Red Flags to Watch For in Private Investments

What is Regulation D?

Regulation D (primarily Rules 506(b) and 506(c)) is the dominant private offering framework in the U.S. It allows issuers to raise capital from accredited investors without filing a full SEC registration. According to SEC capital formation data, Regulation D consistently represents well over half of all exempt-market capital formation in the United States, and in recent years has accounted for multiple trillions of dollars in aggregate annual capital raised.

In this article, we outline several of the principal red flags that frequently arise in private investment offerings, particularly those utilizing the Regulation D exemption, that investors should keep in mind during their diligence review.

Red Flags

1) Unclear business model or unsubstantiated commercial rationale

An issuer should be able to concisely articulate its product, target customer, and economic value. Excessive reliance on industry-wide TAM (Total Addressable Market), aspirational positioning, or conceptual narratives, without observable revenue numbers or customer unit economics, may indicate that the offering lacks operational grounding or economic logic.

2) Documentation inconsistency across offering materials

If pitch decks, pro forma models, offering memoranda, or subscription agreements reflect differing numbers, materially different assumptions, or inconsistent disclosures, it suggests an inadequate internal review. 

Additionally, repeated typos, formatting inconsistencies, or language errors in formal offering documents can themselves be an indicator of weak internal controls.

High quality issuers typically apply the same precision in investor communications that they apply to capital allocation. The presence of limited offering materials, basic drafting, or grammatical errors may reflect rushed preparation, insufficient legal review, or a lack of procedural rigor.

Although Regulation D offerings are exempt from full SEC registration, issuers must still meet disclosure requirements, verify investor qualifications, and comply with anti-fraud provisions. Offering materials prepared by an issuer in absence of legal counsel risk incomplete or misleading documents and potential violations that could result in legal and financial consequences.

3) Urgency or pressure-based selling

Professional issuers expect investors to conduct due diligence. Attempts to accelerate subscription decisions, minimize questions, or discourage document review signal that speed is being prioritized over investor suitability and transparency. A well-governed issuer welcomes inquiry from investors.

4) Unresolved tax liens, litigation matters, regulatory findings, or prior securities-law violations

Previous violations of securities law, substantial tax liens, major credit defaults, foreclosures, or bankruptcies, particularly when recent and not transparently addressed, may indicate weak financial judgment.

Avoidance, minimization, or refusal to provide documentation and timeline detail is itself a red flag. Investors should refrain from participating in offerings where these matters are not fully disclosed or supported with evidence of remediation.

5) No founder “skin in the game”

Alignment is a core underwriting principle. If investors are contributing most of the capital while founders are not making proportional commitments, investors may be accepting disproportionate downside risk. Misalignment of incentives materially increases the probability that founders and sponsors may:

• pursue high-volatility strategies (“swing for the fences”) to compensate for limited personal downside

• extract liquidity prior to operational maturity

• authorize dilutive capital raises that disproportionately impact outside investors

Investors should closely evaluate capitalization tables, compensation levels, and downside exposure to ensure that economics are meaningfully tied to long-term performance.

Additional Real Estate / Real Asset Specific Red Flags

Beyond the general concerns above, private real estate offerings, including Reg D offerings, Series LLC farmland investment vehicles, and development stage strategies, present additional diligence considerations. Examples include:

• Opaque fee waterfalls / promote mechanics: If the waterfalls / promote structure cannot be diagrammed in less than one page, economic alignment is unclear by design. 

• Sponsor track record is limited, non-verifiable, or not relevant to the stated business plan: A real estate sponsor should be able to demonstrate completed projects of similar size and asset class. If past performance cannot be independently substantiated, if claims rely solely on anecdotal narrative, or if the sponsor’s experience is in an unrelated discipline, investors carry risk that may not be priced into the underwriting.

• Underwriting that reflects only the best-case scenarios with no adverse case modelling: Pro forma returns should reflect more than a single optimistic scenario. Credible underwriting should also evaluate downside cases (e.g., slower lease up, higher operating expenses, budget overrun, lower exit valuations, tenant rollover risk, etc.). When the underwriting model assumes only frictionless execution and does not quantify downside scenarios, investors should be doubtful of the risk-return profile presented by the issuer. 

  
  

Disclosure

The information contained herein is for informational purposes only, is not intended to be and shall not be construed as investment advice, an offer to sell, a solicitation of an offer to buy, or a recommendation of any security. Private investments are speculative, illiquid, and may involve a high degree of risk. Past performance is not indicative of future results. Investors should conduct their own research, consult with their own advisors, and carefully review offering documents prior to making any investment decision.