DPP BEST PRACTICES

Dana Woodbury, ModeratorPresident, Buttonwood Investment Services

Rick ChessPartner, Chess Law Firm, PLC

Kirk MichiePartner, Triton Pacific Securities, LLC

Peter MagnusonManager, Due Diligence, Securities America

Defining terms

Understanding the assets

classes

Learning structures

Portfolio implementation

Conducting due diligence

Economics of the deal

Suitability

Comparing offerings

Due Diligence

Sponsor

Offering / Programs

Asset class

Assets

Sponsors

How Well Capitalized

Depth of Management

Prior Performance

Offering / Programs

Viability of Business Plan

Does Their Fee Structure Put The Investor First?

What are their fees?

Asset Class

Macro View – Does It Make Sense?

Is the Time Right?

Is It Geographically Appropriate?

Assets

Do The Individual Assets Make Sense?

Economics of the Offering

Risk vs. Return

What is investment risk?

Are there other more liquid investments?

Are there other less expensive investments with comparable

Objectives?

Risks Investing in DPPs• Asset class risk – market cycles• Specific asset risk• Credit risk• Illiquidity • Leverage risk• Sponsor / Manager risk

Key Points to Consider:1. Judge an investment primary on its economics and secondary on

its tax benefits. 2. Prior performance doesn’t guarantee future results – but should

be reviewed.3. Like in traditional investments generally, the more risk the more

return.

Rules and Regulations that apply to DPPs

FINRA 11-02: Know your customerFINRA 10-22: Reg. D regulation and Due DiligenceFINRA 09-27: Member private offeringsNASD 05-18: Private placement of TICsNASD Rule 2310/FINRA 10-22: Suitability

Many more…..

Suitability• FINRA Rule 2111 replaced NASD Rule

2030 (Effective October 2011)• New Suitability Framework – 3

obligationsReasonable basis – suitable for some investors – reasonable

investigation required.Customer specific – suitable for that investor based on profile

factorsQuantitative – series of transactions

• Recommendation trigger – facts/circumstances

Suitability AnalysisNet worth & Income: Accredited, Qualified and Institutional

Position: Asset allocation, age, experience, time, liquidity needs, risk tolerance, etc.

BD/Rep: Reasonable basis

RIA/IAR: Fiduciary duty (clients best interest)

State: Regulations and limitations

Suitability

Basic Suitability for Public non-traded Alternatives 1. A minimum net worth (exclusive of home, home

furnishings, and personal automobiles) of at least $250,000 or

2. A minimum net worth (as previously described) of at least $70,000 and a minimum annual gross income of at least $70,000.

Certain states may have additional requirements or concentration limitations.

Suitability – Accredited Investor1. A natural person who has individual net worth, or joint net worth with

the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;

2. A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or

3. A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

4. A bank, insurance company, registered investment company, business development company, or small business investment company;

5. An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;

6. A charitable organization, corporation, or partnership with assets exceeding $5 million;

7. A director, executive officer, or general partner of the company selling the securities;

8. A business in which all the equity owners are accredited investors

Rules and Regulations for Reg. D

While Regulation D securities are exempt from SEC registration they still have many rules and regulations that must followed:• Anti-fraud provisions• Blue Sky laws• Form D filing with SEC• PPMs numbered/tracked• Private Placement selling restrictions

General Solicitation – JOBS ActJOBS Act

Directs the SEC to amend rule to permit general solicitation of offerings exempted from registration (Reg. D offerings)

SEC RuleIssuer takes reasonable steps to verify that

investors are accredited, andAll investors actually are accredited or the

issuer reasonably believes so at the time of sale

Potential Investor BenefitsPortfolio Diversification

Traditionally a negative correlation with the value of more liquid securities (e.g., stocks)

Reduced Portfolio Volatility Investor risk is effectively spread among multiple assetsInflation HedgeMany alternative investments are hard assets which general rise

with inflationCash Flow for IncomeUnderlying assets generates income at rates in excess of prevailing

interest ratesGrowth for Total Return Underlying assets may appreciate over the term of the investment

providing capital appreciation. Capital Preservation Underlying assets are often hard assets (sometimes insured) or

may be investments in a senior position or with collateral.

Potential Tax BenefitsAvoid double taxation of stock

1. REITs2. BDCs3. Partnership structure subject to Subchapter K (i.e., not

subject to entity-level income tax before flow through /distribution to investors).

Tax deferral through Section 1031 like-kind exchangeInvestors may be able to exchange their interest in the entity for

other interests in a Section 1031 like-kind exchange.Investors generally take a basis in new investment equal to their

basis in the old investment rather than pay tax on the exchange.

Depreciation Depending on the underlying investment property, investors

may receive a share of depreciation deductions.

Potential Tax BenefitsPassive Income / Losses

Investors will generally be deemed to receive passive income or losses.

Passive losses may only be applied against passive income, but any excess passive losses are carried over to the next year.

Drilling Costs and Depletion from Energy Based InvestmentsIntangible Drilling Costs (labor, chemicals, etc.) – 100%

deductible during first year (I.R.C. 263)Tangible Drilling Costs (equipment) – 100% deductible over

seven-year useful life (I.R.C. 263)Tax Credits / Incentives from States or Federal GovernmentLow-Income / Affordable HousingHistoric Building RestorationAlternative or Green Energy

Fees

Front-End Load• Sales Commissions• Offering & Organization

• Legal• Printing• Sponsor Due Diligence

• Wholesaler Commissions

More Fees

Operational• Property Management• Asset Management

• Legal• Printing• Sponsor Due Diligence

• Construction Fees• Leasing commissions & tenant improvements• Capital expenditures• NNN vs. NN vs. N

And More Fees

Liquidation• Brokerage fees• Internalization fees

• Advisor• Board of Directors• Sponsor

• Listing Fees• Profit Sharing

Securities licensing for DPPs

Series 7 – General Securities & REITs & BDCs

Series 22 – Private DPPsSeries 62 – Corporate SecuritiesSeries 63 – State RegistrationSeries 65 - RIA

Obtaining your DPP Designation

• Earn the Direct Participation Professional (DPP) designation – Eight (8) credit hours

• Two required core classes

Fundamentals of Direct Participation Programs (1 DPP credit)

Best Practices in Direct Participation Programs (1 DPP credit)

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