, helping ensure that your capital-raising efforts remain on solid ground.

Misaligned Expectations Between Sponsors and Investors

One of the primary mistakes observed during capital raises is the tendency to provide advice in areas where expertise is lacking, particularly in tax, legal, and investment matters. While these topics are often integral to discussions surrounding capital raises, offering specific advice can lead to unintended consequences. It is important to understand that advice on these topics should be left to professionals who are equipped to handle them.

Discussing tax-related topics such as depreciation can be challenging. In passive investments, depreciation rules are complex and highly situation-specific. Passive losses usually offset only passive gains unless the investor qualifies as a real estate professional, in which case those losses may be treated as active. Because tax outcomes vary widely by investor, providing tax guidance without a full understanding of individual circumstances can be misleading and potentially harmful.

It is best to avoid giving tax advice and instead direct investors to their own accountants. The same applies to legal matters, which should be handled by qualified legal professionals. Investment advice also requires caution, as meaningful guidance is impossible without a clear understanding of an investor’s personal situation. Presenting an opportunity as suitable without proper analysis can be misleading, unethical, and legally risky.

In summary, during a capital raise, it is crucial to steer clear of offering tax, legal, or investment advice. Always include standard disclaimers, clarifying that you are not acting as their accountant, lawyer, or financial advisor. By doing so, the integrity of the capital-raising process is preserved, and potential liabilities are minimized.

Understanding Solicitation Rules During a Capital Raise

In capital raising—especially through syndications and securities—it is essential to understand the rules that govern these activities. When raising capital through securities, an entity must either register publicly or qualify for an exemption. One of the most commonly used exemptions is Regulation D, which includes Rule 506(b) and Rule 506(c).

Rule 506(b) vs 506(c): What You Can and Cannot Communicate

A common question during a capital raise under Rule 506(b) is what can and cannot be communicated. The primary restriction is the prohibition on general solicitation, which includes publicly promoting or advertising a capital raise. When relying on a 506(b) exemption, you should not publicly state that funds are being raised for a specific deal. Some legal professionals also recommend avoiding any mention of raising capital altogether, as it may be interpreted as solicitation.

It is important to distinguish between what is restricted and what is permitted under Rule 506(b). While publicly discussing specific deals is prohibited, marketing yourself or your business is allowed. You may share information about your company, the types of deals you pursue, and your general track record, as long as you avoid referencing any active offering. Crossing into deal-specific details can violate 506(b) rules.

Rule 506(c), by contrast, allows general solicitation. Under this exemption, sponsors may publicly share information about a specific deal, including asset type, target internal rate of return (IRR), and where investors can learn more. This flexibility comes with additional compliance requirements that must be followed carefully.

Understanding these distinctions and adhering to the applicable rules is essential for maintaining compliance during a capital raise.

The Importance of Disclaimers and Conservative Language in Capital Raising

Discussing past deals, track records, and historical returns can be a powerful marketing tool. Regulators are well aware of this influence. As a result, any reference to prior performance should consistently include the disclaimer that past performance is not indicative of future results. This language is not a formality; it serves as an important legal safeguard against claims of implied guarantees.

If a deal underperforms, investors who incur losses may pursue legal action. In those cases, attorneys will closely review all communications and marketing materials to assess whether any promises were made, particularly regarding the return of capital. For this reason, it is essential to clearly separate historical results from expectations for current or future deals and to reinforce that prior performance does not predict future outcomes.

Why Language Choice Matters in Investor Communications

In marketing materials, it is best to avoid the term “projections” and use “target” instead. This terminology is more consistent with the language used by institutional investors and broker-dealers. The word “target” reflects an intended outcome without implying certainty, whereas “projections” may suggest guaranteed results.

Using Conservative Language to Build Investor Trust

For investors conducting due diligence, language strongly shapes their perception of the operator. It is important to demonstrate commitment and competence without overselling or making unrealistic claims. Using conservative language signals prudence and discipline, reinforcing that investor interests come first. This includes setting targets that are reasonable and defensible rather than overly optimistic.

Consistently referring to “target returns” instead of “projections,” while reinforcing standard disclaimers, helps establish credibility. Trust is further strengthened when financial buffers are structured in favor of investors, reflecting a conservative and responsible approach to capital management.

The Role of Disclosures in Capital Raising

Why Clear Disclosures Protect Both Investors and Operators

Clear and consistent disclosures are not only a legal requirement but also a strategic advantage in capital raising. Reiterating that you are not providing tax, legal, or investment advice reinforces professionalism and proper boundaries. Consistently reminding investors that past performance does not predict future results, and that projections represent targets, further strengthens credibility. This level of transparency positions the operator as disciplined, conscientious, and trustworthy.

Using Transparency to Manage Investor Expectations

Using these disclaimers effectively communicates that while every effort is made to achieve the best possible outcomes, there are inherent risks in any investment. By acknowledging these risks upfront and stating that certain factors are beyond your control, you manage investor expectations realistically. This level of honesty not only protects you legally but also strengthens the relationship with your investors by building trust through clear communication.

While this approach might seem daunting, it’s important to remember that transparency and caution do not hinder your ability to raise capital. On the contrary, they contribute to a more robust and sustainable capital-raising strategy. When you clearly articulate the risks and uncertainties, investors are more likely to appreciate your candor and view you as a reliable partner who values their interests. This trust is invaluable, especially when deals do not perform as expected.

Moreover, incorporating these disclosures can provide peace of mind. By ensuring that your communications and marketing materials include these disclaimers, you reduce the likelihood of misunderstandings or legal challenges should a deal go sideways. This proactive approach helps avoid sleepless nights worrying about whether something said or written might be taken out of context.

In conclusion, by being mindful of what you say, particularly when dealing with a 506(b) exemption, and by including necessary disclaimers, you set yourself up for success. This practice not only protects you legally but also enhances your reputation, allowing you to raise capital with greater confidence and integrity.

With these guidelines in place, may your efforts to raise capital be both fruitful and secure.

Going Deeper on Capital Raising and Investor Alignment

Raising capital effectively requires more than understanding the rules. It requires clear structure, disciplined communication, and alignment between sponsors and investors over the life of a deal.

For investors and operators who want to explore how experienced multifamily teams approach capital raising, deal structuring, and investor expectations, you can learn more about the educational frameworks used inside MIH.

Learn more about the MIH Multifamily Mastermind

Disclaimer: This information is provided for educational purposes only and does not constitute tax or legal advice. Readers should consult with their own professional advisors for tailored guidance.