How to Raise Capital & What is the Lifetime Value of Your Investors
How should you raise capital for your first real estate deal? What is the lifetime value of your investors? Should you get investment commitments or a deal first? Dave Dubeau has been investing in real estate since 2003 and helps beginner investors to learn how to raise capital.
Let's say we're ready to do a first raise. I have a list I have relationships, people know what I have been doing. What is the first thing that I should do?
You're setting the stage that's way beyond where most people are. Most people, when they start raising capital, are a best kept secret, a lot of the people that they hang around with don't know that they're actively investing in real estate or don't really know what they're up to. The first step is, in my opinion, to create a target group of prospective investors that you're going to really focus in on. Most of the clients that we work with are what are called Mom and Pop real estate investors who are just getting started with raising capital, they haven't done it before, they want to raise their first $500,000 - $1.5 million. If you're looking to raise 10s of millions of dollars the day after tomorrow, this is going to be pretty basic for you. With that in mind, we want to focus on the highest likelihood of success. If you don't have a track record with raising capital yet, who is going to invest with you? A big mistake I see a lot of people making is they go out to the general public, anybody with a pulse and a checkbook, they think could be a good prospective investor. For somebody to start investing with you, they need to know you, they need to like you, they need to trust you with their money. If you're going out to strangers, they don't know you, they don't like you, they certainly do not trust you with their money. That's a very difficult hurdle to overcome off the get go.
The second challenge is this organization called the Securities and Exchange Commission. They say that it's illegal for us as mom and pop investors to go out and raise capital from the general public unless we're either licensed to do so, or we have exemptions, an offering memorandum, our corporate structure all set up in a certain way, which tends to be quite expensive, especially if you're just getting started. So we want to start with people that we have a pre existing relationship with, because we are allowed to work with close friends, family members and business associates, if we do it properly. So let's create a target group of between 150 and 200 of these people, and let's focus all of our initial energies on communicating with them and break the ice with them. Reconnect with them on a personal level first, before we start talking business, before we start talking real estate.
We do a very simple three step, warm up campaign, or break the ice campaign. We send the first couple of messages automated via email. Hey, it's Dave, it's been a while since we've been in contact, just thought I'd reach out, see how you're doing, catch up a little bit. Here's what I've been up to. Do a brief overview of what you've been up to for the last three, four, or five years. And then at the end of it, Enough about me. How about you? How are you doing? Please reply to this email, I'd love to reconnect and find out how you're doing. Send that out to all 200 people, and then your job is to answer emails. Don't worry, not all 200 people are going to get back to you. If you're doing it right, you'll probably have somewhere between 15 and 25 people responding back you. There's capital in those reconnections, make sure you have a little bit of back and forth even if it's just by email, or instant messenger or text or whatever, go back and forth a little bit with these folks. This is going to help set the stage for actually starting to proactively market and raise capital.
Should people ask how much they would be interested in investing before or after getting a property under contract?
The chicken in the egg question. Should I have a deal in hand and then go looking for money? Or should I have the money in hand and then go look for the deal? My personal opinion is, let's get some soft commitments from prospective investors first. Let's get our investor ducks in a row and then let's go looking for properties. Because when you have a deal on the go, yes, that's a good motivator, but the challenge is, you're desperate. You need the cash for this deal, and that desperation, whether you want it or not is going to ooze out of every pore in your body. You don't want to be that creepy person that's freaking everybody out, this seems needy. I far prefer to have these capital conversations first, and get people to even sign off on an expression of interest. That's very powerful. It's not a legally binding document, it just says something like, I am willing and able to invest the sum up to $100,000 with Steff, in one of her upcoming real estate deals anytime within the next six months. Sign off on that, put the date on it, it's still not a guarantee, but that person is much more likely to invest with you when you've a deal than if they just said, Yes, I'm interested.
You talk about the lifetime value of an investor, can you elaborate on that? A lot of people don't think about that, and it's very important to know.
Let's pretend we're looking at one of your self storage facilities. The purchase price is $1.5M, you need to raise $500,000 and let's say you raise it in five $100,000 chunks. The question then becomes, how much is that investor worth to you over the lifetime of your working relationship? If I come into that deal with $150,000, and that gets me a quarter of the investor pool, then the question would be, how much is that asset going to be worth to Steff over the length of time that you're going to hold? Let's use a 10 year time frame just to have a book end, over 10 years, what do you think the total gross profit on that property is going to be, the increased value in the property, the cash flow over that time, the mortgage pay down, all of these things? Let's say $2 million and let's say they get half and you get half. That means that deal is worth $1 million to Steff over that 10 year timeframe.
You divide that by the number of investors, five, so that's $200,000. That's what that investor is worth to you for that deal. Now, the question would be, are they only going to invest in one deal with you? Or do you think they might invest in two, three or four? Let's say they invest in four deals, if the average profit that they're worth to you is $200,000 and now they invest in four deals. That's $800,000. Now, let's say they're happy with the investments they're doing with you, they will refer other investors to you, and that person would be worth something similar. That's the math that everybody should be thinking about.
When I had a business years ago, I heard about the lifetime value of a client from a guy named Jay Abraham. I crunched it for that business, the lifetime value of a client for me was $12,000. I thought that that was great. By knowing that number, I know what I'm willing to do to get a new client on board. Fast forward 15 years, I got into real estate investing, I was doing single family homes, rent to own, I crunched the number then, and my number was $120,000. That's 10x from my other business. That's why we're in the business of real estate. You're in commercial real estate investing, your numbers are even higher. The amount that investors have to put in might be a little higher as well. But you're looking at between $800,000 to 1.5 million, probably on the conservative side, per investor. So then the question becomes, how motivated are you to bring investors on board?
A lot more than I was five minutes ago.
That's a broad overview of the lifetime worth of an investor.
What are your top three tips for someone raising money today?
1. Focus on the low hanging fruit first, people that you have that pre existing relationship with, I'm firmly believe that there's at least one to $2 million dollars worth of capital, if not more, within your current contacts.
2. When it comes to the chicken and the egg, don't wait until you get a deal to start raising capital. Start raising capital now.
3. Be consistent about it. Another big mistake I see a lot of people making is they're hit and miss. When it comes to raising capital, they have a deal on the go, they're like hamsters in the cage going crazy. They either finance the deal or they don't get it. And then it's crickets until the next deal comes along. Constant, consistent, edu-taning, communication. Something else that is very important is when you talk to a non real estate person about real estate, and you're talking about cap rates, ROI, IRR, etc, their eyes glaze over, because don't understand it. Most of our prospective investors are not real estate professionals like us, so we need to simplify it.
Follow up is very important for everything, not only in this case, but on purchasing properties, hiring people, getting bids, and everything in between. The good news is that most people suck at follow up. If you're good at it, you stand out.
You invest passively, please put that passive investor hat on, what should people look for in an operator that is brand new to them? They have no idea if they're good or bad. What should they look for as they analyze that potential deal and operator?
I actually don't work with people that I don't have a pre-existing relationship with. I can't really answer that question. I know the people that I work with personally and professionally, I know of their reputation, I check them out, I get references. I've people pitch me all the time on raising capital for them or investing in their deals, but I have to know you first.