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EX-3.3 - EX-3.3 - Shepherd's Finance, LLCd315903dex33.htm
EX-5.1 - EX-5.1 - Shepherd's Finance, LLCd315903dex51.htm
EX-4.1 - EX-4.1 - Shepherd's Finance, LLCd315903dex41.htm
EX-3.2 - EX-3.2 - Shepherd's Finance, LLCd315903dex32.htm
EX-3.1 - EX-3.1 - Shepherd's Finance, LLCd315903dex31.htm
EX-10.9 - EX-10.9 - Shepherd's Finance, LLCd315903dex109.htm
EX-24.1 - EX-24.1 - Shepherd's Finance, LLCd315903dex241.htm
EX-25.1 - EX-25.1 - Shepherd's Finance, LLCd315903dex251.htm
EX-10.7 - EX-10.7 - Shepherd's Finance, LLCd315903dex107.htm
EX-10.5 - EX-10.5 - Shepherd's Finance, LLCd315903dex105.htm
EX-21.1 - EX-21.1 - Shepherd's Finance, LLCd315903dex211.htm
EX-10.1 - EX-10.1 - Shepherd's Finance, LLCd315903dex101.htm
EX-23.1 - EX-23.1 - Shepherd's Finance, LLCd315903dex231.htm
EX-10.3 - EX-10.3 - Shepherd's Finance, LLCd315903dex103.htm
EX-10.2 - EX-10.2 - Shepherd's Finance, LLCd315903dex102.htm
EX-10.8 - EX-10.8 - Shepherd's Finance, LLCd315903dex108.htm
EX-10.6 - EX-10.6 - Shepherd's Finance, LLCd315903dex106.htm
EX-10.4 - EX-10.4 - Shepherd's Finance, LLCd315903dex104.htm
EX-10.12 - EX-10.12 - Shepherd's Finance, LLCd315903dex1012.htm
EX-10.13 - EX-10.13 - Shepherd's Finance, LLCd315903dex1013.htm
EX-10.10 - EX-10.10 - Shepherd's Finance, LLCd315903dex1010.htm
EX-10.14 - EX-10.14 - Shepherd's Finance, LLCd315903dex1014.htm
EX-10.11 - EX-10.11 - Shepherd's Finance, LLCd315903dex1011.htm
Table of Contents

As filed with the Securities and Exchange Commission on May 11, 2012

Registration No.

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM S-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

Shepherd’s Finance, LLC

(Exact name of registrant as specified in its charter)

 

Delaware   6153   36-4608739

(State or jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

 

3508 Washington Road

McMurray, Pennsylvania 15317

(412) 913-8719

(Address, including zip code, and telephone number, including area code, of principal executive offices)

Daniel M. Wallach

Chief Executive Officer

3508 Washington Road

McMurray, Pennsylvania 15317

(412) 913-8719

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies of all communications, including copies of all communications sent to agent for service, should be sent to:

Michael K. Rafter, Esq.

Baker, Donelson, Bearman,

Caldwell & Berkowitz, PC

3414 Peachtree Road, Suite 1600

Atlanta, Georgia 30326

Telephone: (404) 443-6702

Facsimile: (404) 238-9626

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. x

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨

  Accelerated filer ¨  

Non-accelerated filer ¨

(Do not check if a

smaller reporting company)

  Smaller reporting company x

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of Securities

to be Registered

 

Proposed Maximum

Aggregate Offering

Price (1)

 

Amount of

Registration Fee (2)

Fixed Rate Subordinated Notes

  $700,000,000   $80,220

 

 

(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o)

(2) Pursuant to Rule 457(p) of the Securities Act of 1933, $80,220 of the filing fee previously paid for the terminated offering of Fixed Rate Subordinated Notes of Shepherd’s Finance, LLC pursuant to its Registration Statement on Form S-1 (File No. 333-180727), initially filed on April 13, 2012, is offset against the currently due filing fee.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant files a further amendment which specifically states that this Registration Statement will thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement becomes effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission and various states is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION – PRELIMINARY PROSPECTUS DATED MAY 11, 2012

SHEPHERD’S FINANCE, LLC

$700,000,000 Fixed Rate Subordinated Notes

Shepherd’s Finance, LLC is offering up to $700,000,000 in aggregate principal amount of our Fixed Rate Subordinated Notes (“Notes”) on a continuous basis. The initial minimum investment amount required is $500. From time to time, we may, however, change the minimum investment amount that is required. The maximum investment amount per investor is $1,000,000 aggregate principal amount, or $1,000,000 per Note, but a higher maximum investment amount may be approved on a case-by-case basis.

We will issue the Notes in varying purchase amounts and maturities that we will establish from time to time. For each purchase amount and maturity, we also will establish an interest rate. The maturity dates for our Notes may range from one year to four years.

We may market our Notes in many ways, including but not limited to, publishing the then current features (e.g. the maturities and interest rates currently offered by us) of the Notes in newspapers or on billboards, advertising on the internet and through direct mail campaigns. At any time, you also may obtain the then applicable features of the Notes from our web site at www.shepherdsfinance.com or by calling             -            -            (toll free). However, the information on our website is not a part of this prospectus. Upon any change in the features of the Notes, we will file a Rule 424(b)(2) prospectus supplement setting forth the then applicable features.

We are offering the Notes directly, without an underwriter or placement agent, and on a continuous basis. We do not have to sell any minimum amount of Notes to accept and use the proceeds of this offering. Therefore, once you purchase a Note, we may immediately use the proceeds of your investment and your investment will be returned only if we repay your Note. We cannot assure you that all or any portion of the Notes we are offering will be sold. We have not made any arrangement to place any of the proceeds from this offering in an escrow, trust or similar account. The Notes are not listed on any securities exchange and there will not be any public trading market for the Notes. We have the right to reject any investment, in whole or in part, for any reason.

We may redeem the Note, in whole or in part, at any time prior to maturity, upon 30 to 60 days’ written notice, for a redemption price equal to the principal amount plus any earned but unpaid interest thereon to the date of redemption. Additionally, you may request early redemption of a Note purchased by you at any time on or after 180 calendar days after issuance of a Note, but we reserve the right to decline your request for any reason. If we grant your redemption request, we will mail you a payment equal to the principal amount plus any earned but unpaid interest to the date of redemption, minus a 180-day interest penalty.

The Notes mature between one and four years from the date of issuance. Between 30 to 60 days prior to the maturity date, we will mail to you a letter notifying you of the upcoming maturity date and, if we are offering you any renewal options and have an effective offering available, a renewal form containing instructions to exercise the renewal options. If you do not respond, principal and any earned but unpaid interest will be paid to you.

You should read this prospectus and any applicable prospectus supplement carefully before you invest in the Notes. The Notes are our general unsecured obligations and are subordinated in right of payment to all of our present and future senior debt. As of the year ended December 31, 2011, we had $2,378,091 in debt outstanding that ranks equal or senior to the Notes offered pursuant to this prospectus. We expect to incur additional debt in the future, including without limitation, the Notes offered pursuant to this prospectus and senior debt (from banks or related parties).

The Notes are not certificates of deposit or similar obligations guaranteed by any depository institution and are not insured by the Federal Deposit Insurance Corporation (FDIC) or any governmental or private insurance fund, or any other entity. We do not contribute funds to a separate account such as a sinking fund to repay the Notes upon maturity.

 

   

Our Notes are not insured or guaranteed by the FDIC or any third party, so repayment of your Note depends upon our ability to manage our business and generate adequate cash flows.

 

   

The Notes are risky speculative investments. Therefore, you should not invest in the Notes unless you are able to afford the loss of your entire investment.

 

   

There will not be any market for the Notes, so you should only purchase them if you do not have any need for your money prior to the maturity of the Note.

 

   

We can provide no assurance that any Notes will be sold or that we will raise sufficient proceeds to carry out our business plans. If we do not raise sufficient funds for our business plan, we may not be able to generate enough cash to repay the Notes that have been sold.

 

   

You will not have the benefit of an independent review of the terms of the Notes, the prospectus or our Company, as is customarily performed in underwritten offerings.

 

   

Payment on the Notes is subordinate to the payment of our outstanding present and future senior debt. Since there is no limit on the amount of senior debt we may incur, our present and future senior debt may make it difficult to repay the Notes.

 

   

We are controlled by Daniel M. Wallach, as, currently, he is our only officer and beneficially owns all of our outstanding membership interests.

 

   

If we lose or are unable to hire or retain key personnel, we may be delayed or unable to implement our business plan, which would adversely affect our ability to repay the Notes.

 

   

We have a limited operating history and limited experience operating as a company, so we may not be able to successfully operate our business or generate sufficient revenue.

 

   

Currently, we are reliant on a single developer and homebuilder for all of our revenues and a portion of our financing.

 

   

Our operations are not subject to the stringent banking regulatory requirements designed to protect investors, so repayment of your investment is completely dependent upon our successful operation of our business.

 

   

Most of our assets will be commercial construction loans to homebuilders and/or developers which are a higher than average credit risk, and therefore could expose us to higher rates of loan defaults, which could impact our ability to repay amounts owed to you.

 

   

Our Chief Executive Officer (who is also on our Board of Managers) will face conflicts of interest as a result of the secured affiliated loans made to us, which could result in actions that are not in the best interests of our Note holders.

See “Risk Factors” beginning on page 14 for significant factors you should consider before buying the Notes.

These securities have not been approved or disapproved by the Securities and Exchange Commission or any state securities commission, and neither the Securities and Exchange Commission nor any state securities commission has passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

      Price to Public   Underwriting Discount and Commission (1)    Proceeds to  Company (2)

Per Note

   100%   None    100%

Total

   $700,000,000   None    $700,000,000

(1) The Notes are not being offered or sold pursuant to any underwriting or similar agreement, and no commissions or other remuneration will be paid in connection with their sale. The Notes will be sold at face value.

(2)We will receive all of the net proceeds from the sale of the Notes, which, if we sell all of the Notes covered by this prospectus, we estimate will total approximately $698,482,000 after expenses.

The date of this prospectus is             , 2012


Table of Contents

SHEPHERD’S FINANCE, LLC

TABLE OF CONTENTS

 

QUESTIONS AND ANSWERS

     1   

PROSPECTUS SUMMARY

     8   

Our Company and Our Business

     8   

The Offering

     9   

Summary of Consolidated Financial Data

     12   

RISK FACTORS

     14   

Risks Related to Our Offering and Structure

     14   

Risks Related to Our Business

     17   

Risks Related to Conflicts of Interest

     24   

FORWARD-LOOKING STATEMENTS

     25   

USE OF PROCEEDS

     26   

SELECTED FINANCIAL DATA

     27   

BUSINESS

     29   

Overview

     29   

Investment Objectives and Opportunity

     29   

Our Loan Portfolio

     33   

Competition

     36   

Regulatory Matters

     36   

Legal Proceedings

     37   

Reports to Security Holders

     37   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     37   

Overview

     37   

Critical Accounting Estimates

     41   

Consolidated Results of Operations

     43   

Consolidated Financial Position

     45   

Contractual Obligations

     47   

Off-Balance Sheet Arrangements

     47   

Liquidity and Capital Resources

     47   

Inflation, Interest Rates, and Housing Starts

     49   

Recent Accounting Pronouncements

     51   

Internal Control over Financial Reporting

     51   

MANAGEMENT

     51   

Executive Officers

     51   

Board of Managers

     52   

 

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Committees of the Board of Managers

     52   

Limitations on Liability

     53   

EXECUTIVE COMPENSATION

     54   

Executive Officer Compensation

     54   

Board of Managers Compensation

     54   

PRINCIPAL SECURITY HOLDERS

     55   

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     55   

Transactions with Affiliates

     55   

Affiliate Transaction Policy

     55   

DESCRIPTION OF NOTES

     56   

General

     56   

Established Features of Notes

     56   

Subordination

     57   

Redemption by Us Prior to Maturity

     57   

Redemption at the Request of the Holder Prior to Maturity

     57   

Redemption upon Your Death

     57   

Extension at Maturity

     57   

No Restrictions on Additional Debt or Business

     57   

Modification of Indenture

     58   

Place, Method and Time of Payment

     58   

Events of Default

     58   

Satisfaction and Discharge of Indenture

     59   

Reports

     59   

Service Charges

     59   

Book Entry Record of Your Ownership

     59   

Transfer

     59   

Concerning the Trustee

     59   

PLAN OF DISTRIBUTION

     59   

CHARITABLE MATCH PROGRAM

     60   

LEGAL MATTERS

     61   

EXPERTS

     61   

WHERE YOU CAN FIND MORE INFORMATION

     61   

INDEX TO FINANCIAL STATEMENTS

     61   

You should rely only upon the information contained in this prospectus. We have not authorized anyone to

provide you with information different from that contained in this prospectus. We are offering to sell the

Notes only in jurisdictions where offers and sales are permitted.

 

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Table of Contents

QUESTIONS AND ANSWERS

Below we have provided some of the more frequently asked questions and answers relating to the offering of the Notes. Please see the “Prospectus Summary” and the remainder of the prospectus for more information about the offering of the Notes.

 

 

 

Q: Who is Shepherd’s Finance, LLC?

 

A: Shepherd’s Finance, LLC, along with our consolidated subsidiaries, (“Shepherd’s Finance,” “we,” “our,” “us” or the “Company”) is a finance company organized as a limited liability company in the State of Delaware. Our business is focused on commercial lending to participants in the residential construction and development business. Our Chief Executive Officer (who is also on our Board of Managers) is Daniel M. Wallach. Mr. Wallach is responsible for overseeing our day-to-day operations. We were organized in the Commonwealth of Pennsylvania in 2007 under the name 84 RE Partners, LLC and changed our name to Shepherd’s Finance, LLC on December 2, 2011. We converted to a Delaware limited liability company on March 29, 2012.We are located in McMurray, Pennsylvania, a suburb of Pittsburgh.

All of our outstanding membership interests are owned directly or beneficially by Mr. Wallach and his wife; therefore, Mr. Wallach is able to exercise significant control over our business, including with respect to the composition of our Board of Managers. A Manager may be removed by a vote of holders of 80% of our outstanding voting membership interests.

 

 

 

Q: What are your primary business activities?

 

A: We plan on extending and servicing commercial loans to small to medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. We also will extend and service loans for the purchase of undeveloped land and the development of that land into residential building lots. Most of the loans will be for “spec homes” or “spec lots,” meaning they are built or developed speculatively (with no specific end-user homeowner in mind). The loans will be secured, and the collateral will be the land, lots, and constructed items thereon, as well as additional collateral, as we deem appropriate.

On December 30, 2011, we extended three commercial loans for the acquisition and development of lots and land in a suburb of Pittsburgh, Pennsylvania. One loan is collateralized by 16 building lots and an unimproved parcel of land of approximately 34 acres. The other two loans are collateralized by approximately 54 acres of undeveloped land. One of these other two loans is for a portion of the purchase price and other general purposes of the borrower (including the funding of a loan to us), and the other is for the development of the land into building lots. The total advanced on these loans as of December 31, 2011 was $5,504,497. The estimated value of the total collateral for these loans was $7,550,000, which is based on an appraisal of the collateral prepared for us in March 2012.

 

 

 

Q: What is your experience in this type of lending?

 

A:

Our Chief Executive Officer, Daniel M. Wallach, has been in the housing industry since 1985. He was the CFO of a multi-billion dollar supplier of building materials to home builders for eleven years. He also was responsible for that company’s lending business for twenty years. During those years, he was responsible for the creation and implementation of many secured lending programs to builders. Some of these were done fully by that company, and some were done in partnership with banks. In general, the creation of all loans, and the resolution of defaulted loans, was his responsibility whether the loans were company loans or loans in partnership with banks. Through these programs, he was responsible for the creation of approximately $2,000,000,000 in loans which generated interest spread after deducting for loan losses of

 

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  approximately $55,000,000. Through the years, he managed the development of systems for reducing and managing the risks and losses on defaulted loans. Mr. Wallach also was responsible for that company’s unsecured debt to builders, which reached over $300,000,000 at its peak. He also gained experience in securing defaulted unsecured debt at that company.

 

 

 

Q: Given the current low number of housing starts in the U.S. today, why will your potential customers want to borrow from you?

 

A: While the number of housing starts has dropped to historically low levels, there are still more than 400,000 single family homes being built in the U.S. on a yearly basis. Many small to medium size home builders can build homes for customers who have their own financing, but are unable to supply financing to build speculative or model homes. The ability to have either a speculative home or a model home can greatly increase the total number of homes they can sell per year, so despite the high cost of that type of financing today, we believe that there is a significant demand for it. Banks, which historically have been the most popular provider of that type of financing, are mostly not in that business today, or in the business at a greatly reduced level. We believe that this void in supply gives us the opportunity to profit in this business niche.

 

 

 

Q: What is the role of the Board of Managers?

 

A: While our officer is responsible for our day-to-day operations, our Board of Managers is responsible for overseeing our business. Our Board of Managers is comprised of Daniel M. Wallach, who is also our Chief Executive Officer, and two independent Managers–Bill Myrick and Kenneth R. Summers.

 

 

 

Q: What kind of offering is this?

 

A: We are offering up to $700,000,000 in Notes.

 

 

 

Q: How are the Notes sold?

 

A: The Notes are offered directly by us without an underwriter or placement agent. We intend to market the Notes primarily by advertisements in local and/or national newspapers, roadway sign advertisements, advertisements on the internet, or through direct mail campaigns and other miscellaneous media in states in which we have properly registered the offering or qualified for an exemption from registration.

 

 

 

Q: What will you do with the proceeds raised from this offering?

 

A: If all of the Notes offered by this prospectus are sold, we expect to receive approximately $698,482,000 in net proceeds (after deducting all costs and expenses associated with this offering). We intend to use substantially all of the net proceeds from this offering as follows and in the following order of priority:

 

   

to make payments on other borrowings, including loans from affiliates;

   

to pay Notes on their scheduled due date and Notes that we are required to redeem early;

   

to make interest payments on the Notes; and

   

to the extent we have remaining net proceeds and adequate cash on hand, to fund any one or more of the following activities:

  ¡    

to extend commercial construction loans to homebuilders to build single or multi-family homes or develop lots;

 

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  ¡    

to make distributions to equity owners;

  ¡    

for working capital and other corporate purposes;

  ¡    

to purchase defaulted secured debt from financial institutions at a discount;

  ¡    

to purchase defaulted unsecured debt from suppliers to homebuilders at a discount and then secure it with real estate or other collateral;

  ¡    

to purchase real estate, which we will operate our business in; and

  ¡    

to redeem Notes which we have decided to redeem prior to maturity.

 

 

 

Q: What is a Note?

 

A: A Note is our promise to pay you a specified rate of interest for a specific period of time and to repay your principal investment upon maturity. The Notes are our general unsecured obligations and are subordinate in right of payment to all present and future senior debt. “Subordinated” means that if we are unable to pay our debts as they come due, all of the senior debt would be paid in full first. After the senior debt is paid in full, any remaining money would be used to repay the Notes and other subordinated debt that are equal to the Notes in priority. As of December 31, 2011, we had $878,091 in senior debt, and $1,500,000 in subordinated debt. We expect to incur debt in the future, including more senior debt and the Notes offered pursuant to this prospectus.

 

 

 

Q: What is an indenture?

 

A: As required by United States federal law, the Notes will be governed by a document called an “indenture.” An indenture is a contract between us and a trustee. The main role of the trustee is to enforce your rights against us if we are in default of our obligations under the Notes. Defaults are described in this prospectus under “Description of Notes – Events of Default.” There are some limitations on the extent to which the trustee acts on your behalf. These limitations are described in this prospectus under “Description of Notes – Events of Default.”

The Notes will be issued under an indenture dated              between us and U.S. Bank National Association (“U.S. Bank”), as trustee. The indenture does not limit the principal amount of debt securities that we may issue under it. The indenture is governed by Pennsylvania law and will be qualified under the Trust Indenture Act of 1939.

 

 

 

Q: Is my investment in the Notes insured or guaranteed?

 

A: No, the Notes are:

 

   

NOT certificates of deposit with an insured financial institution;

   

NOT guaranteed by any depository institution; and

   

NOT insured by the FDIC or any governmental or private insurance fund, or any other person or entity.

The Notes are backed only by the faith and credit of our Company and our operations. You are dependent upon our ability to effectively manage our business to generate sufficient cash flow, including cash flow from our commercial lending activities, for the repayment of principal at maturity and the ongoing payment of interest on the Notes.

 

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Q: How is the interest rate determined?

 

A: From time to time, we will establish the interest rate(s) we are offering for various purchase amounts and maturities. By referring to the features (e.g. the maturities and interest rates) which are in effect at the time, you will see the interest rate(s) and maturity date(s) we are currently offering for your desired purchase amount. The interest rate offered on the Notes depends on which maturity date and purchase amount you select. The interest rate on a Note purchased by you is fixed and will not change over the term of the Note.

 

 

 

Q: How is interest calculated and paid to me?

 

A: Interest will be calculated based on the actual number of days your Note is outstanding. Interest is calculated and compounded monthly based on a 365-day year (366-day in case of a leap year). Interest will be earned daily, and we will pay interest to you monthly or at maturity as you request. If you choose to be paid interest at maturity rather than monthly, the interest will be compounded monthly. If any day on which a payment is due with respect to a Note is not a business day, then you will not be entitled to payment of the amount due until the following business day, and no additional interest will be due as a result of such delay. If you elect to be paid interest monthly, interest on your Note will be paid on the first business day of every month. Your first interest payment date will be the month following the month in which the Note is issued, except that if a new Note is issued within the last 10 days preceding an interest payment date, the first interest payment will be made on the next succeeding interest payment date (i.e. approximately 35-40 days after issuance). No payments under $50 will be made, with any interest payment being accrued to your benefit and earning interest on a monthly compounding basis until the payment due to you is at least $50 on an interest payment date.

 

 

 

Q: If I elect to have interest on the Note paid in one lump sum at maturity, can I change my election later?

 

A: Yes, we will allow you to change your election so that you receive monthly payments of earned and unpaid interest instead. You should contact us at         -        -             or use our website www.shepherdsfinance.com to find out what you need to do to change your election.

 

 

 

Q: When do the Notes mature?

 

A: All of our maturity dates will be at least one year from the date of issuance, but no longer than four years from the date of issuance. Not all maturity dates may be offered at all times. We will publish the maturity date(s) we are offering from time to time along with the other established features of the Notes we are then offering.

 

 

 

Q: May I renew a Note purchased by me?

 

A: Between 30 to 60 days prior to the maturity date of the Note, you will receive a letter notifying you of the upcoming maturity date and, if we are offering you any renewal options and have an effective offering available: (1) a current prospectus and (2) a renewal form containing your renewal options. The renewal form will describe the terms of the Notes offered at that time and you may select one of the renewal options offered. We may, at our choosing, offer any one or more of the following renewal options (most likely at an interest rate different from your interest rate) at:

 

   

the same term length as the original term length;

 

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a different term length;

   

various term lengths, from which you may select; or

   

other renewal terms may be offered by us at our choosing.

If you properly complete, execute and return the renewal form at least five business days prior to the maturity date, your Note will be deemed renewed under the renewal terms selected, and a Note confirmation will be issued by us within five business days after the original maturity date. If you do not respond or if there are no options for renewal offered to you, then principal and any earned but unpaid interest will be paid to you at maturity.

 

 

 

Q: May I redeem a Note prior to maturity?

 

A: Beginning 180 calendar days after the issuance date, you may request, in writing, that we redeem the Note. Your request, however, is subject to our consent and we may decline your request at our choosing. If we agree to your redemption request, a 180-day interest penalty will be imposed. This means that you will not receive the last 180 days’ worth of interest and, if the accrued and unpaid interest is not sufficient to cover the amount of the penalty, then any remaining amount of the penalty shall be deducted from the principal amount of the Note (i.e. we will subtract the remaining interest penalty from your original investment).

 

 

 

Q: What happens if I die prior to the maturity date?

 

A: At the written request of the executor or administrator of your estate (or if your Note is held jointly with another investor, the joint owner of your Note), we will redeem any Note at any time after death. The redemption price will be equal to the principal amount plus earned but unpaid interest payable on the Note, without any interest penalty. We will seek to honor any such request as soon as reasonably possible based on our cash position at the time and our then current cash needs, but generally within two weeks of the request. It is possible that the subordination provisions in the indenture may restrict our ability to honor your request.

 

 

 

Q: Can you force me to redeem my Note?

 

A: Yes. At any time we may call all or a portion of your Note for redemption. We will give you 30 to 60 days’ notice of the mandatory redemption and repay your Note for a price equal to the principal amount plus earned but unpaid interest to the day we repay your Note.

 

 

 

Q: What are some of the significant risks of my investment in the Notes?

 

A: You should carefully read and consider all risk factors beginning on page 14 of this prospectus prior to investing. Below is a summary of some of the significant risks of an investment in the Notes:

 

   

Our Notes are not insured or guaranteed by the FDIC or any third party, so repayment of your Note depends upon our ability to manage our business and generate adequate cash flows.

 

   

The Notes are risky speculative investments. Therefore, you should not invest in the Notes unless you are able to afford the loss of your entire investment.

 

   

There will not be any market for the Notes, so you should only purchase them if you do not have any need for your money prior to the maturity of the Note.

 

   

You will not have the benefit of an independent review of the terms of the Notes, the prospectus or our Company as is customarily performed in underwritten offerings.

 

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Payment on the Notes is subordinate to the payment of our outstanding present and future senior debt. Since there is no limit on the amount of senior debt we may incur, our present and future senior debt may make it difficult to repay the Notes.

 

   

We can provide no assurance that any Notes will be sold or that we will raise sufficient proceeds to carry out our business plans. If we do not raise sufficient funds for our business plan, we may not be able to generate enough cash to repay the Notes that have been sold.

 

   

We are controlled by Daniel M. Wallach, as, currently, he is our only officer and beneficially owns all of our outstanding membership interests.

 

   

If we lose or are unable to hire or retain key personnel, we may be delayed or unable to implement our business plan, which would adversely affect our ability to repay the Notes.

 

   

We have a limited operating history and limited experience operating as a company, so we may not be able to successfully operate our business or generate sufficient revenue.

 

   

Currently, we are reliant on a single developer and homebuilder for all of our revenues and a portion of our financing.

 

   

Our operations are not subject to the stringent banking regulatory requirements designed to protect investors, so repayment of your investment is completely dependent upon our successful operation of our business.

 

   

Most of our assets will be commercial construction loans to homebuilders and/or developers which are a higher than average credit risk, and therefore could expose us to higher rates of loan defaults, which could impact our ability to repay amounts owed to you.

 

   

We depend on the availability of significant sources of credit to meet our liquidity needs and our failure to maintain these sources of credit could materially and adversely affect our liquidity in the future.

 

   

Our business plan is to rapidly grow commercial lending, and while our ownership has extensive experience in this type of lending, a team of employees will need to be hired and perform at a high level for us to be successful. We do not have experience in this type of capital structure (using Notes).

 

   

If the proceeds from the issuance of the Notes exceed the cash flow needed to fund the desirable business opportunities that are identified, we may not be able to invest all of the funds in a manner that generates sufficient income to pay the interest and principal on the Notes.

 

   

The collateral securing our mortgage loans may not be sufficient to pay back the principal amount in the event of a default by the borrowers.

 

   

Currently we are substantially reliant on the local homebuilding industry in the Pittsburgh, Pennsylvania market.

 

   

We have incurred a significant amount of secured debt, which consists of two loans from affiliates collateralized by a lien against all of our assets, and expect to incur a significant amount of additional debt in the future, including issuance of the Notes, which will subject us to increased risk of loss.

 

   

Our business is not industry-diversified and the homebuilding industry has undergone a significant downturn. Further deterioration in industry or economic conditions could further decrease demand and pricing for new homes and residential home lots. A decline in housing values similar to the recent national downturn in the real estate market would have a negative impact on our business. Smaller value declines will also have a negative impact on our business. These factors may decrease the likelihood we will be able to generate enough cash to repay the Notes.

 

   

We expect to be substantially reliant upon the net offering proceeds we receive from the sale of our Notes to meet principal and interest obligations on previously issued Notes.

 

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Additional competition may decrease our profitability, which would adversely affect our ability to repay the Notes.

 

   

Additional competition for investment dollars may decrease our liquidity, which would adversely affect our ability to repay the Notes.

 

   

Our real estate loans are illiquid, which could restrict our ability to respond rapidly to changes in economic conditions.

 

   

Because we require a substantial amount of cash to service our debt, we may not be able to pay our obligations under the Notes.

 

   

Our Chief Executive Officer (who is also on our Board of Managers) will face conflicts of interest as a result of the secured affiliated loans made to us, which could result in actions that are not in the best interests of our Note holders.

 

   

Our Chief Executive Officer will face conflicts of interest as a result of his equity ownership in the Company, which could result in actions that are not in the best interests of our Note holders.

 

 

 

Q: How do I purchase a Note?

 

A: You may purchase a Note from us by visiting our website at www.shepherdsfinance.com and following the instructions under the heading “How to Invest in Shepherd’s Finance Fixed-Rate Notes” or by calling         -        -             to request a copy of the prospectus along with an investment application. Upon receipt of your application and investment check and the posting of your investment, we will send you a confirmation, which describes, among other things, the term, interest rate and principal amount.

We reserve the right to reject any investment. Among other reasons, we may reject an investment if the information in your investment application is incorrect or incomplete, or if the interest rate or maturity you have selected has not been offered by us in the past seven (7) calendar days for your desired investment amount at the time we receive your investment documents.

 

 

 

Q: Whom may I contact for more information?

 

A: You can obtain additional copies of this prospectus and review the established features of the Notes at www.shepherdsfinance.com or by calling         -        -             (toll free). However, the information contained on our website is not part of this prospectus. If you have questions about the suitability of an investment in the Notes for you, you should contact your own investment, tax and other financial advisors.

 

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PROSPECTUS SUMMARY

This summary highlights selected information, most of which was not otherwise addressed in the “Questions and Answers” section of this prospectus. For more information about us, you should carefully read the entire prospectus, including the section entitled “Risk Factors,” the consolidated financial statements and other consolidated financial data, any related prospectus supplement and the documents we have referred you to in “Where You Can Find More Information” on page 61. There will be no trading market for the Notes, so you will not be able to use the money you invest until the maturity or other repayment of the Note. Your right to be repaid prior to maturity is at our sole discretion, except upon your death.

Our Company and Our Business

We were organized in the Commonwealth of Pennsylvania in 2007 under the name 84 RE Partners, LLC and changed our name to Shepherd’s Finance, LLC on December 2, 2011. Our business is focused on commercial lending to participants in the residential construction and development business. We converted to a Delaware limited liability company on March 29, 2012. We are located in McMurray, Pennsylvania, a suburb of Pittsburgh. For U.S. federal income tax purposes, we are taxed as a partnership.

Our Chief Executive Officer (who is also on our Board of Managers) is Daniel M. Wallach. Mr. Wallach is currently our only officer and the sole member of management. We have a Board of Managers, which includes two independent Managers. Our officers are responsible for our day-to-day operations, while the Board of Managers is responsible for overseeing our business. The independent Managers, acting through the nominating and corporate governance committee, must approve all affiliate transactions. All of our outstanding membership interests are owned directly or beneficially by Mr. Wallach and his wife; therefore, Mr. Wallach is able to exercise significant control over our business, including with respect to the composition of our Board of Managers. A Manager may be removed by a vote of holders of 80% of our outstanding voting membership interests.

On December 30, 2011, we extended three commercial loans for the acquisition and development of lots and land in a suburb of Pittsburgh, Pennsylvania. These loans are demand loans and are backed by collateral including the real estate involved, subordinated debt from us and an interest escrow account with us. The total advanced on these loans as of December 31, 2011 was $5,504,497. The estimated value of the total collateral for these loans was $7,550,000, which is based on an appraisal of the collateral prepared for us in March 2012.

On December 30, 2011, we obtained two demand loans from our members to finance our operations. The total outstanding balance on these loans on December 31, 2011 was $878,091. These demand loans are collateralized by a lien against all of our assets and are senior in right of payment to the Notes.

In the past, we were the lessor in three commercial real estate leases (which were treated as direct financing leases for accounting purposes) with an affiliate of 84 Lumber Company. At the time of the transactions, Mr. Wallach was the Chief Financial Officer of 84 Lumber Company. Mr. Wallach’s employment with 84 Lumber Company ended in April of 2011, and the leased properties were sold to 84 Lumber Company affiliates in May and September 2011, thereby terminating the leases.

In conjunction with the lease terminations discussed above, we redeemed the ownership interests of two of our former members.

We plan on extending and servicing commercial loans to small to medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. We also will extend and service loans for the purchase of undeveloped land, and the development of that land into residential building lots. Most of the loans will be for “spec homes” or “spec lots,” meaning they are built or developed speculatively (with no specific end-user home owner in mind). The loans will be secured, and the collateral will be the land, lots, and constructed items thereon, as well as additional collateral as we deem appropriate. The loans will be demand loans, but the typical length of a home construction loan will range between six months and two years and is expected to average 10 months; and the typical length of a development project will range between three and six years.

 

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The housing market has recently been plagued by declining values and a lack of housing starts. We believe that despite the resulting issues in the speculative construction industry, it is a good time for this type of lending because:

 

   

Many traditional lenders to this market have exited or cut back, reducing competition and allowing large spreads (the difference between our cost of funds and the rate we charge our borrowers). Better builders can be obtained as customers, with higher spreads;

   

There are fixed costs involved in running this kind of operation, such as some payroll and the costs of maintaining public borrowings. These require a fixed interest rate spread in dollars to cover these costs. Because insured financial institution deposit rates are at historic lows, we hope to be able to attract enough funds to reach this required spread before those rates go up, and before competition significantly increases on our lending; and

   

We will do various things to try to mitigate the risks inherent in this type of lending by:

  o Keeping the ratio of our loan amount to the value of the security being given (known as “loan-to-value” or “LTV”) to between 60% and 80%;
  o Generally using deposits from the builder on home construction loans to ensure the completion of the home. Lending losses on defaulted loans are usually a higher percentage when the home is not built, or is only partially built;
  o Having a higher yield than other forms of secured real estate lending;
  o Paying major subcontractors and suppliers directly, which reduces the frequency of liens on the property (liens generally hurt the net realized value of loss mitigation techniques);
  o Aggressively working with builders who are in default on their loan before and during foreclosure. This technique generally yields a reduced realized loss; and
  o Market grading. All lending markets will be reviewed by analyzing their historic housing start cycles. Then, the current position of housing starts will be examined in each market. Markets will be classified into volatile, average, or stable, and then graded based on that classification and our opinion of where the market is in its housing cycle. This grading will be used to determine the builder deposit amount, the LTV, and the yield.

Our loans will likely be marketed by lending representatives who work for us and are driven to maintain long-term customer relationships. Our goal is not to be a customer’s only source of commercial lending, but an extra, more user-friendly piece of their financing.

Our goal is to market our loans on a nationwide basis. We believe that this goal can only be achieved with sufficient funds from this offering.

The Offering

 

Securities Offered

  

We are offering up to $700,000,000 in aggregate principal amount of our Notes. The Notes are governed by an indenture between us and U.S. Bank, as trustee. The Notes do not have the benefit of a sinking fund and will not be guaranteed by the FDIC or any governmental or private insurance fund, or any other person or entity.

 

Minimum Investment (in whole dollars)

 

   A minimum investment of $500 is required.

Maximum Investment (in whole dollars)

 

   The maximum investment is $1,000,000 per Note, or $1,000,000 in the aggregate per investor, but a higher maximum investment amount may be approved by us on a case-by-case basis.
Interest Rate   

Various rates will be offered by us from time to time, which will be impacted by the maturity date selected by you (see Maturity below) and the denomination/purchase amount selected by you.

 

 

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Payment of Interest   

Interest will be calculated based on the actual number of days your Note is outstanding. Interest is calculated and compounded monthly based on a 365/366 day year. Interest will be earned daily, and we will pay interest to you monthly or at maturity as you request. If you choose to be paid interest at maturity rather than monthly, the interest will be compounded monthly. If any day on which a payment is due with respect to a Note is not a business day, then you will not be entitled to payment of the amount due until the following business day, and no additional interest will be due as a result of such delay. If you elect to be paid interest monthly, interest on your Note will be paid on the first business day of every month. Your first interest payment date will be the month following the month in which the Note is issued, except that if a new Note is issued within the last 10 days preceding an interest payment date, the first interest payment will be made on the next succeeding interest payment date (i.e. approximately 35-40 days after issuance). No payments under $50 will be made, with any interest payment being accrued to your benefit and earning interest on a monthly compounding basis until the payment due to you is at least $50 on an interest payment date.

 

Maturity   

Ranging from one year to four years from the date of issuance.

 

Renewals   

If we have an effective offering available (and deliver you a current prospectus), we may, at our choosing, offer any one or more of the following renewal options (most likely at an interest rate different from your interest rate) at:

 

•      the same term length as the original term length;

•      a different term length;

•      various term lengths, from which you may select; or

•      other renewal terms may be offered by us at our choosing.

 

If you properly complete, execute and return the renewal form at least five business days prior to the maturity date, your Note will be deemed renewed under the renewal terms selected, and a new Note will be issued by us within five business days after the original maturity date. If you do not respond or if there are no options for renewal offered to you, then principal and any earned but unpaid interest will be paid to you at maturity.

 

Redemption by You   

Subject to our agreement in our sole discretion, you may redeem a Note purchased by you at any time beginning 180 calendar days after the issuance date, with a 180-day interest penalty. This means that you will not receive the last 180 days’ worth of interest and, if the accrued and unpaid interest is not sufficient to cover the amount of the penalty, then any remaining amount of the interest penalty shall be deducted from the principal amount of the Note (i.e. we will subtract the remaining interest penalty from your original investment).

 

Redemption in the Event of Death   

Unless the subordination provisions in the indenture restrict our ability to make the redemption, at the written request of the executor or administrator of your estate (or if your Note is jointly held with another investor, at the written request of your joint investor), we will redeem the Note at any time after death for a redemption price equal to the principal amount plus earned but unpaid interest payable on the Note, without any interest penalty. We will seek to honor any such redemption request as soon as reasonably possible, based on our then current cash position and needs, but generally within two weeks of the request.

 

Redemption by Us   

At any time we may call your Note for redemption upon 30 to 60 days’ notice. The redemption price will be equal to the principal amount plus accrued and unpaid interest to the date of the redemption.

 

 

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Subordination   

The Notes are subordinated, in all rights to payment and in all other respects, to all of our senior debt. Senior debt includes, without limitation, all of our bank debt and our secured affiliate loans and any we obtain in the future. This means that if we are unable to pay our debts when due, all of the senior debt would be paid first, before any payment would be made on the Notes.

 

Events of Default   

Under the indenture, an event of default is generally defined as (1) a default in the payment of principal or interest on the Notes that is not cured for 30 days, (2) bankruptcy or insolvency, or (3) our failure to comply with provisions of the Notes or the indenture if such failure is not cured or waived within 60 days after the receipt of a specific notice.

 

Transfer Restrictions   

Transfer of a Note is effective only upon the receipt of valid transfer instructions from the Note holder of record.

 

Trustee   

U.S. Bank

 

Plan of Distribution   

This offering is being conducted directly by us, without any underwriter or placement agent.

 

Charitable Match Program   

We offer a charitable match program for interest payments that you elect to give to a qualifying charity. If you choose to participate in the program and donate all or a portion of your interest payments to charity, when we calculate your interest we will deduct the percentage of interest you selected and keep track of that amount separate from your information. After interest is calculated for all Note holders at the beginning of December of each year, all of the money for each charity will be totaled up and sent in one check to each charity. Each check will have the name and address of each contributor, and the amount each contributed. Our matching portion will be included in the total check. We will match your interest payment donation up to 10% of your interest.

 

Risk Factors   

See “Risk Factors” beginning on page 14 and other information included in this prospectus and any prospectus supplement for a discussion of factors you should carefully consider before investing in the Notes.

 

 

 

 

 

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Summary of Consolidated Financial Data

(All dollar [$] amounts shown in thousands.)

The following table summarizes selected consolidated financial data from our business. You should read this summary together with “Selected Financial Data”, “Management’s Discussion and Analysis of Financial Condition and Results from Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus.

The summary consolidated financial data as of and for the fiscal years ended December 31, 2011 and 2010 is derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of and for the fiscal years ended 2009, 2008 and 2007 is derived from our unaudited consolidated financial statements not included in this prospectus.

As of, and for, the year ended December 31

 

     2011     2010     2009     2008     2007      

Operations Data

    (Audited)        (Audited)        (Unaudited)        (Unaudited)        (Unaudited)     

Interest income

  $ 5      $ -      $ -      $ -      $ -     

Total revenue

    5        -        -        -        -     

Selling, general and administrative expenses

    5        -        -        -        -     

Total operating expenses

    5        -        -        -        -     

Income (loss) from continuing operations

    -        -        -        -        -     

Discontinued operations:

                                         

Interest income

    638        1,033        1,033        1,033        602     

Total revenue

    638        1,033        1,033        1,033        602     

Selling, general and administrative expenses

    69        13        15        11        69     

Interest expense

    260        442        468        510        319     

Total operating expenses

    329        455        483        521        388     

Income from discontinued operations

  $ 309      $ 578      $ 550      $ 512      $ 214     

 

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As of, and for, the year ended December 31

 

     2011     2010     2009     2008     2007      

Balance Sheet Data

    (Audited)        (Audited)        (Unaudited)        (Unaudited)        (Unaudited)     

Cash

  $ 50      $ -      $ -      $ -      $ -     

Accrued interest

    2        -        -        -        -     

Prepaid expenses

    26        -        -        -        -     

Loans receivable, net

    4,580        -        -        -        -     

Assets of discontinued operations

    -        10,339        10,328        10,329        10,327     

Total assets

    4,658        10,339        10,328        10,329        10,327     

Customer interest escrow

    450        -        -        -        -     

Notes payable unsecured

    1,500        -        -        -        -     

Notes payable related party

    878        -        -        -        -     

Liabilities of discontinued operations

    -        7,863        8,253        8,691        9,088     

Total liabilities

    2,828        7,863        8,253        8,691        9,088     

Members’ capital

    1,830        2,476        2,075        1,638        1,239     

Members’ contributions

    -        -        -        -        1,138     

Members’ distributions1

  $ (955)      $ (177)      $ (113)      $ (113)      $ (113)     

1 Fiscal 2011 includes in this amount $(250) for the redemption of the ownership interests of two of our former members; $(383) was a return of capital to certain of the remaining members; and $(322) was earnings distributed to the members.

 

 

 

 

 

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RISK FACTORS

(All dollar [$] amounts shown in thousands.)

Our operations and your investment in the Notes are subject to a number of risks. You should carefully read and consider these risks, together with all other information in this prospectus, before you decide to buy the Notes. If any of these risks occur in the future, our business, consolidated financial condition, operating results and cash flows and our ability to repay the Notes could be materially adversely affected.

Risks Related to Our Offering and Structure

Our Notes are not insured or guaranteed by the FDIC or any third party, so repayment of your Note depends upon our ability to manage our business and generate adequate cash flows.

Our Notes are not certificates of deposit or similar obligations or guaranteed by any depository institution and are not insured by the FDIC or any governmental or private insurance fund, or any other entity. Therefore, you are dependent upon our ability to manage our business and generate adequate cash flows. If we are unable to generate sufficient cash flow to repay our debts, you could lose your entire investment.

The Notes are risky speculative investments. Therefore, you should not invest in the Notes unless you are able to afford the loss of your entire investment.

The Notes may not be a suitable investment for you, and we advise you to consult your investment, tax, and other professional financial advisors prior to deciding whether to invest in the Notes. The characteristics of the Notes, including the maturity and interest rate, may not satisfy your investment objectives. The Notes may not be a suitable investment for you based on your ability to withstand a loss of interest or principal or other aspects of your financial situation, including your income, net worth, financial needs, investment risk profile, return objectives, investment experience and other factors. Before deciding whether to purchase Notes, you should consider your investment allocation with respect to the amount of your contemplated investment in the Notes in relation to your other investments and the diversity of those holdings. If you cannot afford to lose all of your investment, you should not invest in these Notes.

There will not be any market for the Notes, so you should only purchase them if you do not have any need for your money prior to the maturity of the Note.

The Notes will not be listed on a national securities exchange or authorized for quotation on the NASDAQ Stock Market, or any securities exchange. There will not be a CUSIP identification number for the Notes; there will not be any trading market for the Notes; and it is unlikely that the Notes will be able to be used as collateral for a loan. Except as described elsewhere in this prospectus, you have no right to require redemption of the Notes. You should only purchase these Notes if you do not have the need for your money prior to the maturity of the Note.

You will not have the benefit of an independent review of the terms of the Notes, the prospectus or our Company as is customarily performed in underwritten offerings.

The Notes are being offered by our executive officer without an underwriter or placement agent. Therefore, you will not have the benefit of an independent review of the terms of the Notes, the prospectus or our Company. Accordingly, you should consult your investment, tax, and other professional financial advisors prior to deciding whether to invest in the Notes.

Payment on the Notes is subordinate to the payment of our outstanding present and future senior debt. Since there is no limit on the amount of senior debt we may incur, our present and future senior debt may make it difficult to repay the Notes.

As of December 31, 2011, we had $878 of senior debt outstanding. The Notes are subordinate and junior in priority to any and all of our senior debt and equal to any and all non-senior debt, including other Notes. There are no restrictions in the indenture regarding the amount of senior debt or other indebtedness that we may incur. Upon the maturity of our senior debt, by lapse of time, acceleration or otherwise, the holders of our senior debt have

 

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first right to receive payment, in full, prior to any payments being made to you as a Note holder or to other non-senior debt. Therefore, upon such maturity of our senior debt, you would only be repaid in full if the senior debt is satisfied first and, following satisfaction of the senior debt, if there is an amount sufficient to fully satisfy all amounts owed under the Notes and any other non-senior debt.

We can provide no assurance that any Notes will be sold or that we will raise sufficient proceeds to carry out our business plans. If we do not raise sufficient funds for our business plan, we may not be able to generate enough cash to repay the Notes that have been sold.

We are conducting this offering of Notes ourselves without any underwriter or placement agent. We have no experience in conducting a notes offering or any other securities offering. Although we intend to sell up to maximum offering amount of the Notes, there is no minimum amount of proceeds that must be received from the sale of the Notes in order to accept proceeds from Notes actually sold. Accordingly, we can provide no assurance about the total principal amount of Notes that will be sold. Therefore, we cannot assure you that we will raise sufficient proceeds to carry out our business plans.

We are controlled by Daniel M. Wallach, as, currently, he is our only officer and beneficially owns all of our outstanding membership interests.

Daniel M. Wallach, our Chief Executive Officer (who is also on our Board of Managers) constructively or beneficially owns all of the equity interests in our Company. As our only executive officer, Mr. Wallach is responsible for all aspects of our day-to-day operations. Though the approval of the independent Managers is required for all affiliate transactions, Mr. Wallach will, nonetheless, be able to exercise significant control over our affairs as the independent Managers may be removed by a vote of holders of 80% of our outstanding voting membership interests.

If we lose or are unable to hire or retain key personnel, we may be delayed or unable to implement our business plan, which would adversely affect our ability to repay the Notes.

Our success depends to a significant degree upon the contributions of Daniel M. Wallach, our Chief Executive Officer and Manager. We do not have an employment agreement with Mr. Wallach and cannot guarantee that he will remain affiliated with us. If he were to cease his affiliation with us, our operating results would suffer. We believe that our future success depends, in part, upon our ability to hire and retain additional personnel. We cannot assure you that we will be successful in attracting and retaining such personnel, which could hinder our ability to implement our business plan.

There is no “early warning” on your Note if we perform poorly. Only interest and principal payment defaults on your Note can trigger a default on your Note prior to a bankruptcy.

There are a limited number of performance covenants to be maintained under the Notes and/or the indenture. Therefore, no “early warning” of a possible default by us exists. Under the indenture, only (i) the non-payment of interest and/or principal on the Notes by us when payments are due, (ii) our bankruptcy or insolvency, or (iii) a failure to comply with provisions of the Notes or the indenture (if such failure is not cured or waived within 60 days after receipt of a specific notice) could cause a default to occur.

If we are unable to meet our Note maturity and redemption obligations, and we are unable to obtain additional financing or other sources of capital, we may be forced to sell off our operating assets or we might be forced to cease our operations, and you could lose some or all of your investment.

Our Notes have maturities ranging from one year to four years. In addition, holders of our Notes may request redemption upon death. We intend to pay our Note maturity and redemption obligations using our normal cash sources, such as collections on our loans to customers, as well as proceeds from the sale of the Notes. We may experience periods in which our Note maturity and redemption obligations are high. Since our loans are generally repaid when our borrower sells a real estate asset, our operations and other sources of funds may not provide sufficient available cash flow to meet our continued Note maturity and redemption obligations. Therefore, we will be substantially reliant upon the net offering proceeds we receive from the sale of the Notes to pay these obligations.

 

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If we are unable to repay or redeem the principal amount of the Notes when due, and we are unable to obtain additional financing or other sources of capital, we may be forced to sell off our operating assets or we might be forced to cease our operations, and you could lose some or all of your investment.

The indenture does not contain the type of covenants restricting our actions, such as restrictions on creating senior debt, paying distributions to our owners, merging, recapitalizing, and/or entering into highly leveraged transactions. The indenture does not contain provisions requiring early payment of Notes in the event we suffer a material adverse change in our business or fail to meet certain financial standards. Therefore, the indenture provides very little protection of your investment.

The Notes do not have the benefit of extensive covenants. The covenants in the indenture are not designed to protect your investment if there is a material adverse change in our consolidated financial condition, results of operations or cash flows. For example, the indenture does not contain any restrictions on our ability to create or incur senior debt or other debt to pay distributions to our equity holders, including our Chief Executive Officer. It also does not contain any financial covenants (such as a fixed charge coverage or a minimum amount of equity) to help ensure our ability to pay interest and principal on the Notes. The indenture does not contain provisions that permit Note holders to require that we redeem the Notes if there is a takeover, recapitalization or similar restructuring. In addition, the indenture does not contain covenants specifically designed to protect you if we engage in a highly leveraged transaction. Therefore, the indenture provides very little protection of your investment.

Management has broad discretion over the use of proceeds from this offering; therefore, you have no assurance that the funds will be used effectively to generate cash for payment of principal and interest on the Notes.

We expect to use the proceeds from this offering for purposes detailed in this prospectus under the “Questions and Answers” and “Use of Proceeds” sections. Because no specific allocation of the proceeds is required in the indenture, our management will have broad discretion in determining how the proceeds of the offering will be used.

You will not have the opportunity to evaluate our investments before they are made.

We intend to use the net offering proceeds in accordance with the “Use of Proceeds” section, including investment in secured real estate loans for the acquisition and development of parcels of real property as single-family residential lots and/or the construction of single-family homes. Since we have not identified any investments that we will make with the net proceeds of this offering, we are generally unable to provide you with information to evaluate the potential investments we may make with the net offering proceeds before you purchase the Notes. You must rely on our management to evaluate our investment opportunities, and we are subject to the risk that our management may not be able to achieve our objectives, may make unwise decisions or may make decisions that are not in our best interest.

There is no sinking fund to ensure repayment of the Notes at maturity, so you are totally reliant upon our ability to generate adequate cash flows.

We do not contribute funds to a separate account, commonly known as a sinking fund, to repay the Notes upon maturity. Because funds are not set aside periodically for the repayment of the Notes over their respective terms, you must rely on our consolidated cash flows from operations, investing and financing activities and other sources of financing for repayment, such as funds from the sale of the Notes, loan repayments, and other borrowings. To the extent cash flows from operations and other sources are not sufficient to repay the Notes you may lose all or part of your investment.

If a large number of our Note holders die, we may be unable to repay their investments.

Upon the death of an investor, if requested by the executor or administrator of the investor’s estate (or if the Note is held jointly, by the surviving joint investor), we are obligated to redeem his or her Notes without any interest penalty. Such redemption requests are not subject to our consent but may be subject to restrictions in the indenture. If a large number of our investors, or a single investor holding a significant portion of the Notes, die within a short period of time, we could be faced with a large number of redemption requests. If the amounts of those redemptions

 

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are too high, and we cannot offset them with loan repayments, secure new financing, or issue additional Notes, we may not have the liquidity to redeem the investments.

If we default in our Note payment obligations, the indenture agreement provides that the trustee could accelerate all payments due under the Notes, which would further negatively affect our financial position.

Our obligations with respect to the Notes are governed by the terms of indenture agreement with U.S. Bank, as trustee. Under the indentures, in addition to other possible events of default, if we fail to make a payment of principal or interest under any Note and this failure is not cured within 30 days, we will be deemed in default. Upon such a default, the trustee or holders of 25% in principal of the outstanding Notes could declare all principal and accrued interest immediately due and payable. If our total assets do not cover these payment obligations, we would most likely be unable to make all payments under the Notes when due, and we might be forced to cease our operations.

We have the right to pay your investment back to you before the stated maturity of your investment. If we do, you may not be able to reinvest the proceeds at comparable rates and you will stop earning interest on your investment.

At any time we may redeem all or a portion of the outstanding Notes purchased by you prior to their maturity. In the event we redeem any part or all of your Notes early, you would have the risk of reinvesting the proceeds at the then-current market rates, which may be higher or lower.

The portion of our business plan utilizing a note offering for a source of funds for commercial lending purposes as described in this prospectus is new to us. This may decrease the likelihood that we will be successful and able to pay principal and interest on the Notes.

We have no experience with managing a notes offering as a source of funds for our business activities. There can be no assurance that results of our new business plan will be similar to or better than the results we obtained under our prior business plan.

Risks Related to Our Business

We have a limited operating history and limited experience operating as a company, so we may not be able to successfully operate our business or generate sufficient revenue.

We were organized in May 2007 and, in the past, we were the lessor in three commercial real estate leases (which were treated as direct financing leases for accounting purposes) with an affiliate of 84 Lumber Company. At the time of the initial leases, our Chief Executive Officer, Daniel M. Wallach, was the Chief Financial Officer of 84 Lumber Company. Mr. Wallach’s employment with 84 Lumber Company ended in April of 2011, and the leased properties were sold to 84 Lumber Company affiliates in May and September 2011, thereby terminating the leases. Recently, in December 2011, we made our first real estate loan of the type described in our “Business” section. Therefore, we have a limited operating history and limited experience operating as a company from which to evaluate our business or our likelihood of future success in operating our business, generating revenues, or achieving profitability. We cannot assure you that we will be able to operate our business successfully or implement our operating policies and strategies described in this prospectus.

Currently, we are reliant on a single developer and homebuilder for all of our revenues and a portion of our financing.

As of December 31, 2011, our loan portfolio consists of loans made to Benjamin Marcus Homes, LLC and Investor’s Mark Acquisitions, LLC, both of which are owned by Mark Hoskins. We also have an unsecured loan payable to Investor’s Mark Acquisitions, LLC. Therefore, currently, we are substantially reliant upon a single developer and homebuilder for all of our revenues and a portion of our financing. Any event of bankruptcy, insolvency or general downturn in the business of this developer and homebuilder will have a substantial adverse financial impact on our business and our ability to pay back your investment in the Notes.

 

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Our operations are not subject to the stringent banking regulatory requirements designed to protect investors, so repayment of your investment is completely dependent upon our successful operation of our business.

Our operations are not subject to the stringent regulatory requirements imposed upon the operations of commercial banks, savings banks, and thrift institutions, and are not subject to periodic compliance examinations by federal or state banking regulators. For example, we will not be well diversified in our product risk and we cannot benefit from government programs designed to protect regulated financial institutions. Therefore, an investment in our Notes does not have the regulatory protections that the holder of a demand account or a certificate of deposit at a bank does. The return on Notes purchased by you is completely dependent upon our successful operations of our business. To the extent that we do not successfully operate our business, our ability to pay interest and principal on the Notes will be impaired.

Most of our assets will be commercial construction loans to homebuilders and/or developers which are a higher than average credit risk, and therefore could expose us to higher rates of loan defaults, which could impact our ability to repay amounts owed to you.

Our primary business will be extending commercial construction loans to homebuilders, along with some loans for land development. These loans are considered higher risk because the ability to repay depends on the homebuilder’s ability to sell a newly built home. These homes typically are not sold by the homebuilder prior to commencement of construction. Therefore, we may have a higher risk of loan default among our customers than other commercial lending companies. If we suffer increased loan defaults, in any given period, our operations could be materially adversely affected and we may have difficulty making our principal and interest payments on the Notes.

We depend on the availability of significant sources of credit to meet our liquidity needs and our failure to maintain these sources of credit could materially and adversely affect our liquidity in the future.

We plan to maintain a line of credit with a financial institution in the future, so that we may draw funds when necessary to meet our obligation to redeem maturing Notes, pay interest on the Notes, meet our commitments to lend money to our customers, and other general corporate purposes. We do not have a financial institution line of credit at this time. If we fail to obtain such a line of credit or maintain one, we will be more dependent on the proceeds from the Notes for our continued liquidity. If the sale of the Notes is significantly reduced or delayed for any reason and we fail to obtain or renew a line of credit, or we default on our line of credit, our ability to meet our obligations, including our Note obligations, could be materially adversely affected and we may not have enough cash to payback your investment. Also, the failure to maintain an active line of credit (and therefore using cash for liquidity instead of a borrowing line), even though we have liquidity from the Notes will reduce our earnings, because we will be paying interest on the Notes, while we are holding cash instead of reducing our line of credit.

Our business plan is to rapidly grow commercial lending, and while our ownership has extensive experience in this type of lending, a team of employees will need to be hired and perform at a high level for us to be successful. We do not have experience in this type of capital structure (using Notes).

There are many risks in running this business plan, including but not limited to rapid growth, liquidity and capital structure issues, and changing markets. We believe that we have effectively created a start-up financial institution. Most start-up financial institutions grow to the level that we are anticipating over a long period of time, typically measured in years. In contrast, we anticipate rapid expansion to our desired portfolio size. We cannot be sure that we will be successful in managing our growth. In order to successfully manage our growth, we must:

 

   

hire, train, manage and retain employees;

 

   

create loan products that are attractive to customers, protect us, and are profitable;

 

   

manage the duration and amounts of both our assets (loans to customers) and liabilities (our line of credit, Notes, and other debt);

 

   

create systems to track both our investors’ and our customers’ accounts; and

 

   

control our expenses.

 

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The strains posed by these demands are magnified by the start-up nature of our operations. Our failure to operate profitably or with enough liquidity could prevent us from being able to pay interest or principal on the Notes.

If the proceeds from the issuance of the Notes exceed the cash flow needed to fund the desirable business opportunities that are identified, we may not be able to invest all of the funds in a manner that generates sufficient income to pay the interest and principal on the Notes.

Our ability to pay interest on our debt, including the Notes, pay our expenses, and cover loan losses is dependent upon interest and fee income we receive from loans extended to our customers. If we are not able to lend to a sufficient number of customers at high enough interest rates, we may not have enough interest and fee income to meet our obligations, which could impair our ability to pay interest and principal to you. If money brought in from new Notes and from repayments of loans from our customers exceeds our short term obligations such as expenses, Note interest and redemptions, and line of credit principal and interest, then it is likely to be held as cash, which will have a lower return than the interest rate we are paying on the Notes. This will lower earnings and may cause losses which could impair our ability to repay the principal and interest on the Notes.

The collateral securing our mortgage loans may not be sufficient to pay back the principal amount in the event of a default by the borrowers.

In the event of default, our mortgage loan investments are generally dependent entirely on the loan collateral to recover our investment. Our loan collateral consists primarily of a mortgage on the underlying property. In the event of a default, we may not be able to recover the premises promptly and the proceeds we receive upon sale of the property may be adversely affected by risks generally related to interests in real property, including changes in general or local economic conditions and/or specific industry segments, declines in real estate values, increases in interest rates, real estate tax rates and other operating expenses including energy costs, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, and other factors which are beyond our or our borrowers’ control. Current market conditions may reduce the proceeds we are able to receive in the event of a foreclosure on our collateral. There can be no assurance that our remedies with respect to the loan collateral will provide us with a recovery adequate to recover our investment.

Currently, we are substantially reliant on the local homebuilding industry in the Pittsburgh, Pennsylvania market.

Our loan investments are currently not diversified geographically. As of December 31, 2011 and through the date of this prospectus, all of our loan investments are concentrated in the Pittsburgh, Pennsylvania market. Accordingly, any adverse conditions affecting the local housing market in this area will have a magnified adverse effect on our loan portfolio and adversely affect our ability to pay back your investment in the Notes.

We have incurred a significant amount of secured debt, which consists of two loans from affiliates collateralized by a lien against all of our assets, and expect to incur a significant amount of additional debt in the future, including issuance of the Notes, which will subject us to increased risk of loss.

As of December 31, 2011, we had $878 of secured debt outstanding, which consists of the two loans from affiliates. The affiliate loans are collateralized by a lien against all of our assets. In addition, we expect to incur a significant amount of additional debt in the future, including issuance of the Notes, borrowing under credit facilities and other arrangements. The Notes will be subordinated in right of payment to all secured debt, including the affiliate loans. Therefore, in the event of a default on the secured debt, affiliates of our Company, including Mr. Wallach, have the right to receive payment ahead of our Note holders. Accordingly, our business is subject to increased risk of a total loss of your investment if we are unable to repay all of our secured debt, including the affiliate loans.

 

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Our business is not industry-diversified and the homebuilding industry has undergone a significant downturn. Further deterioration in industry or economic conditions could further decrease demand and pricing for new homes and residential home lots. A decline in housing values similar to the recent national downturn in the real estate market would have a negative impact on our business. Smaller value declines will also have a negative impact on our business. These factors may decrease the likelihood we will be able to generate enough cash to repay the Notes.

Developers and homebuilders to whom we may make loans will use the proceeds of our loans to develop raw land into residential home lots and construct homes. The developers obtain the money to repay our development loans by selling the residential home lots to homebuilders or individuals who will build single-family residences on the lots, or by obtaining replacement financing from other lenders. A developer’s ability to repay our loans is based primarily on the amount of money generated by the developer’s sale of its inventory of single-family residential lots. Homebuilders obtain the money to repay our loans by selling the homes they construct or by obtaining replacement financing from other lenders, and thus, the homebuilders’ ability to repay our loans is based primarily on the amount of money generated by the sale of such homes.

The homebuilding industry is cyclical and is significantly affected by changes in industry conditions, as well as in general and local economic conditions, such as:

 

   

employment level and job growth;

 

   

demographic trends, including population increases and decreases and household formation;

 

   

availability of financing for homebuyers;

 

   

interest rates;

 

   

affordability of homes;

 

   

consumer confidence;

 

   

levels of new and existing homes for sale, including foreclosed homes and homes held by investors and speculators; and

 

   

housing demand generally.

These conditions may occur on a national scale or may affect some of the regions or markets in which we operate more than others.

We anticipate that we will generally lend a percentage of the values of the homes and lots. These values are determined shortly prior to the lending. If the values of homes and lots in markets in which we lend drop fast enough to cause the builders losses that are greater than their equity in the property, we will be forced to liquidate the loan in a fashion which will cause us to lose money. If these losses when combined and added to our other expenses are greater than our revenue from interest charged to our customers, we will lose money overall, which will hurt our ability to pay interest on the Notes and repay the principal on the Notes. Values are typically affected by demand for homes, which can change due to many factors, including but not limited to, demographics, interest rates, overall economy, cost of building materials and labor, availability of financing for end-users, inventory of homes available and governmental action or inaction. The tightening credit markets have made it more difficult for potential homeowners to obtain financing to purchase homes. If housing prices continue to decline or sales in the housing market continue to decline, our customers may have a hard time selling their homes at a profit. This could cause the amount of defaulted loans that we will own to increase. An increase in defaulted loans would reduce our revenue and could lead to losses on our loans. A decline in housing prices will further increase our losses on defaulted loans. If the amount of defaulted loans or the loss per defaulted loan is large enough, we will operate at a loss, which will decrease our equity. This could cause us to become insolvent, and we will not be able to pay back your investment in the Notes.

 

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We expect to be substantially reliant upon the net offering proceeds we receive from the sale of our Notes to meet principal and interest obligations on previously issued Notes.

We intend to use the net offering proceeds from the sale of Notes to, among other things, make payments on other borrowings, fund redemption obligations, make interest payments on the Notes, and to run our business to the extent that other sources of liquidity from our operations (e.g., repayment of loans we have previously extended to our customers) and our credit line are inadequate. However, these other sources of liquidity are subject to risks. Our operations alone may not produce a sufficient return on investment to repay interest and principal on your Notes. We may not be able to obtain or retain a line of credit. We may not be able to attract new investors, have sufficient loan repayments, or have sufficient borrowing capacity when we need additional funds to repay principal and interest on your Notes or redeem your Notes. If any of these things occur, our liquidity and capital needs may be severely affected and we may be forced to sell off our loan receivables and other operating assets, or we might be forced to cease our operations.

Additional competition may decrease our profitability, which would adversely affect our ability to repay the Notes.

We may experience increased competition for business from other companies and financial institutions that are willing to extend the same types of loans that we extend at lower interest rates and/or fees. These competitors also may have substantially greater resources, lower cost of funds, and a better established market presence. If these companies increase their marketing efforts to our market niche of borrowers, or if additional competitors enter our markets, we may be forced to reduce our interest rates and fees in order to maintain or expand our market share. Any reduction in our interest rates, interest income or fees could have an adverse impact on our profitability and our ability to repay the Notes.

Additional competition for investment dollars may decrease our liquidity, which would adversely affect our ability to repay the Notes.

We could experience increased competition for investment dollars from other companies and financial institutions that are willing to offer higher interest rates. We may be forced to increase our interest rates in order to maintain or increase the issuance of Notes. Any increase in our interest rates could have an adverse impact on our liquidity and our ability to meet a debt covenant under our line of credit and/or to repay the Notes.

Our real estate loans are illiquid, which could restrict our ability to respond rapidly to changes in economic conditions.

The real estate loans we currently hold and intend to make are illiquid. As a result, our ability to sell under-performing assets in our portfolio or respond to changes in economic or other conditions may be very limited.

Because we require a substantial amount of cash to service our debt, we may not be able to pay our obligations under the Notes.

To service our total indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors, including our successful financial and operating performance. We cannot assure you that our business plans will succeed or that we will achieve our anticipated financial results.

If we, our ownership, or any of our future employees suffer from severe negative publicity, we could be faced with significantly greater payments on Note redemption obligations than we have cash available for such payments or redemptions.

If we, our ownership, or any of our future employees suffer from severe negative publicity, our rate of new Note issuances could be negatively impacted, which would reduce the amount of cash available to make interest and principal payments on our debt including the Notes. In such event, we could be declared in default on the Notes and other debt instruments, and you could lose your entire investment.

If we do not achieve our anticipated financial results, we may not be able to generate sufficient cash flows from operating, investing and financing activities or to obtain sufficient funding to satisfy all of our obligations, including our obligations under the Notes.

 

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We are subject to risk of significant losses on our loans because we do not require our borrowers to insure their collateral for our loans.

It is customary for lenders extending loans secured by real estate to require the borrower to provide title insurance and hazard insurance with minimum coverage amounts set by the lender. We do not plan to require some or all of our homebuilders to provide either title or hazard insurance on their collateral for our loans to them. This represents an additional risk to us as the lender. The homebuilder may have a fire or other property damage claim, which normally would be covered by insurance, but may result in a loss on the loan because insurance proceeds are not available.

Increases in interest rates, reductions in mortgage availability or increases in other costs of home ownership could prevent potential customers from buying new homes and adversely affect our business and financial results.

Most new home purchasers finance their home purchases through lenders providing mortgage financing. Prior to the recent volatility in the financial markets, interest rates were at historically low levels and a variety of mortgage products were available. As a result, home ownership became more accessible. The mortgage products available included features that allowed buyers to obtain financing for a significant portion or all of the purchase price of the home, had very limited underwriting requirements or provided for lower initial monthly payments. Accordingly, more people were qualified for mortgage financing.

Since 2007, the mortgage lending industry has experienced significant instability, beginning with increased defaults on subprime loans and other nonconforming loans and compounded by expectations of increasing interest payment requirements and further defaults. This, in turn, resulted in a decline in the market value of many mortgage loans and related securities. Lenders, regulators and others questioned the adequacy of lending standards and other credit requirements for several loan products and programs offered in recent years. Credit requirements tightened, and investor demand for mortgage loans and mortgage-backed securities declined. In general, fewer loan products, tighter loan qualifications and a reduced willingness of lenders to make loans make it more difficult for many buyers to finance the purchase of homes. These factors serve to reduce the pool of qualified homebuyers and made it more difficult to sell to first time and move-up buyers.

A reduction in the demand for new homes may reduce the amount and price of the residential home lots sold by the developers and homebuilders to which we loan money and/or increase the amount of time such developers and homebuilders must hold the home lots in inventory. These factors increase the likelihood of defaults on our loans, which would adversely affect our business and financial results.

In the event we foreclose on the property securing certain of our loans, we have agreed to provide a limited preference in our foreclosure proceeds to a third party, which could reduce the amount of proceeds that we would receive on a foreclosure of the property.

The property securing the New IMA Loan and the Existing IMA Loan is subject to a mortgage in the amount of $1,290, which is held by an unrelated third party. In connection with the closing of the New IMA Loan and the Existing IMA Loan, the holder of this mortgage entered into an agreement to amend, restate and further subordinate such mortgage. This subordination agreement also provides that, in the event of a foreclosure on and liquidation of the property securing the New IMA Loan and the Existing IMA Loan, we are entitled to receive liquidation proceeds up to $2,225, which excludes the collateral securing the BMH Loan, at which point the holder of this mortgage is entitled to receive liquidation proceeds up to the amount necessary to satisfy its outstanding mortgage, and we are then entitled to any remainder of the liquidation proceeds. The current appraised value of this collateral (this property is currently undeveloped) is less than $2,225. Thus, in the event of a default, the third party would currently only receive any of the proceeds remaining from the sale of the collateral after we have been paid in full.

If a large number of our borrowers are unable to repay their loans within a normal average number of months, we will experience a significant reduction in our income and/or liquidity, and may not be able to repay the Notes as they become due.

Loans that we extend are expected to be repaid in a normal average number of months, typically 10 months, depending on the size of the loan. We will have interest paid on a monthly basis, but will also charge a fee

 

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which will be earned over the life of the loan. If these loans are repaid over a longer period of time, the amount of income that we receive on these loans expressed as a percentage of the outstanding loan amount will be reduced, and fewer loans with new fees will be able to be made, since the cash will not be available. This will reduce our income as a percentage of the Notes, and if this percentage is significantly reduced it could impair our ability to pay you principal and interest on the Notes.

The homebuilding industry’s strategies in response to the adverse conditions in the industry have had limited success, and the continued implementation of these and other strategies may not be successful.

Since the downturn began, most homebuilders have been focused on generating positive operating cash flow, resizing and reshaping their product for a more price-conscious consumer and adjusting finished new home inventories to meet demand, and did so in many cases by significantly reducing the new home prices and increasing the level of sales incentives. Notwithstanding these strategies, homebuilders continued to experience an elevated rate of sales contract cancelations. Many of the factors that affect new sales and cancelation rates are beyond the control of the homebuilding industry. It is uncertain how long the reduction in sales and the increased level of cancelations will continue. Continued decreases in new home sales would increase the likelihood of defaults on our loans and, consequently, reduce our ability to repay your investment in the Notes.

Our cost of funds will be substantially higher than that of banks.

Because we do not offer FDIC insurance, and because we want to grow our Note program faster than most banks want to grow their CD base, our Notes will offer significantly higher rates than bank CDs. As a result, our cost of funds will be higher than banks’ cost of funds. This may make it more difficult for us to compete against banks when they rejoin our niche lending market in large numbers. This could result in losses which could impair or eliminate our ability to pay interest and principal on your Notes.

We are exposed to risk of environmental liabilities with respect to properties which we take title. Any resulting environmental remediation expense may reduce our ability to repay the Notes.

In the course of our business, we may foreclose and take title to real estate that could be subject to environmental liabilities. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances or chemical release at any property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be material and adversely affected.

We will be subject to the general market risks associated with real estate construction and development.

Our financial performance will depend on the successful construction and/or development and sale of the homes and real estate parcels that serve as security for the loans we make to homebuilders and developers. As a result, we will be subject to the general market risks of real estate construction and development, including weather conditions, the price and availability of materials used in construction of homes and development of lots, environmental liabilities and zoning laws, and numerous other factors that may materially and adversely affect the success of the projects.

We may be subject to changes in our business as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. These changes may restrict our ability to pursue or limit the feasibility of pursuing our business plan.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 represents a comprehensive overhaul of the financial services industry within the United Sates and will require a number of federal agencies to implement numerous new rules, many of which may not be implemented for several months or years. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact our business. However, compliance with these laws and regulations may impact our lending operations and/or result in additional costs and expenses, which may impact our consolidated results of operations, financial condition or liquidity.

 

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We will be required to devote resources to comply with various provisions of the Sarbanes-Oxley Act, including Section 404 relating to internal controls testing, and this may reduce the resources we have available to focus on our core business.

Pursuant to Section 404 (“Section 404”) of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the related rules adopted by the SEC and the Public Company Accounting Oversight Board, beginning with our Annual Report on Form 10-K for the fiscal year 2013, our management will be required to report on the effectiveness of our internal controls over financial reporting. We may encounter problems or delays in completing any changes necessary to our internal controls over financial reporting. Among other things, we may not be able to conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. Any failure to comply with the various requirements of the Sarbanes-Oxley Act may require significant management time and expenses and divert attention or resources away from our core business. In addition, we may encounter problems or delays in completing the implementation of any requested improvements provided by our independent registered public accounting firm.

If we do not meet the requirements to maintain effective internal controls over financial reporting, our ability to raise new capital will be harmed.

If we do not maintain effective internal controls of our financial reporting in accordance with Section 404, it could result in delaying future SEC filings or future offerings. If future SEC filings or future offerings are delayed, it could have an extreme negative impact on our cash flow causing us to default on our obligations.

Risks Related to Conflicts of Interest

Our Chief Executive Officer (who is also on our Board of Managers) will face conflicts of interest as a result of the secured affiliated loans made to us, which could result in actions that are not in the best interests of our Note holders.

As of December 31, 2011, we had borrowed $250 from The 2007 Daniel M. Wallach Legacy Trust and $628 from Daniel M. Wallach, our Chief Executive Officer (who is also on our Board of Managers), and his wife, Joyce Wallach. These affiliate loans are collateralized by a lien against all of our assets. The Notes will be subordinated in right of payment to all secured debt, including these affiliate loans. Pursuant to each promissory note, the affiliates have the option of funding any amount up to the face amount of the note, in the lender’s sole and absolute discretion. Therefore, Mr. Wallach will face conflicts of interest in deciding whether and when to exercise any rights pursuant to the promissory notes and pledge agreement. If these Wallach affiliates exercise their rights to collect on their collateral upon a default by us, we could lose some or all of our assets, which could have a negative effect on our ability to repay the Notes.

Our Chief Executive Officer will face conflicts of interest as a result of his equity ownership in the Company, which could result in actions that are not in the best interests of our Note holders.

Our Chief Executive Officer beneficially owns all of the voting and non-voting equity of the Company. Since the Company is taxed as a partnership for federal income tax purposes, all profits and losses flow through to the equity owners. Therefore, Mr. Wallach and his affiliated equity owners of the Company will be motivated to distribute profits to the equity owners on an annual basis, rather than retain earnings in the Company for Company purposes. There is currently no limit in the indenture or otherwise on the amount of funds that may be distributed by the Company to its equity owners. If substantial funds are distributed to the equity owners, the liquidity and capital resources of the Company will be reduced and our ability to repay the Notes may be negatively impacted.

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of the federal securities laws. Words such as “may,”“will,”“expect,”“anticipate,”“believe,”“estimate,”“continue,”“predict,” or other similar words identify forward-looking statements. Forward-looking statements appear in a number of places in this prospectus, including without limitation, “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” and include statements regarding our intent, belief or current expectation about, among other things, trends affecting the markets in which we operate, our business, financial condition and growth strategies. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those predicted in the forward-looking statements as a result of various factors, including but not limited to those set forth in the “Risk Factors” section of this prospectus.

If any of the events described in “Risk Factors” occur, they could have an adverse effect on our business, financial condition, and results of operations. When considering forward-looking statements, you should keep these risk factors, as well as the other cautionary statements in this prospectus in mind. You should not place undue reliance on any forward-looking statement. We are not obligated to update forward-looking statements.

 

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USE OF PROCEEDS

(All dollar [$] amounts shown in thousands.)

We expect to incur approximately $1,518 in initial expenses to offer the Notes pursuant to this prospectus. The net proceeds we receive from this offering will be equal to the amount of the Notes we sell, less our offering expenses. If we sell the maximum offering amount of the Notes, which is $700,000, we estimate that our net proceeds less our initial offering expenses will be approximately $698,482.

We will receive cash proceeds in varying amounts from time to time as the Notes are sold. Due to our inability to predict with any certainty whatsoever the amount and timing from inflows of (i) the sale of Notes, (ii) our customer loan repayments, and (iii) our borrowing capacity, we cannot provide any specific allocation of proceeds we will use for any particular purpose. However, we intend to use substantially all of the net offering proceeds as follows, in the following order of priority:

 

   

to make payments on other borrowings, including loans from affiliates;

   

to pay Notes on their scheduled due date and Notes that we are required to redeem early;

   

to make interest payments on the Notes; and

   

to the extent we have remaining net proceeds and adequate cash on hand, to fund any one or more of the following activities:

  o to extend commercial construction loans to homebuilders to build single or multi-family homes or develop lots;
  o to make distributions to equity owners;
  o for working capital and other corporate purposes;
  o to purchase defaulted secured debt from financial institutions at a discount;
  o to purchase defaulted unsecured debt from suppliers to homebuilders at a discount and then secure it with real estate or other collateral;
  o to purchase real estate, which we will operate our business in; and
  o to redeem Notes which we have decided to redeem prior to maturity.

There is no minimum number or amount of the Notes that we must sell to receive and use the proceeds from the sale of the Notes, and we cannot assure you that all or any portion of the Notes will be sold. In the event that we do not raise sufficient proceeds from our offerings of Notes to adequately fund our operations, we could curtail the amount of funds we loan to our customers, or we could wrap up operations and pay back our debt, including the Notes. This might result in the Notes being paid back early. Please see “Risk Factors – Risks Related to Our Business – We will be substantially reliant upon the net offering proceeds we receive from the sale of our Notes to meet our liquidity needs,” “Risk Factors – Risks Related to our Offering – There is no sinking fund to ensure repayment of the Notes at maturity, so you are totally reliant upon our ability to generate adequate cash flows” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

 

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SELECTED FINANCIAL DATA

(All dollar [$] amounts shown in thousands.)

The following selected consolidated financial data should be read together with our consolidated financial statements and accompanying notes and “Management Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. The selected consolidated financial data in this section is not intended to replace our consolidated financial statements and the accompanying notes. Our historical results and information are not necessarily indicative of our future results. Our business model for the future is different than what we have done in the past.

The summary consolidated financial data as of and for the fiscal years ended December 31, 2011 and 2010 is derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of and for the fiscal years ended 2009, 2008 and 2007 is derived from our unaudited consolidated financial statements not included in this prospectus.

As of, and for, the year ended December 31

 

     2011     2010     2009     2008     2007  
Operations Data   (Audited)     (Audited)     (Unaudited)     (Unaudited)     (Unaudited)  

Interest income

  $ 5      $ -      $ -      $ -      $ -   

Total revenue

    5        -        -        -        -   

Selling, general and administrative expenses

    5        -        -        -        -   

Total operating expenses

    5        -        -        -        -   

Income (loss) from continuing operations

    -        -        -        -        -   

Income (loss) from discontinued operations

    309        578        550        512        214   

Net income (loss)

  $         309      $         578      $         550      $         512      $         214   

Balance Sheet Data

                                       

Cash

  $ 50      $ -      $ -      $ -      $ -   

Accrued interest

    2        -        -        -        -   

Prepaid expenses

    26        -        -        -        -   

Loans receivable, net

    4,580        -        -        -        -   

Assets of discontinued operations

    -        10,339        10,328        10,329        10,327   

Total assets

    4,658        10,339        10,328        10,329        10,327   

Customer interest escrow

    450        -        -        -        -   

Note payable unsecured

    1,500        -        -        -        -   

Note payable related party

    878        -        -        -        -   

Liabilities of discontinued operations

    -        7,863        8,253        8,691        9,088   

Total liabilities

    2,828        7,863        8,253        8,691        9,088   

Members’ capital

    1,830        2,476        2,075        1,638        1,239   

Members’ contributions

    -        -        -        -        1,138   

Members’ distributions1

  $ (955)      $ (177)      $ (113)      $ (113)      $ (113)   

1 Fiscal 2011 includes in this amount $(250) for the redemption of the ownership interests of two of our former members; $(383) was a return of capital to certain of the remaining members; and $(322) was earnings distributed to the members.

 

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Summarized unaudited quarterly consolidated financial data

for the quarters ended

 

         March 31,    
2011
   

      June 30,    

2011

    September 30,
2011
    December 31,
2011
 

Operations Data

                               

Total revenue

  $ -      $ -      $ -      $ 5   

Selling, general and administrative expenses

    -        -        -        5   

Net income from continuing operations

    -        -        -        -   

Discontinued operations:

                               

Interest income

    258        227        153        -   

Total revenue

    258        227        153        -   

Selling, general and administrative expenses

    3        45        21        -   

Interest expense

    108        90        62        -   

Total operating expenses

    111        135        83        -   

Net income from discontinued operations

    147        92        70        -   

Net income

  $ 147      $ 92      $ 70      $ -   
         
                                 
     March 31,
2010
   

June 30,

2010

    September 30,
2010
    December 31,
2010
 

Operations Data

                               

Total revenue

  $ -      $ -      $ -      $ -   

Selling, general and administrative expenses

    -        -        -        -   

Net income from continuing operations

    -        -        -        -   

Discontinued operations:

                               

Interest income

    258        258        258        259   

Total revenue

    258        258        258        259   

Selling, general and administrative expenses

    2        5        3        3   

Interest expense

    114        112        108        108   

Total operating expenses

    116        117        111        111   

Net income from discontinued operations

    142        141        147        148   

Net income

  $ 142      $ 141      $ 147      $ 148   

 

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BUSINESS

Overview

We were organized in the Commonwealth of Pennsylvania in 2007 under the name 84 RE Partners, LLC and changed our name to Shepherd’s Finance, LLC on December 2, 2011. We converted to a Delaware limited liability company on March 29, 2012. Our business is focused on commercial lending to participants in the residential construction and development business. We believe this market is underserved because of the lack of traditional lenders currently participating in the market. We are located in McMurray, Pennsylvania, a suburb of Pittsburgh. Our operations are governed pursuant to our operating agreement.

From 2007 through the majority of 2011, we were the lessor in three commercial real estate leases (which were treated as direct financing leases for accounting purposes) with an affiliate of 84 Lumber Company. Beginning in late 2011, we began commercial lending to residential homebuilders. Because of our limited operating history, we are an early stage finance company. We currently have no paid employees. Our only officer is our Chief Executive Officer–Daniel M. Wallach. Our Board of Managers is comprised of Mr. Wallach and two independent Managers–Bill Myrick and Kenneth R. Summers. Our officers are responsible for our day-to-day operations, while the Board of Managers is responsible for overseeing our business.

The commercial loans we intend to extend are expected to be secured by first mortgages on the underlying real estate. We plan on extending and servicing commercial loans to small to medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. We also will extend and service loans for the purchase of undeveloped land, and the development of that land into residential building lots.

Our Chief Executive Officer, Daniel M. Wallach, has been in the housing industry since 1985. He was the CFO of a multi-billion dollar supplier of building materials to home builders for eleven years. He also was responsible for that company’s lending business for twenty years. During those years, he was responsible for the creation and implementation of many secured lending programs to builders. Some of these were done fully by that company, and some were done in partnership with banks. In general, the creation of all loans, and the resolution of defaulted loans, was his responsibility whether the loans were company loans or loans in partnership with banks. Through these programs, he was responsible for the creation of $2,000,000,000 in loans which generated interest spread after deducting for loan losses of $55,000,000. Through the years, he managed the development of systems for reducing and managing the risks and losses on defaulted loans. Mr. Wallach also was responsible for that company’s unsecured debt to builders, which reached over $300,000,000 at its peak. He also gained experience in securing defaulted unsecured debt at that company.

To fund our business, we anticipate having three sources of capital - senior secured borrowings, the Notes and other unsecured borrowings, and equity capital.

Investment Objectives and Opportunity

Background and Strategy

Finance markets are highly fragmented, with numerous large, mid-size and small lenders and investment companies, such as banks, savings and loan associations, credit unions, insurance companies and institutional lenders, all competing for investment opportunities. Many of these market participants are, as a result of the current credit environment, not participating in this market to the extent they had before the credit crisis. We believe that these lenders will be unable to satisfy the current demand for residential construction financing, creating attractive opportunities for niche lenders such as us for many years. Additionally, while we believe the current credit environment will be temporary, we believe the many participants in the finance markets will significantly alter their lending standards, which will also create attractive, long-term opportunities for us. Our goal is not to be a customer’s only source of commercial lending, but an extra, more user-friendly piece of their financing.

 

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We intend to create and service these construction loans differently than most lenders have done in the past, in that we will:

 

   

Focus on long term lending relationships through salespeople that only do this type of lending;

   

Be a specialist in this type of lending;

   

Have a national footprint for lending without having the overhead of a national footprint of branches;

   

Generally use appraisers who are experts in the specific market (rather than simply using the cheapest or most readily available);

   

Work out defaulted loans with the same person that created that loan, which will help both control the creation of bad loans, and the losses on bad loans;

   

Pursue customers with defaulted loans faster and more aggressively than typical lenders; and

   

While pursing those customers, offer creative solutions to help them sell their home while in default (such as furniture allowances and interest rate buy downs for their customers).

We believe that while creating speculative construction loans is a high risk venture, the reduction in competition, the differences in our lending versus typical bank lending (listed above); and our loss mitigation techniques (covered below) will all help to make this a profitable business.

The housing market has recently been plagued by declining values and a lack of housing starts. We believe that, despite the resulting issues in the speculative construction industry, it is a good time for this type of lending because:

 

   

Many traditional lenders to this market have exited or cut back, reducing competition and allowing large spreads (the difference between our cost of funds and the rate we charge our borrowers). Better builders can be obtained as customers, with higher spreads;

   

The number of housing starts and the value of homes built are both low. We believe that we are at the bottom of the housing cycle, and that it is likely that housing starts and values will both increase over time. Both of these items increasing should have a positive effect on our performance;

   

There are fixed costs involved in running this kind of operation, such as some payroll and the costs of maintaining public borrowings. These require a fixed interest rate spread in dollars to cover these costs. Because insured financial institution deposit rates are at historic lows, we hope to be able to attract enough funds to reach this required spread before these rates go up, and before competition significantly increases on our lending; and

   

We will do various things to try to mitigate the risks inherent in this type of lending by:

  o Keeping the LTV between 60% and 80%;
  o Generally using deposits from the builder on home construction loans to ensure the completion of the home. Lending losses on defaulted loans are usually a higher percentage when the home is not built, or is only partially built;
  o Having a higher yield than other forms of secured real estate lending;
  o Paying major subcontractors and suppliers directly, which reduces the frequency of liens on the property (liens generally hurt the net realized value of loss mitigation techniques);
  o Aggressively working with builders who are in default on their loan before and during foreclosure. This technique generally yields a reduced realized loss; and
  o Market grading. All lending markets will be reviewed analyzing their historic housing start cycles. Then, the current position of housing starts will be examined in each market. Markets will be classified into volatile, average, or stable, and then graded based on that classification and our opinion of where the market is in its housing cycle. This grading will be used to determine the builder deposit amount, the LTV, and the yield.

Additionally, most financial institutions are highly regulated. In exchange for that regulation, they offer FDIC insurance to their investors. We are not highly regulated, nor do we offer FDIC insurance to our investors. While we are subject to some regulation, such as anti-terrorism and commercial lending laws, currently, we are not subject to consumer lending rules or federal banking regulations. We believe this provides us with the opportunity to learn from the positive aspects of banking regulations while avoiding costly regulatory compliance.

 

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Since we are not a tightly regulated company, we feel that we have a competitive edge that allows us to make prudent, business-minded decisions. While regulators are restricting investments by regulated financial institutions in commercial construction loans, our business plan will emphasize commercial construction lending as our main line of business. We believe this to be an opportunity as the regulatory environment and resulting contraction in commercial lending has resulted in this segment of the market having fewer lenders. We also believe the real estate market has reached historically low levels, and feel, based on recent data relating to housing starts and home values, that the market has stabilized. Finally, while we plan to institute many of the underwriting requirements and activities used by regulated financial institutions, we believe being unregulated provides us with more flexibility in our underwriting process and procedures.

Outside of differences in our lending policies, we believe the benefits to not being regulated include:

 

   

our ability to better manage our outflow of funds because our Notes have a stated term. Banks must offer demand deposit accounts (checking accounts) and other accounts, which provide that funds can be withdrawn at any time;

   

avoiding FDIC insurance and other regulatory fees;

   

not being subject to the Community Reinvestment Act; and

   

eventually having less leverage than a bank.

Conversely, our lack of regulation introduces us to other risks which may harm us. For example, we:

 

   

are not well diversified in our product risk;

   

cannot benefit from government programs designed to protect regulated financial institutions;

   

are not subject to periodic examinations by federal or state banking regulators; and

   

our cost of funds will be higher.

In addition, our Note holders will have greater risks than depositors in a regulated financial institution, since their investments will not be insured. See “Risk Factors - Risks Related to Our Business - Our operations are not subject to the stringent banking regulatory requirements designed to protect investors, so repayment of your investment is completely dependent upon our successful operation of our business.”

To help mitigate the risks associated with not being regulated, we intend to:

 

   

follow many of the same underwriting principals used by banks;

   

maintain loan files which will, generally, contain similar information as a bank loan file;

   

secure our loans with mortgages and other documents like banks do; and

   

monitor many of the same ratios bank regulators monitor.

So while we will, in our opinion, improve on some policies and procedures used by banks today which we would not be able to do if we were regulated (such as appraiser selection and geographic diversity) we will follow many of the policies and procedures set up by the various bank regulators. We believe this balanced approach will help us mitigate risk while providing us the opportunity to enter into what we believe to be an underserved market.

Our loans will likely be marketed by lending representatives who work for us and are driven to maintain long-term customer relationships. To date, we have not retained any personnel in addition to our Chief Executive Officer. Hiring and retaining high quality lending representatives should not be difficult in the short-term banking environment, where construction lenders will have a hard time finding and keeping employment with traditional lenders. In his previous experience, our Chief Executive Officer has had a nationwide staff of 20 lenders working in the field. Compensation will be focused on the profitability of loans originated, not simply the volume of those loans originated.

We are initially focusing our business on transactions originating in the Pittsburgh area. Over time we expect to expand into other geographic areas as we build or acquire market expertise that will allow us to successfully finance transactions in those areas. Our goal is to market our loans on a nationwide basis. We believe

 

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that this goal can only be achieved with sufficient funds from this offering. Currently, our loan portfolio consists of loans made to one customer, but, as we grow our loan assets, we intend to significantly diversify our customer base.

Lines of Business

Commercial Construction Loans to Homebuilders

We plan on extending and servicing commercial loans to small to medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. We also will extend and service loans for the purchase of undeveloped land and the development of that land into residential building lots. Most of the loans will be for “spec homes” or “spec lots,” meaning they are built or developed speculatively (with no specific end-user home owner in mind). The loans will be secured, and the collateral will be the land, lots, and constructed items thereon, as well as additional collateral as we deem appropriate. The loans will be demand loans, but the typical length of a home construction loan will range between six months and two years and is expected to average 10 months; the typical length of a development project will range between three and six years. See “Risk Factors—Risks Related to Our Business” generally.

We will fund the loans we originate using available cash resources that are generated primarily from borrowings, net cash flow and proceeds of the Notes.

There is a seasonal aspect to home construction, and this will affect monthly cash flow. In general, since these investments will last 10 months on average, and since we intend to be geographically diverse, we expect the seasonality impact to be somewhat mitigated if we are successful.

Our officer is responsible for all aspects of our commercial construction loan business, including:

 

   

closing and recording of mortgage documents;

   

collecting principal and interest payments;

   

enforcing loan terms and other borrower’s requirements;

   

periodic review of each loan file; and

   

exercising our remedies in connection with defaulted or non-performing loans.

We expect that our customers will typically be small to medium sized home builders that are currently building in the markets in which we will lend to them. Generally, they will benefit from doing business with us not just because they will be able to sell additional homes (which we will finance), but because as they build additional homes, they will be able to increase homes that will be built as contracted homes, where the eventual home owner supplies the loan. Builders generally have more success selling homes when a model or spec homes is available for customers to see. We anticipate that most of our lending will be based on the following general policies:

 

Customer Type

   Small to Medium Size Homebuilders

Loan Type

   Commercial

Loan Purpose

   Construction of Homes or Development of Lots

Security

   Homes, Lots, and/or Land

Loan to Value Averages

   60-80%

Loan Amounts

   Average home construction loan $200,000, development loans vary greatly

Term

   Demand

Rate

   Cost of Funds plus 2%, minimum rate of 7%

 

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Origination Fee

   5% for home construction loans, development loans on a case by case basis

Title Insurance

   Only on high loan risks

Hazard Insurance

   Only on high loan risks

General Liability Insurance

   Always

Credit

   Credit – Builder should have significant building experience in the market, be building in the market currently, be able to make payments of interest, be able to make the required deposit, have acceptable personal credit, and have open lines of credit (unsecured) with suppliers reasonable within terms. We will generally not advertise to find customers, but use our loan representatives. We believe this approach will allow us to focus our efforts on builders that meet our acceptable risk profile.

We may change these policies at any time based on then-existing market conditions or otherwise, at the discretion of our officer and Board of Managers.

Purchases and Securitization of Unsecured Debt from Suppliers to Homebuilders

Homebuilders generally buy their construction materials from building supply companies, which offer unsecured credit lines for these purchases. Sometimes, the builder is unable to pay the principal due on their line of credit when due, and in a small percentage of these cases, the builder owns unencumbered real estate. When this is the case, the building supply company may convert the unsecured line of credit to secured, using this real estate as security. In some of these situations, the building supply company is unwilling to complete this type of transaction, and is willing to take a payment of a percentage of the balance of the unsecured line as full payment. If we pay the building supply company a percentage of this debt, and then take the real estate as collateral for the whole amount of the original debt, management’s experience indicates we will be able to eventually collect from the builder, or from the sale of the property through foreclosure or otherwise, creating a profit for ourselves. We have not completed any of these transactions, but may choose to do so if the opportunity presents itself.

Purchases of Defaulted Secured Debt from Financial Institutions

Many financial institutions made loans to homebuilders when lot and home values were higher than they are today. In many cases, these loans defaulted, and eventually these loans result in collateral foreclosure. After the foreclosure proceeding, the properties usually become the property of the financial institution, which then sells the property, generally at a loss. While the loan is in the foreclosure process, and after the process while the real estate is owned and for sale, the bank holds a nonperforming asset. Sometimes these nonperforming assets negatively impact the banks’ profitability and regulatory ratios. Some banks choose to cleanse their books of these items at a severe loss, allowing them to, while taking a loss, get back to their commercial lending business. There are opportunities to purchase some portfolios of defaulted loans, and/or real estate owned through foreclosure at deep discounts compared to the actual value of the property, if the owner works them out properly. We have not completed any of these transactions, but may choose to do so if the opportunity presents itself.

Our Loan Portfolio

Our assets are generally cash and loans receivable. From 2007 through September 2011, our assets were commercial real estate leases. We were the lessor in three commercial real estate leases (which were treated as direct financing leases for accounting purposes) with an affiliate of 84 Lumber Company. The lessee had purchase options, which were eventually exercised in May and September 2011, thereby terminating the leases. From

 

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September 2011 through December 30, 2011, our only asset was cash, which we held waiting for the creation of new loans.

On December 30, 2011, pursuant to a credit agreement by and between us, Benjamin Marcus Homes, LLC (“BMH”), Investor’s Mark Acquisitions, LLC (“IMA”) and Mark L. Hoskins (“Hoskins”) (the “Credit Agreement”), we originated two new loan assets, one to BMH as borrower (the “BMH Loan”) and one to IMA as borrower (the “New IMA Loan”). See “Risk Factors—Risks Related to Our Business - We are currently reliant on a single developer and homebuilder for our revenues and some of our debt.” Pursuant to the Credit Agreement, we also assumed the position of lender on an existing loan to IMA (the “Existing IMA Loan”) and assumed the position of borrower on another existing loan in which IMA serves as the lender (the “SF Loan”). The BMH Loan, the New IMA Loan and the Existing IMA Loan are all cross-defaulted and cross-collateralized with each other. Further, IMA and Hoskins serve as guarantors of the BMH Loan, and BMH and Hoskins serve as guarantors of the New IMA Loan and the Existing IMA Loan. The terms and conditions of these loans are set forth in further detail below.

BMH Loan

The BMH Loan is a revolving demand loan in the original principal amount of up to $4,164,000, of which $3,568,000 was funded at closing. We collected a fee of $750,000 upon closing of the BMH Loan, which fee was funded from proceeds of the loan. Additionally, $450,000 of the loan proceeds was allocated to an interest escrow account (the “Interest Escrow”). Interest on the BMH Loan accrues annually at 2% plus the greater of (i) 5.0% or (ii) the weighted average price paid by us on or in connection with all of our borrowed funds (such weighted average price includes interest rates, loan fees, legal fees and any and all other costs paid by us on our borrowed funds, and, in the case of funds borrowed by us from our affiliates, the weighted average price paid by such affiliate on or in connection with such borrowed funds). Pursuant to the Credit Agreement, interest payments on the BMH Loan will be funded from the Interest Escrow, with any shortfall funded by BMH. Payments of principal on the BMH Loan are due upon our demand and in accordance with the payment schedule and other terms and conditions set forth in the Credit Agreement. The Credit Agreement obligates BMH to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the BMH Loan. The BMH Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve BMH of its obligation to continue to make payments on the BMH Loan as set forth in the Credit Agreement.

The BMH Loan is secured by a first priority mortgage in residential property consisting of 16 building lots, and an unimproved parcel of land of approximately 34 acres, all located in the subdivision commonly known as the Hamlets of Springdale in McMurray, Pennsylvania, a suburb of Pittsburgh, as well as the Interest Escrow. The seller of the property securing the BMH Loan has retained a second mortgage in the amount of $400,000.

Existing IMA Loan

The Existing IMA Loan is a demand loan in the original principal amount of $1,686,767, of which $1,686,767 was outstanding as of December 31, 2011. Interest on the Existing IMA Loan accrues annually at a rate of 7.0%. Pursuant to the Credit Agreement, interest payments on the Existing IMA Loan will be funded from the Interest Escrow, with any shortfall funded by IMA. Payments of principal on the Existing IMA Loan are due upon the earlier of our demand or the satisfaction in full of the indebtedness related to the BMH Loan and the New IMA Loan. The Credit Agreement obligates IMA to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the Existing IMA Loan. The Existing IMA Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve IMA of its obligation to continue to make payments on the Existing IMA Loan as set forth in the Credit Agreement.

The Existing IMA Loan is secured by a mortgage in the residential property that also secures the New IMA Loan.

 

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New IMA Loan

The New IMA Loan is a demand loan in the original principal amount of up to $2,225,000, of which $250,000 was funded at closing. We collected a fee of $250,000 upon closing of the New IMA Loan, which fee was funded from proceeds of the loan. Interest on the New IMA Loan accrues annually at 2.0% plus the greater of (i) 5.0% or (ii) the weighted average price paid by us on or in connection with all of our borrowed funds (such weighted average price includes interest rates, loan fees, legal fees and any and all other costs paid by us on our borrowed funds, and, in the case of funds borrowed by us from our affiliates, the weighted average price paid by such affiliate on or in connection with such borrowed funds), plus 2.0%. Pursuant to the Credit Agreement, interest payments on the New IMA Loan will be funded from the Interest Escrow, with any shortfall funded by IMA. Payments of principal on the New IMA Loan are due upon our demand and in accordance with the payment schedule and other terms and conditions set forth in the Credit Agreement. The Credit Agreement obligates IMA to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the New IMA Loan. The New IMA Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve IMA of its obligation to continue to make payments on the New IMA Loan as set forth in the Credit Agreement.

The New IMA Loan is secured by a mortgage in residential property consisting of approximately 54 acres of undeveloped land, all located in the subdivision commonly known as the Tuscany Subdivision in McMurray, Pennsylvania, a suburb of Pittsburgh. The property securing the New IMA Loan and the Existing IMA Loan is subject to a mortgage in the amount of $1,290,000 which is held by an unrelated third party. In connection with the closing of the New IMA Loan and the Existing IMA Loan, the holder of this mortgage entered into an agreement to amend, restate and further subordinate such mortgage. This subordination agreement also provides that, in the event of a foreclosure on and liquidation of the property securing the New IMA Loan and the Existing IMA Loan, we are entitled to receive liquidation proceeds up to $2,225,000, which excludes the collateral securing the BMH Loan, at which point the holder of this mortgage is entitled to receive liquidation proceeds up to the amount necessary to satisfy its outstanding mortgage, and we are then entitled to any remainder of the liquidation proceeds. See “Risk Factors—Risks Related to Our Business—In the event we foreclose on the property securing certain of our loans, we have agreed to provide a limited preference in our foreclosure proceeds to a third party, which could reduce the amount of proceeds that we would receive on a foreclosure of the property.”

SF Loan

The SF Loan, under which we are the borrower, is an unsecured loan in the original principal amount of $1,500,000, of which $1,500,000 was outstanding as of December 31, 2011. Interest on the SF Loan accrues annually at a rate of 5.0%. Payments of interest only are due on a monthly basis, with the principal amount due on the date that the BMH Loan and the New IMA Loan are paid in full. We may prepay the SF Loan in part or in full at any time without penalty, subject to the terms and conditions set forth in the underlying promissory note. Pursuant to the Credit Agreement, payments on the SF Loan will be used to fund the Interest Escrow. Further, pursuant to that certain Amended and Restated Commercial Pledge Agreement by and between us, IMA and BMH, IMA has pledged its interest in the SF Loan as collateral for IMA’s obligations under the New IMA Loan and the Existing IMA Loan.

As of December 31, 2011, the details of our loan portfolio were as follows:

(All dollar [$] amounts shown in thousands.)

 

Item    Term      Interest Rate      Funded to  
borrower  
     Collateral  
amount  
 

BMH Loan

       Demand*             COF +2% (7% Floor)                       

16 Lots

                     $ 2,368       $ 1,760   

Land for phases 3, 4 and 5

                       -         1,930   

Interest Escrow

                       450         450   

Loan Fee

                       750         -   

Total BMH Loan

                       3,568         4,140   

 

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Item    Term   Interest Rate    Funded to
borrower
     Collateral
amount
 

  IMA Loans

                          

  New IMA Loan (all loan fee)

   Demand*   COF +2% (7% Floor)      250           -   

  Existing IMA Loan

   Demand**     7%      1,686           1,910   

  Total IMA Loans

              1,936           1,910   
                            

  Unearned loan fee

              (1,000)           -   

  Deferred loan expense

              76              

  SF Loan

              -           1,500   
                            

  Total

            $             4,580         $         7,550   

*These are the stated terms; however, in practice, we anticipate that principal will be repaid upon the sale of each developed lot.

**These are the stated terms; however, in practice, we anticipate that principal will be repaid upon the sale of each developed lot after the BMH loan and the New IMA loan are satisfied.

Competition

Historically, our industry has been highly competitive. We compete for opportunities with numerous public and private investment vehicles, including financial institutions, specialty finance companies, mortgage banks, pension funds, opportunity funds, hedge funds, REITs and other institutional investors, as well as individuals. Many competitors are significantly larger than us, have well established operating histories and may have greater access to capital, resources and other advantages over us. These competitors may be willing to accept lower returns on their investments or to modify underwriting standards and, as a result, our origination volume and profit margins could be adversely affected.

We believe that this is a good time to extend commercial loans to builders in the residential real estate market because, currently, this market appears underserved, home values are low, and many of our competitors have sustained losses due to declines in home values and, therefore, are reluctant to lend in this space at this time. We expect our loans to be different than other lenders in the markets in which we are active. Typically the differences are:

 

   

our loans may have a higher fee;

   

our loans may include an interest free period (whereas normal lenders charge interest); and

   

some of our loans may have lower costs as a result of not requiring title or hazard insurance.

Regulatory Matters

Financial Regulation

Our operations are not subject to the stringent regulatory requirements imposed upon the operations of commercial banks, savings banks, and thrift institutions, and are not subject to periodic compliance examinations by federal or state banking regulators.

Further, our Notes are not certificates of deposit or similar obligations or guaranteed by any depository institution and are not insured by the FDIC or any governmental or private insurance fund, or any other entity.

The Investment Company Act of 1940

An investment company is defined under the Investment Company Act of 1940, as amended (the “Investment Company Act”) to include any issuer engaged primarily in the business of investing, reinvesting, or trading in securities. Absent an exemption, investment companies are required to register as such with the SEC and to comply with various governance and operational requirements. If we were considered an “investment company”

 

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within the meaning of the Investment Company Act, we would be subject to numerous requirements and restrictions relating to our structure and operation. If we were required to register as an investment company under the Investment Company Act and to comply with these requirements and restrictions, we may have to make significant changes in our proposed structure and operations to comply with exemption from registration, which could adversely affect our business. Such changes may include, for example, limiting the range of assets in which we may invest. We intend to conduct our operations so as to fit within an exemption from registration under the Investment Company Act for purchasing or otherwise acquiring mortgages and other liens on and interest in real estate. In order to satisfy the requirements of such exemption, we may need to restrict the scope of our operations.

Environmental Compliance

We do not believe that compliance with federal, state, or local laws relating to the protection of the environment will have a material effect on our business in the foreseeable future. However, loans we extend or purchase are secured by real property. In the course of our business, we may own or foreclose and take title to real estate that could be subject to environmental liabilities with respect to these properties. We (or our loan customers) may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical release at a property. The costs associated with the investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. To date, we have not incurred any significant cost related to environmental compliance and we do not anticipate incurring any significant costs for environmental compliance in the future.

Legal Proceedings

As of the date of this prospectus, we are not aware that we or our members are a party to any pending or threatened legal proceeding or proceeding by a governmental authority that would have a material adverse effect on our business.

Reports to Security Holders

We intend to file quarterly and annual reports as required by the SEC. The annual reports we file with the SEC will contain consolidated financial information that has been examined and reported upon, with an opinion expressed by an independent registered public accounting firm. You may access this information on-line, at our website, at www.shepherdsfinance.com, or by calling us at              (toll free) to have copies mailed to you at no cost. However, information contained on our website does not constitute part of this prospectus, and you should rely only on the information contained in or specifically incorporated by reference into this prospectus in deciding whether to invest in the Notes.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS

(All dollar [$] amounts shown in thousands.)

The following discussion should be read in conjunction with the information included in our audited annual consolidated financial statements and related notes and other consolidated financial data included in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

We are a Delaware limited liability company. Our business is focused on commercial lending to participants in the residential construction and development business. We were organized in 2007 in Pennsylvania under the name 84 RE Partners, LLC. 84 RE Partners is the sole member in three consolidating subsidiaries, 84

 

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REPA, LLC, 84 RENC, LLC (will be terminated in 2012), and 84 REFL, LLC (also will be terminated in 2012). In conjunction with a change in strategic direction, as discussed more fully below, 84 RE Partners, LLC changed its name on December 2, 2011 to Shepherd’s Finance, LLC (the “Company”, “we” or “our”). On March 29, 2012, we converted to a Delaware limited liability company. We are located in McMurray, Pennsylvania, a suburb of Pittsburgh.

Control Environment

Prior to March 2012, we were managed by Daniel M. Wallach, as our sole Manager. Therefore, prior to that time, Mr. Wallach had direct and exclusive control over the management of the Company’s operations.

In March 2012, we assembled a Board of Managers, which includes two independent Managers in addition to Mr. Wallach. Our officers are responsible for our day-to-day operations, while the Board of Managers is responsible for overseeing our business. The independent Managers, acting through the nominating and corporate governance committee, must approve all affiliate transactions. All of our outstanding membership interests are owned by Mr. Wallach and his wife; therefore, Mr. Wallach is able to exercise significant control over our business, including with respect to the composition of our Board of Managers. A Manager may be removed by a vote of holders of 80% of our outstanding voting membership interests.

Historical Operations

During 2007 and continuing through portions of 2011, we were the lessor in three commercial real estate leases (which were treated as direct financing leases for accounting purposes) with an affiliate of 84 Lumber Company. During the majority of time of the business relationship between us and 84 Lumber, Mr. Wallach was employed by 84 Lumber, while also operating as the our sole Manager. The leased properties were sold to 84 Lumber in May and September of 2011, and the leases were thereby terminated. This business model generated consistent profits, positive cash flows and returns to the members for the duration of these financings. The results of operations, cash flows and financial position related to the commercial real estate leases are presented as Discontinued Operations in management’s discussion and analysis and the accompanying consolidated financial statements and footnotes.

Change in Strategy

In late 2011, management elected to transform our business model. The Company intends to focus most of its future efforts on commercial lending to residential homebuilders to finance construction of single family residential properties. The single family residential construction loans will be extended to residential homebuilders and, as such, are commercial loans. The Company also intends to lend money to residential homebuilders to develop undeveloped land into residential building lots known as acquisition and development loans, which are also considered commercial loans.

Our plans include expanding our lending capacity and funding our business operations by extending Notes to the general public, which are unsecured subordinated debt. Eventually, the Company intends to repay its debt from affiliates with secured debt from a bank or through other liquidity.

Recent Transactions

From September 2011 through December 30, 2011, our only asset was cash, which we held waiting for the creation of new loans. On December 30, 2011, we originated three new loan assets, which are commercial loans for residential development in a suburb of Pittsburgh, Pennsylvania. One loan is collateralized by 16 building lots and an unimproved parcel of land of approximately 34 acres. The other two loans are collateralized by approximately 54 acres of undeveloped land. These three loans are to borrowers who are affiliated with each other and are cross-collateralized. We also assumed a note payable of $1,500 to the borrower from its prior lender. The builder was funded to pay us our loan fee, and also to create an account with an interest escrow. The note payable and interest escrow are collateral for the loans. The total advanced on these loans as of December 31, 2011 was $5,504. The estimated value of the total collateral for these loans was $7,550, which is based on an appraisal of the collateral prepared for us in March 2012.

 

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To assist in financing these opportunities, on December 30, 2011, we obtained funding from two demand loans from our members. The total outstanding balance on these loans on December 31, 2011 was $878. These demand loans are collateralized by a lien against all of our assets and are senior in right of payment to the Notes.

Economic and Industry Dynamics

Demand for residential construction loans has been negatively impacted by the decrease in housing starts (a key driver relative to commercial lending to residential homebuilders) over the past six years. This decrease followed 15 years of increases in housing starts. Home values also decreased during the housing start decline. The combination of these events, along with others, presented significant hurdles to residential homebuilders.

Due to the need to fund either part or all of the costs of their construction projects, homebuilders often have to partner with lending institutions. The normal lending institutions (banks, S&L, credit unions, etc.) have all been negatively impacted by these same recent trends, which have raised default rates and losses related to commercial lending loans issued to residential homebuilders. In fact, many state and federal regulators are discouraging community banks and lending institutions from lending to residential homebuilders.

We believe all the factors above present three significant opportunities. The first opportunity, and our primary focus, is to become the lender of choice or secondary lender to residential homebuilders during the absence of lending at the homebuilder’s local financial institution or community bank. Another is to purchase and securitize the loans made by building supply companies to those homebuilders. Finally, we may acquire deeply discounted defaulted debt from other financial institutions. While we have not entered into any transactions related to the final two opportunities, we will remain mindful of those opportunities to generate a return from such transactions.

Perceived Challenges and Anticipated Responses

The following is not intended to represent a comprehensive list or description of the risks or challenges facing the Company (for a more complete list of challenges and risks, see “Risk Factors” elsewhere in this prospectus). Currently, our management is most focused on the following challenges along with the corresponding actions to address those challenges:

 

Perceived Challenges and Risks    Anticipated Management Actions/Response
Start-up operations   

Our management has experience in commercial lending to residential homebuilders. However, this will represent management’s first attempt to create a stand-alone operation of this type with a capital structure of this type. Management believes possessing experience in business, track record in this type of lending, and the contacts made in previous endeavors will assist with staffing and other challenges it will face with this new endeavor.

 

Concentration of loan portfolio (i.e. how many of the loans are of one type, with any particular customer, or within any particular geography)   

Our management plans to extend loans to multiple lenders in multiple geographies across the U.S. in order to diversify this risk to the degree possible while continuing to focus on residential homebuilder customers.

 

Potential loan value-to-collateral value issues (i.e. being underwater on particular loans)   

Our management anticipates managing this challenge by risk-rating both the geographic region and the builder, then adjusting the loan-to-value (i.e. the loan amount versus the value of the collateral) based on the risk assessments. Additionally, management anticipates collecting a deposit up-front.

 

 

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Potential increases in interest rates, which would reduce operating income   

Our management intends to offer variable rate loans that incorporate a spread (i.e. profit) above the Company’s costs of funds to insulate it against this risk. A more detailed description is included in Interest Spread below.

 

Liquidity   

Our management has short, intermediate and long term plans including, but not limited to:

 

•        Short term – focus on generating operating cash flow and (if necessary) equity infusions and/or affiliate debt;

•        Intermediate – issue public debentures as contemplated in this prospectus; and

•        Long-term – execute a form of bank financing to replace the demand loans from affiliates.

 

Opportunities

Although we can give no assurance as to our success in our efforts, in the future, our management intends to focus its efforts on the following opportunities:

 

   

receiving money from the Notes, sufficient enough to operate our business plan;

   

growing loan assets, and the staffing and operations to handle it. We anticipate hiring the office staff as loan volume grows, and hiring the origination staff, which will be field based, as our liquidity allows for new loan origination. The goal for the field staff is to have a geographic coverage that eventually covers most of the continental U.S.;

   

replacing our existing lines of credit from our affiliates with lines of credit from financial institutions. We would like the maximum amount (the credit limit) to be about 20% of our asset size, and our outstanding amounts to average around 10% of our asset size;

   

producing a profit, and making distributions to our owners to cover their tax burden from our operations, and, if possible, to give them a return on their investment; and

   

retaining earnings to grow the equity of the Company.

Understanding and Evaluating Our Operating Results

Our results of operations are driven by three major factors—interest spread, loan losses and selling, general and administrative (SG&A) expenses.

Interest Spread

Interest spread is generally made up of the following three components:

     Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings).

•     Fee income. This fee is generally recognized over the life of the loan, spread so that the effective interest rate on the loan is level during the life of the loan. The amount of interest spread on these loans will depend on the life of the loans, as well as the fee percentage. As more competition comes into the residential construction lending market, we expect this portion of spread income to decrease.

•     Amount of nonperforming assets. Since we are paying interest on all money we borrow, any asset created or funded with borrowed funds that does not have an interest return costs us money. There is an interest expense for us, with no interest income to offset it. Generally there are two types of nonperforming assets. The first is nonperforming loans, which do not generate interest income unless actually received in cash. We currently do not

 

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have any nonperforming loans. The second nonperforming asset type is money borrowed which is not invested in loans. We typically carry a small cash balance, so this has not been a factor in our existence until the fourth quarter of 2011. While this cash was funded with equity, had it been funded with debt we would have lost the potential earning power of this cash balance.

We calculate interest spread by taking the difference between interest income and expense, and dividing it by our weighted average outstanding loan balance. As we increase our operations, we anticipate that this spread initially will be higher, while our competitors remain on the construction lending sidelines, and then decrease as competition for these loan assets increases.

Loan Losses

The second major factor in determining our profitability is loan losses. During our existence to date, we have not held nonperforming loans and incurred no loan losses; but this is unlikely to continue. We anticipate lending to the residential construction industry, which is in a weak position today. Losses on loans occur with nonperforming loans (i.e. when customers are unable to repay their interest and/or principal). Normally, the loss in this situation is the difference between the collateral value and the loan value, less any costs of disposal. Homes recently constructed during the past several years have created significant losses because many homes are worth less than the appraised value at the time the loan was created. Losses also occur in loans when homes are partly built at the point of default, or never built. Generally, a declining real estate market will be the primary driver for loan losses. We believe that while current values may fall in some real estate markets, in general, values are low and represent a lower risk than at other times over the last five years.

SG&A Expenses

SG&A expenses for us are almost all of the expenses that are not interest and loan losses. Our SG&A expenses have been very low, since our business required very little oversight to operate in the past. We have recorded no salaries in our existence. In the future, we will be recording salaries and other expenses related to running a commercial lending operation. We will need to have employees who generate loans, underwrite them, close them, fund them, administer them, and eventually collect them. We will have administrative expenses as well. We will have outside party expenses for auditing and legal, and we will have loan loss collection expenses. We have not been accustomed to incurring these expenses in the past.

Our SG&A expenses will also increase significantly when we become a public company. Upon the effectiveness of the registration statement, of which this prospectus is a part, we will become a public reporting company under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As a result, we will need to comply with federal securities laws, regulations and requirements, including certain provisions of the Sarbanes-Oxley Act. Compliance with the requirements of being a public company will increase our general and administrative expenses to pay our employees, legal counsel, accountants, and other advisors to assist us in, among other things, external reporting, instituting and maintaining internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act, and preparing and distributing periodic public reports in compliance with our obligations under the federal securities laws.

Critical Accounting Estimates

To assist you in evaluating our consolidated financial statements, we describe below the critical accounting estimates. We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used would have a material impact on our consolidated financial condition or results of operations.

 

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Loan Losses

Nature of estimates required

Loan losses are accounted for both on the consolidated balance sheets and the consolidated statements of operations. On the consolidated statements of operations, management estimates the amount of losses to capture during the current year; this current period amount incurred is referred to as the loan loss provision. The calculation of our allowance for loan losses, which appears on our consolidated balance sheets, requires us to compile relevant data for use in a systematic approach to assess and estimate the amount of probable losses inherent in our commercial lending operations and to reflect that estimated risk in our allowance calculations. The risk of losses occurs when customers cannot pay their principal and interest due. In the past, we have estimated that risk to be minimal, and therefore have not proceeded to compare the value of the collateral versus the amount lent. For current and future loans, we will use the policy summarized as follows:

For loans to one borrower with committed balances less than 10% of our total committed balances on all loans extended to all customers, we will analyze for impairment all loans which are more than 60 days past due at the end of a quarter. For loans to one borrower with committed balances equal to or greater than 10% of our total committed balances on all loans extended to all customers, we will analyze all loans for impairment. The analysis on loans, if required, will develop a collateral value to be compared to the principal amount of the loan. If the value determined is less than the principal amount due (less any builder deposit), then the difference will be included in the loan loss. As values change, estimated loan losses may be provided for more or less than the previous period, and some loans may not need a loss provision based on payment history. For homes which are partially complete, we appraise on an as-is and completed basis, and use the one that more closely aligns with our planned method of disposal for the property.

All loans that are individually evaluated for impairment will have an appraisal done within the last 13 months. There will also be a broker’s opinion of value (“BOV”) prepared, if the appraisal is more than six months old. The lower of any BOV prepared in the last six months or appraisal done in the last 13 months will be used, unless we determine a BOV to be invalid based on the comparable sales used. If we determine a BOV to be invalid, we will use the appraised value. Appraised values are adjusted down for costs associated with asset disposal.

Appraisers are state certified, and are selected by first attempting to utilize the appraiser who completed the original appraisal report. If that appraiser is unavailable or not affordable, we will use another appraiser who appraises routinely in that geographic area. BOVs are created by real estate agents. We try to first select an agent we have worked with, and then, if that fails, we will select another agent who works in that geographic area.

Sensitivity analysis

Due to the timing of the issuance of our outstanding loans receivable and the fact that the loans are performing, we recorded neither an allowance for loan loss nor any loan loss provision. Therefore, a sensitivity analysis at this time would not be meaningful.

Fair Value

Nature of estimates required

Currently, fair value has the potential to impact the calculation of the loan loss provision most heavily. Specifically relevant to the loan loss reserve is the fair value of the underlying collateral supporting the outstanding loan balances. At December 31, 2011, no provision for loan loss was necessary as our outstanding loans were performing and the collateral value (fair value) was more than sufficient to recover the value of the outstanding loans. Fair value measurements are an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Due to a rapidly changing economic market, an erratic housing market, the various methods that could be used to develop fair value estimates and the myriad of assumptions that could be used, determining the collateral’s fair value requires significant judgment.

 

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Sensitivity analysis

 

Change in Fair Value Assumption    2011 Loan  Loss
Provision
Higher/(Lower)

Increasing fair value of the total collateral by 29%*

   $-  

Decreasing fair value of the total collateral by 29%**

   $144  

* Increases in the fair value of the collateral do not impact the loan loss provision, as the value generally is not “written up”.

**If the loans were nonperforming, assuming a gross amount of the loans outstanding of $5,504, and the fair value of the total collateral on all outstanding loans was reduced by 29%, a loan loss provision of $144 would be required.

Other Loss Contingencies

Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple forecasts that often depend on judgments about potential actions by third parties such as courts, arbitrators, juries, or regulators.

Other Significant Accounting Policies

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies related to credit quality information, discontinued operations, fair value measurements, offsetting assets and liabilities, related party transactions and revenue recognition require difficult judgments on complex matters that are often subject to multiple and recent changes in the authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standard setters and regulators. Specific conclusions have not been reached by these standard setters, and outcomes cannot be predicted with confidence. Also, see Notes 1 and 2 to our consolidated financial statements, as they discuss accounting policies that we have selected from acceptable alternatives.

Consolidated Results of Operations

Key financial and operating data for the years ended December 31, 2011 and 2010 are set forth below. For a more complete understanding of our industry, the drivers of our business, and our current period results, you should read this discussion in conjunction with our consolidated financial statements, including the related notes and the other information contained in this prospectus.

Accounting principles generally accepted in the United States of America (U.S. GAAP) require that the Company report financial and descriptive information about reportable segments and how these segments were determined. Our management determines the allocation and performance of resources based on operating income, net income and operating cash flows. Segments are identified and aggregated based on the products sold or services provided and the market(s) they serve. Based on these factors, management has determined that the Company’s ongoing operations are in one segment, commercial lending.

Additionally, our consolidated financial statements reflect the information regarding the direct finance, commercial real estate lease asset disposal group as discontinued operations. Unless otherwise indicated, the consolidated balance sheets, statements of operations and cash flows associated with the disposal group have been presented in the consolidated financial statements separately from continuing operations.

 

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For the years ended December 31, 2011 and 2010

 

  (in thousands of dollars)    2011      2010  
   

  Interest Income

     

Interest and fee income on loans

   $ 5       $ -       

Interest expense

     -         -       
   

Net interest income (loss)

     5         -       

Less: Loan loss provision

     -         -       
   

Net interest income

     5         -       

  Non-Interest Expense

     

Selling, general and administrative

     5         -       
   

Total non-interest expense

     5         -       
   

  Income (loss) from continuing operations

     -         -       

  Income from discontinued operations, net

     309         578     
   

  Net income

   $         309       $         578     

 

 

Interest Spread

•     Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings). The loans originated in December of 2011 have interest rates which are based on the lenders’ cost of funds, with a minimum cost of funds of 5%. The spread is fixed at 2%. Future loans are anticipated being originated at approximately the same 2% spread.

•     Fee income. The two loans originated in December 2011 had a net origination fee of $924. This fee will be recognized over the life of the loans. We have estimated that the fee income on the loans created in December of 2011 will equate to 4.8% interest spread over the life of the loans. In the future, we anticipate creating loans with fees ranging between 4 to 5% of the maximum loan amount.

•     Amount of nonperforming assets. We typically carry a small cash balance, so this has not been a factor in our existence until the fourth quarter of 2011. We carried cash (approximately $1,800) for the bulk of the quarter, which returned very little interest to us. To mitigate the negative spread on unused borrowed funds (idle cash), we will try to maximize future line of credit borrowings just before our Notes are offered. Ideally, we would like to have a secured line of credit with a credit limit of 20% of our loan assets, and generally carry a balance of 10% of our loan assets on that line. This way, as money comes in from Notes or loan payoffs, it can be used to pay down the line, and as money goes out for Note redemptions and new loans created, money can be drawn on the line. This will help avoid any negative spread on idle cash. As of December 31, 2011, we have two demand loans from our members with a credit limit of $1,500 (which is 27% of our gross loan assets) with an outstanding balance on those lines of $878 (which is 16% of our gross loan assets).

For the year ended December 31, 2011, our weighted average outstanding combined loan and lease balance (including discontinued operations) was $6,367 as compared to $10,327 for the year ended December 31, 2010. As we derive interest income and pay interest expense related to the loans originated and demand loans obtained from our members, respectively, and we increase our operations in future periods, we expect our major income and expense line items to increase.

We calculate interest spread by taking the difference between interest income and expense, and dividing it by our weighted average outstanding combined loan and lease balance. Our interest spread (including discontinued

 

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operations) including fee income for the year ended December 31, 2011 was $383 or 6.0% as compared to an interest spread of $589 or 5.7% for the year ended December 31, 2010. This decrease in actual dollars was due to a lower weighted average outstanding combined loan and lease balance as discussed above. We anticipate the interest spread dollars to increase in 2012 relative to 2011.

Loan Loss Provision

During our existence to date, we have not held any nonperforming loans and have incurred no loan losses; this is unlikely to continue. We anticipate a loan loss provision in the future.

SG&A Expenses

Our SG&A expenses for the year ended December 31, 2011 totaled $5 as compared to $0 for the year ended December 31, 2010 due to the reclassification of the three commercial real estate leases to discontinued operations. We anticipate increases in our operational costs, including anticipated additions of personnel related to lending, underwriting, salaries and benefits, and other administrative costs. We anticipate an increase in our outside party expenses. We also expect increased costs from becoming a public company. Therefore, we anticipate our SG&A expenses to increase significantly and rapidly in fiscal 2012.

Income from Discontinued Operations, Net

For fiscal years ended 2011 and 2010, the income from discontinued operations consisted of the following:

 

      2011      2010  

Interest income on direct financing leases

   $             638       $             1,033   

Selling, general and administrative expenses

     69         13   

Interest expense

     260         442   

Income from discontinued operations

   $ 309       $ 578   
   
   

As noted above, all of the operations and assets and liabilities associated with the direct financing, commercial real estate leases were sold for a sales price that approximated net carrying value at the time of sale; therefore, there was no gain or loss on the disposal of the discontinued operations in 2011.

The commercial real estate leases we originated in 2007 had no fee income but earned an interest rate spread of 3%. The increase in discontinued SG&A costs in 2011 primarily related to the costs of dissolving the lease transactions.

Consolidated Financial Position

As of December 31, 2011 and 2010

 

 (in thousands of dollars)    2011      2010  

 Assets

     

 Cash and cash equivalents

   $ 50       $ -   

 Accrued interest on loans

     2         -   

 Prepaid expenses

     26         -   

 Loans receivable, net

     4,580      

 Assets of discontinued operations

     -         10,339   

 Total assets

   $         4,658       $         10,339   
   
   

 

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As of December 31, 2011 and 2010

 

 (in thousands of dollars)    2011      2010  

 Liabilities and Members’ Capital

     

 Customer interest escrow

   $ 450       $ -   

 Notes payable unsecured

     1,500         -   

 Notes payable related party

     878         -   

 Liabilities of discontinued operations

     -         7,863   

 Total liabilities

     2,828         7,863   

 Members’ capital

     1,830         2,476   

 Total liabilities and members’ capital

   $       4,658       $     10,339   
   
   

Loans Receivable

In December of 2011, we extended new loans, net of unearned loan fees, totaling $4,580. These loans were all to borrowers that are affiliated to each other, and are cross-collateralized. No allowance was deemed necessary for the loans issued in 2011. We expect that we will increase our loans receivable as funds from the issuance of Notes allows in the latter part of 2012.

The loans created in 2011 had a $1,000 loan fee total. The expenses incurred related to issuing the loan were approximately $76, which were netted against the loan amount. The remaining $924, which is netted against the gross loan amount of $5,504, will be spread over the expected life of the loan using the effective interest method. The effective interest rate on the loans was increased by 4.8% as a result of this fee. We expect unearned loan fees to increase along with our commercial lending program.

Customer Interest Escrow

The loans we extended in December of 2011 called for a funded interest escrow account, with funds borrowed against the properties as part of the loan balance. The initial funding on that interest escrow was $450.

Note Payable Unsecured

At the same time that we extended the new loans on December 30, 2011, we assumed a note payable to our borrowing customer (referred to elsewhere in this document as the SF Loan) for $1,500, which was the balance at the end of 2011. This loan is unsecured and has the same priority as the Notes. It is also collateral for the loans we extended to this customer.

Note Payable Related Party

In order to minimize the amount of idle cash on our balance sheet and maximize the loans receivable which create interest spread, we have two lines of credit from affiliates, which at the end of 2011 had a balance of $878 combined. We intend to have a line(s) of credit in the future, and intend to eventually replace these lines from affiliates with lines from unrelated financial institutions.

 

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Assets and Liabilities of Discontinued Operations

At December 31, 2011 and 2010, assets and liabilities associated with the discontinued leases and their related borrowings reflected in the accompanying consolidated balance sheets are as follows:

 

      2011      2010  

Cash and cash equivalents

   $                 -       $ 12   

Investment in direct financing leases

     -         10,327   

Total assets

   $ -       $         10,339   
   
   

Unearned income

   $ -       $ 1,463   

Accrued interest bank loan

     -         252   

Notes payable bank

     -         6,148   

Total liabilities

   $ -       $ 7,863   
   
   

Assets of Discontinued Operations

Our receivables related to direct financing leases were $10,327 at the December 31, 2010. No corresponding allowance was provided for those assets at December 31, 2010. There was no investment in direct financing leases at December 31, 2011, as each property was sold to the lessee in May and September of 2011.

Liabilities of Discontinued Operations

The unearned income of $1,463 represented rental payments paid in advance based on the terms of the leases, which were terminated in 2011.

To fund the purchase of the properties under lease, we had amortizing loans from a bank. The balance at December 31, 2010 was $6,148. An associated amount, $252, of accrued interest had been incurred related to the loans. Those loans were repaid in conjunction with the termination of the leases. We also repaid all of the accrued and unpaid interest during 2011.

Contractual Obligations

We currently have three notes outstanding. The two notes to affiliates are demand notes, and the total balance on these notes is $878 as of December 31, 2011. The third note is an unsecured note for $1,500, which is due at the time our customer repays its debt.

We are obligated to lend money to customers based on agreements we have with them. We do not always have the maximum amount obligated outstanding at any given time. The amount we have not lent, but are obligated to lend, under certain conditions is a potential liquidity use. This amount was $296 at the end of 2011.

Off-Balance Sheet Arrangements

Other than as noted above under “Contractual Obligations,” we do not have any off-balance sheet arrangements that have or are reasonable likely to have a current or future effect on our consolidated financial condition, results of operations, liquidity, capital expenditures, or capital resources that are considered material, other than “Contingencies and Commitments” included in Note 9 of the notes to consolidated financial statements.

Liquidity and Capital Resources

Historically, we have funded our business through credit facilities with banks, borrowings from related parties, equity investments by our members and payments made pursuant to our commercial real estate leases. We

 

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anticipate funding our business primarily through a combination of proceeds from the interest and principal payments made by our customers, two demand loans from our members, the SF Loan, the issuance of Notes, a future line of credit from a bank and equity invested by our members.

Our business of borrowing money and re-lending it to generate interest spread is a heavy user of capital resources. There are several risks in any financing company of this nature, and we will discuss each here and how they relate to our Company and what, if any, mitigation techniques we have or may employ.

First, any financial institution needs to match the maturities of their borrowings with the maturities of their assets. The bulk of most financial institutions’ borrowings are in the form of public investments or deposits. These generally have maturities that are either set periods of time, or upon the demand of the investor/depositor. The risk is that either obligations come due before funds are available to be paid out (a shortage of liquidity) or that funds are repaid before the obligation comes due (idle cash, as described herein). To mitigate these risks, we are not offering demand deposits (for instance, a checking account). Instead, we are offering Notes with varying maturities between one and four years, which we believe will be longer than the average life of the loans we will extend. However, we have the option to repay the Notes early if we wish without penalty. These items protect us against this risk of matching of debt and asset maturity.

Second, financial institutions must have daily liquidity on their debt side, to offset variations in loan balances on a daily basis. Borrowers can repay their notes at any time, and they will request draws as they are ready for them. Further, construction loans are not funded 100% initially, so there are contractual obligations on the lender’s part to fund loans in the future. Most financial institutions mitigate this risk by having a secured line of credit from the Federal Reserve Bank. We have the same risk from customer repayments and draws as banks, and we intend to mitigate this risk by having a secured line of credit with a bank. Our current debt financing consists of the two demand loans from our members and the SF Loan, which had outstanding balances on December 31, 2011 of $878 and $1,500, respectively. Once we refinance the demand loans with a bank line of credit, we intend to maintain the outstanding balance on the line at approximately 10% of our committed loan amount. Failure to refinance the demand loans in the future with a larger bank line of credit may result in a lack of liquidity, or low loan production. Future lines of credit from banks will have expiration dates or be demand loans, which will have risks associated with those maturities.

Third, financial institutions have the risk of swings in market rates on borrowing and lending, which can make borrowing money to fund loans to their customers or fund their operations costly. The rates at which institutions can borrow are not necessarily tied to the rates at which they can lend. In our case, we are lending to customers using a rate which varies monthly with our cost of funds. So while we somewhat mitigate this risk, we are still open to the problem of, at the time of originating loans, wanting to originate new loans at a rate that would make us money, but that rate not being competitive in the market. Lack of lending may cause us to repay Notes early and lose interest spread dollars, hurting our profitability and ability to repay.

In the past, we have been able to manage our liquidity, as our borrowings coincided on a one-to-one basis with our investments, but as we grow our operations, we do not anticipate this trend will continue.

We intend to generate liquidity from:

 

   

borrowings in the form of the demand loans from our members;

   

proceeds from the Notes;

   

borrowings from lines of credit with banks (not in place yet);

   

repayments of loan receivables;

   

interest and fee income;

   

sale of property obtained through foreclosure; and

   

other sources as we determine in the future.

We intend to use liquidity to:

 

   

make payments on other borrowings, including loans from affiliates;

   

pay Notes on their scheduled due date and Notes that we are required to redeem early;

 

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make interest payments on the Notes; and

   

to the extent we have remaining net proceeds and adequate cash on hand, fund any one or more of the following activities:

  o to extend commercial construction loans to homebuilders to build single or multi-family homes or develop lots;
  o to make distributions to equity owners;
  o for working capital and other corporate purposes;
  o to purchase defaulted secured debt from financial institutions at a discount;
  o to purchase defaulted unsecured debt from suppliers to homebuilders at a discount and then secure it with real estate or other collateral;
  o to purchase real estate, which we will operate our business in; and
  o to redeem Notes which we have decided to redeem prior to maturity.

The Company’s anticipated primary sources of liquidity going forward are interest income and principal repayments related to loans it extends, as well as funds borrowed from creditors, including affiliates. Therefore, the Company’s ability to fund its operations is dependent upon these sources of liquidity.

We did not generate a profit from continuing operations during fiscal year 2011. We also used cash in continuing operations during fiscal year 2011 of approximately $2,735. At December 31, 2011, we had cash on hand of approximately $50 and our outstanding debt totaled $2,378, which was unsecured or payable to related parties.

Our current plan is to expand the commercial lending program by using current liquidity and available funding, while pursuing an initial public offering of debentures. We have anticipated the costs of this expansion and the costs of the offering, and we anticipate generating, through normal operations, the cash flows necessary to meet our operating, investing and financing requirements. The two most significant factors driving our current plans are the continued payments of principal and interest by our sole homebuilder customer and the planned public offering. If actual results differ materially from our current plan or if expected financing is not available, we believe we have the ability to discontinue the offering to reduce costs; we also believe we have the ability and intent to obtain funding and generate net worth through additional debt or equity infusions of cash. There can be no assurance, however, that we will be able to implement our strategies or obtain additional financing under favorable terms, if at all.

Inflation, Interest Rates, and Housing Starts

Since we are in the housing industry, we are affected by factors that impact that industry. Housing starts impact our customers’ ability to sell their homes. Faster sales mean higher effective interest rates for us, as the recognition of fees we charge is spread over a shorter period. Slower sales mean lower effective interest rates for us. Slower sales are likely to increase the default rate we experience.

Housing inflation has a positive impact on our operations. When we lend initially, we are lending a percentage of a home’s expected value, based on historical sales. If those estimates prove to be low (in an inflationary market), the percentage we lent on the value actually decreases, reducing potential losses on defaulted loans. The opposite is true in a deflationary housing price market. It is our opinion that values are low in many of the housing markets in the U.S. today, and our lending against these values is much safer than loans made by financial institutions in 2006 to 2008. Below is a graph showing monthly median new home sales prices in the U.S. This does not represent an exact display of what happened to any particular home over 11 years. The numbers not only vary based on inflation and deflation, but also based on size of home and areas of the country where sales are better or worse.

 

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LOGO

Source: U.S. Census Bureau

Interest rates have several impacts on our business. First, rates affect housing (starts, home size, etc.) High long term interest rates may decrease housing starts, having the effects listed above. Higher interest rates will also affect our investors. We believe that there will be a spread between the rate our Notes yield to our investors and the rates the same investors could get on deposits at FDIC insured institutions. We also believe that the spread may need to widen if these rates rise. For instance, if we pay 2% above average CD rates when CD’s are paying 0.5%, when CD’s are paying 3%, we may have to have a larger than 2% difference. This may cause our lending rates, which are based on our cost of funds, to be uncompetitive. High interest rates may also increase builder defaults, as interest payments may become a higher portion of operating costs than the builder is used to. Below is a chart showing average CD rates.

 

Certificates of Deposit Index
Month   2002   2003   2004   2005   2006   2007   2008   2009   2010   2011   2012

Jan

  3.363%   1.688%   1.132%   1.693%   3.674%   5.217%   5.145%   2.730%   0.488%   0.319%   0.313%

Feb

  3.077%   1.643%   1.113%   1.836%   3.837%   5.266%   4.958%   2.572%   0.407%   0.327%   0.315%

Mar

  2.828%   1.586%   1.098%   1.996%   3.996%   5.301%   4.748%   2.428%   0.337%   0.331%   0.316%

Apr

  2.607%   1.533%   1.085%   2.163%   4.158%   5.324%   4.543%   2.265%   0.288%   0.325%    

May

  2.423%   1.483%   1.083%   2.332%   4.318%   5.338%   4.323%   2.091%   0.278%   0.305%    

Jun

  2.263%   1.419%   1.118%   2.492%   4.483%   5.336%   4.108%   1.893%   0.288%   0.280%    

Jul

  2.107%   1.358%   1.162%   2.658%   4.640%   5.324%   3.898%   1.690%   0.293%   0.266%    

Aug

  1.961%   1.303%   1.212%   2.833%   4.774%   5.333%   3.673%   1.483%   0.295%   0.263%    

Sep

  1.868%   1.247%   1.277%   3.000%   4.897%   5.343%   3.517%   1.204%   0.298%   0.268%    

Oct

  1.820%   1.194%   1.355%   3.174%   4.997%   5.323%   3.453%   0.864%   0.300%   0.276%    

Nov

  1.767%   1.171%   1.451%   3.345%   5.081%   5.293%   3.236%   0.685%   0.305%   0.288%    

Dec

  1.726%   1.151%   1.563%   3.512%   5.153%   5.268%   2.965%   0.556%   0.312%   0.304%    
Copyright 2012 MoneyCafe.com

Source: Derivation of Rates Reported by Federal Reserve Board

 

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Housing prices are also generally correlated with housing starts, so that increases in housing starts usually coincide with increase in housing values, and the reverse is generally true. Below is a graph showing single family housing starts from 2000 through 2011.

 

LOGO

Source: U.S. Census Bureau

Recent Accounting Pronouncements

See Note 2 to our consolidated financial statements for a description of new or recent accounting pronouncements.

Internal Control over Financial Reporting

Our management and independent registered public accounting firm did not perform an evaluation of our internal control over financial reporting as of December 31, 2011, as would have been required in accordance with the provisions of the Sarbanes-Oxley Act had we previously been subject to the reporting requirements of the Exchange Act. Had we and our independent registered public accounting firm performed an evaluation of our internal controls over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act, additional control deficiencies may have been identified by management or our independent registered public accounting firm and those control deficiencies also could have represented one or more material weaknesses.

MANAGEMENT

Executive Officers

Initially, Daniel M. Wallach, as our sole executive officer, will be responsible for the day-to-day aspects of our business, including operational and financial oversight. If we are able to successfully raise proceeds in this offering, we anticipate adding personnel, including additional executive officers, to meet the demands of our growing business. We have provided below certain information about Mr. Wallach.

Daniel M. Wallach, age 44, is our Chief Executive Officer and a Manager. He has been our Chief Executive Officer since our Company was founded and, prior to the addition of the two independent Managers in March 2012, he was our sole Manager. Mr. Wallach has over 20 years of experience in finance and real estate. Most recently, from May 2011 to July 2011, Mr. Wallach was an Executive Vice President for Probuild Holdings. Before that, from 1985 to 1989, and 1990 to April 2011, Mr. Wallach held various positions with 84 Lumber Company and affiliates, including Chief Financial Officer and Director. At 84 Lumber, Mr. Wallach oversaw the company’s financial and accounting function, including all aspects related to financial reporting, debt financing, customer financing, customer credit and management information systems. Mr. Wallach was also intimately

 

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involved with the creation of 84 Financial L.P., a finance company affiliated with and owned by 84 Lumber, which had investment objectives similar to ours. Mr. Wallach has also held operational and finance positions with a mortgage brokerage firm and a building contractor. He graduated from Washington and Jefferson College in Washington, Pennsylvania with a B.A. in Business Administration.

Board of Managers

Our Board of Managers is responsible for overseeing our business. Any of the Managers may be removed by a vote of holders of 80% of our outstanding voting membership interests. As a Note holder, you will have no power over our management and affairs.

We have provided below certain information about the Managers in addition to Mr. Wallach.

Bill Myrick, age 50, is one of the independent Managers, to which he was elected in March 2012. He has been involved in lumber and building materials for nearly 30 years. From January 2007 to July 2011, he held various executive officer positions with ProBuild Holdings, including, most recently, Chief Executive Officer, and was responsible for all aspects of the management of ProBuild’s business. From 1982 to January 2007, Mr. Myrick was with 84 Lumber Company, where he held positions including, most recently, Chief Operating Officer. He is a graduate of the Advanced Management Program from Harvard Business School.

Kenneth R. Summers, age 66, is one of the independent Managers, to which he was elected in March 2012. Mr. Summers retired from United Bank, Inc. of Morgantown, West Virginia in July 2011, but continues to be associated with United Bank. Prior to retirement, he had been an Executive Vice President for United Bank since 2001. In that role he was responsible for the expansion and recognition of the bank’s franchise in north central West Virginia. Mr. Summers has over 30 years of experience as a community bank executive. He graduated from the University of Charleston with a B.S. in Accounting and Management.

Committees of the Board of Managers

The Board of Managers has formed the four committees described below. Each of the committees will operate pursuant to a written charter adopted by our Board of Managers. Each charter will set forth the committee’s specific functions and responsibilities.

Audit Committee

Our Board of Managers has established an audit committee, which consists of Messrs. Myrick and Summers, the two independent Managers. The purpose of the audit committee is to oversee the Company’s accounting and financial reporting processes and the audit of the Company’s consolidated financial statements.

Nominating and Corporate Governance Committee

Our Board of Managers has established a nominating and corporate governance committee, which consists of Messrs. Myrick and Summers, the two independent Managers. The nominating and corporate governance committee shall nominate Manager candidates and review and determine whether to offer a voting recommendation to the members for Manager candidates proposed by a member. The nominating and corporate governance committee shall also be charged with reviewing any transaction involving the Company and an affiliate in accordance with the affiliate transaction policy set forth in the Company’s operating agreement.

Compensation Committee

Our Board of Managers has established a compensation committee, which consists of Messrs. Myrick and Summers, the two independent Managers. The compensation committee shall review and approve annually the corporate goals and objectives applicable to the compensation of the Company’s officer, evaluate at least annually the officer’s performance in light of those goals and objectives, and determine and approve the officer’s compensation level based on these evaluations, subject to the approval of the Company’s members holding at least 60% of the votes eligible to be cast by the then-outstanding voting units.

 

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Loan Policy Committee

Our Board of Managers has established a loan policy committee, which consists of Messrs. Wallach and Summers. The loan policy committee shall set standards and procedures for the review and approval of loans made by the Company, and approve significant loans and loans which differ from the standards and procedures it has established.

Limitations on Liability

No Manager or officer shall be liable to us or any other Manager or officer for any loss, damage or claim incurred by reason of any action taken or omitted to be taken by such person in good faith and with the belief that such action or omission is in, or not opposed to, our best interest, so long as such action or omission does not constitute fraud, gross negligence or willful misconduct by such person.

To the fullest extent permitted by Delaware law, the Company shall indemnify, hold harmless, defend, pay and reimburse each of its Managers and its officer against any and all losses, claims, damages, judgments, fines or liabilities, including reasonable legal fees or other expenses incurred in investigating or defending against such losses, claims, damages, judgments, fines or liabilities, and any amounts expended in settlement of any claims to which such person may become subject by reason of:

 

   

Any act or omission or alleged act or omission performed or omitted to be performed on our behalf, or on behalf of any of our members or any direct or indirect subsidiary of the foregoing in connection with our business; or

 

   

The fact that such person is or was acting in connection with our business as our partner, member, stockholder, controlling affiliate, manager, director, officer, employee or agent, any our members, or any of our and any of our members’ respective controlling affiliates, or that such person is or was serving at our request as a partner, member, manager, director, officer, employee or agent of any person including us or any subsidiary of us;

provided, that (x) such person acted in good faith and in a manner believed by such person to be in, or not opposed to, our best interests and, with respect to any criminal proceeding, had no reasonable cause to believe his or her conduct was unlawful, and (y) such person’s conduct did not constitute fraud, gross negligence or willful misconduct, in either case as determined by a final, nonappealable order of a court of competent jurisdiction. In connection with the foregoing, the termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith or, with respect to any criminal proceeding, had reasonable cause to believe that such person’s conduct was unlawful, or that the person’s conduct constituted fraud, gross negligence or willful misconduct.

We shall promptly reimburse (and/or advance to the extent reasonably required) each of the Managers and our officer for reasonable legal or other expenses (as incurred) of such person in connection with investigating, preparing to defend or defending any claim, lawsuit or other proceeding relating to any losses for which such person may be indemnified; provided, that if it is finally judicially determined that such person is not entitled to the indemnification, then such person shall promptly reimburse us for any reimbursed or advanced expenses.

Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the “Securities Act”), may be permitted pursuant to the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

We maintain liability insurance, which insures against liabilities that the Managers or our officer may incur in such capacities.

 

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EXECUTIVE COMPENSATION

Executive Officer Compensation

Currently, we have no employees and our only executive officer is our Chief Executive Officer, Daniel M. Wallach. This discussion describes our anticipated compensation philosophy and policies with respect to Mr. Wallach and any officers we hire in the near term.

Objectives of Executive Officer Compensation Program

The objectives of our executive compensation program will be to attract, retain and motivate highly talented executives and to align each executive’s incentives with our short-term and long-term objectives, while maintaining a healthy and stable financial position. Specifically, our executive compensation program will be designed to accomplish the following goals and objectives:

 

   

maintain a compensation program that is equitable in our marketplace;

   

provide opportunities that integrate pay with the short-term and long-term performance goals;

   

encourage and reward achievement of strategic objectives, while properly balancing a controlled risk-taking behavior; and

   

maintain an appropriate balance between base salary and short-term and long-term incentive opportunity.

Determining Executive Officer Compensation

The compensation committee of our Board of Managers shall be responsible for determining all aspects of our executive compensation program. We expect the determination and assessment of executive compensation will be primarily driven by the following three factors: (1) market data based on the compensation levels, programs and practices of other comparable companies for comparable positions, (2) our financial performance, and (3) executive officer performance. We believe these three factors provide a reasonably measurable assessment of executive performance in light of building value and creating a healthy financial position for us. We will rely upon the judgment of the members of the compensation committee and not on rigid formulas or short-term changes in business performance in determining the amount and mix of compensation elements and whether each element provides the appropriate incentive and reward for performance that sustains and enhances our long-term growth.

Executive Officer Compensation Components

Base Salary

We expect to provide each of our executive officers with a base salary to compensate such officer for services rendered throughout the year. Salaries will be established annually based on the individual’s position, experience, performance, past and potential contribution to us, and level of responsibility, as well as our overall financial performance. No specific weighting will be applied to any one factor considered, and we expect that the independent Managers will use their judgment and expertise in determining appropriate salaries within the parameters of the compensation philosophy.

Membership Interests

As the beneficial owner of all of our outstanding membership interests, Mr. Wallach’s interests are closely aligned with our success. As we hire additional executive officers, we may use membership interests in some fashion as part of their compensation.

Board of Managers Compensation

We will pay each of the independent Managers a retainer of $30,000 per year and $2,000 for the first day and $1,200 for any additional days for meetings of the Board of Managers and committees attended in person. The independent Managers will not receive reimbursement of out-of-pocket expenses incurred in connection with attendance at meetings. Mr. Wallach will receive no compensation for his services as a Manager.

 

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PRINCIPAL SECURITY HOLDERS

The following table sets forth the ownership of our outstanding membership interests as of the date hereof.

 

Title of Class    Name and Address(1) of Owner    Number of
Units(2)
     Percent of
Class
 

  Class A Common Units

   Daniel M. Wallach and Joyce S. Wallach      648         24.6

  Class A Common Units

   2007 Daniel M. Wallach Legacy Trust      1,981         75.4 % 
            2,629         100

(1) The address of each owner listed is 3508 Washington Road, McMurray, Pennsylvania 15317.

(2) The units listed above are owned directly by the owners listed above. All of our outstanding membership interests are beneficially owned by our Chief Executive Officer (who is also on our Board of Managers), Daniel M. Wallach, and his wife, Joyce S. Wallach.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Transactions with Affiliates

As previously described, on December 30, 2011, we obtained two demand loans from our members to finance our operations. These demand loans are collateralized by a lien against all of our assets and are senior in right of payment to the Notes. Daniel M. Wallach, our Chief Executive Officer (who is also on our Board of Managers), is the beneficial owner of all of our outstanding membership interests.

The first loan, in the original principal amount of $1,250,000, is payable to Daniel M. Wallach and Joyce S. Wallach, as tenants by the entirety (the “Wallach Loan”). The second loan, in the original principal amount of $250,000, is payable to the 2007 Daniel M. Wallach Legacy Trust (the “Trust Loan”). The total outstanding balance on these loans as of December 31, 2011 was $878,091. Each of the demand loans is evidenced by a promissory note, is payable upon demand of the lender and bears an interest rate equal to the lender’s cost of funds (defined in the promissory note as the weighted average price paid by the lender on or in connection with all of its borrowed funds). Pursuant to each promissory note, the affiliate has the option of funding any amount up to the face amount of the note, in the lender’s sole and absolute discretion. As of December 31, 2011, the interest rate was 3.73% for both the Wallach Loan and the Trust Loan.

These transactions were approved by Mr. Wallach in his capacity as sole Manager prior to the time we had independent Managers. As the demand loans were made at rates equal to the lenders’ cost of funds, Mr. Wallach determined the terms of the demand loans to be as favorable to us as those generally available from unaffiliated third parties. The independent Managers ratified and approved these transactions subsequent to the formation of the Board of Managers. See “Risk Factors - Risks Related to Conflicts of Interest - Our Chief Executive Officer (who is also one of our Managers) will face conflicts of interest as a result of the secured affiliated loans made to us, which could result in actions that are not in the best interests of our Note holders.”

Affiliate Transaction Policy

Our operating agreement provides that any future transaction involving the Company and an affiliate must be approved by a majority vote of independent Managers not otherwise interested in the transaction upon a determination of such independent Managers that the transaction is on terms no less favorable to the Company than could be obtained from an independent third party. An approval pursuant to this policy shall be set forth in the minutes of the Company and shall include a description of the transaction approved. The responsibility for reviewing and approving affiliate transactions has been delegated to the nominating and corporate governance committee of our Board of Managers, which is comprised entirely of independent Managers.

Pursuant to our operating agreement, we must provide the independent Managers with access, at our expense, to our legal counsel or independent legal counsel, as needed.

 

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DESCRIPTION OF NOTES

General

The Notes will be issued under an indenture dated as of                     between us and U.S. Bank, as trustee. We have no previous relationship with the trustee. The indenture has been filed as an exhibit to the registration statement. You can also obtain a copy of the indenture from us. We have summarized material aspects of the indenture below. The summary is not complete, and you should read the indenture for provisions that may be important to you. The capitalized terms used in the summary have the meanings specified in the indenture.

The Notes are our direct obligations but are not secured. The Notes are registered and issued without coupons. We may change the interest rates and the maturities of the Notes as they are offered, provided that no such change shall affect any Note issued prior to the date of change. We may, at our discretion, limit the maximum amount any investor or related investors may maintain in outstanding Notes.

The total aggregate maximum principal amount of the Notes offered under this prospectus is $700,000,000. The maximum investment amount per Note is $1,000,000 or $1,000,000 in the aggregate per investor, but a higher maximum investment amount may be approved by us on a case-by-case basis. The minimum investment amount is $500; however, from time to time, we may change the minimum investment amount that is required.

Established Features of Notes

Interest will be calculated based on the actual number of days your Note is outstanding. Interest is calculated and compounded monthly based on a 365-day year (366-day in case of a leap year). Interest will be earned daily, and we will pay interest to you monthly or at maturity as you request. If you choose to be paid interest at maturity rather than monthly, the interest will be compounded monthly. If any day on which a payment is due with respect to a Note is not a business day, then you will not be entitled to payment of the amount due until the following business day, and no additional interest will be due as a result of such delay. If you elect to be paid interest monthly, interest on your Note will be paid on the first business day of every month. Your first interest payment date will be the month following the month in which the Note is issued, except that if a new Note is issued within the last 10 days preceding an interest payment date, the first interest payment will be made on the next succeeding interest payment date (i.e. approximately 35-40 days after issuance). No payments under $50 will be made, with any interest payment being accrued to your benefit and earning interest on a monthly compounding basis until the payment due to you is at least $50 on an interest payment date.

Any change to your original request may be made to us by contacting us at         -        -        or by using our website www.shepherdsfinance.com to find out what you need to do to change your election. The Notes mature one to four years from the date of issuance, as offered by us and selected by you. Between 30 to 60 days prior to redemption, you will receive a letter describing redemption/renewal options, if any, which will specify action(s) needed by you. If you do not respond, principal and unpaid interest will be paid to you.

From time to time we will establish varying interest rates and maturity dates for the Notes. The interest rates offered may vary depending on the denomination or purchase amount of the Note. The interest rates thereby established will be fixed for the term of the Note.

Notes with the current established features are available until they are superseded by new established features. The current established features are applicable to all Notes sold by us during the period the current established features are in effect. We intend to publish this information on our website at www.shepherdsfinance.com or it may be obtained by calling (           )             (toll free). We will also file with the SEC a Rule 424(b)(2) prospectus supplement setting forth the established features upon any change in the established features.

 

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Subordination

Our obligation to repay the principal of and make interest payments on the Notes is subordinate in right of payment to all senior debt. This means that if we are unable to pay our debts, when due, all of the senior debt would be paid first, before any payment of principal or interest would be made on the Notes and related party debt which is equal in priority to the Notes.

The term “senior debt” means all of our debt created, incurred, assumed or guaranteed by us, except debt that by its terms expressly provides that such debt is not senior in right of payment to the Notes. Debt is any indebtedness, contingent or otherwise, in respect of borrowed money, or evidenced by bonds, notes, Notes or similar instruments or letters of credit and shall include any guarantee of any such indebtedness. Senior debt includes, without limitation, the demand loans from our members and any line of credit we may incur in the future. The Notes are not senior debt. As of December 31, 2011, the outstanding debt that the Notes would have been subordinate to was $878,091.

The Notes are subordinate to all of our senior debt. We may at any time borrow money on a secured or unsecured basis that would have priority over the Notes.

Redemption by Us Prior to Maturity

We may redeem any Note, in whole or in part, at any time following the first 180 calendar days after the date of issuance of the Note for a redemption price equal to the principal amount plus any unpaid interest thereon to the date of redemption. We will notify Note holders whose Notes are to be redeemed 30 to 60 days prior to the date of redemption.

Redemption at the Request of the Holder Prior to Maturity

At your written request but subject to the subordination provisions and our consent (which may be withheld in our sole discretion), we will redeem any Note at any time following the first 180 calendar days after the date of issuance of the Note for a redemption price equal to the principal amount plus unpaid interest equal to the stated rate of interest minus a penalty in an amount equal to the interest earned over the last 180 days immediately prior to the redemption date. The penalty will be taken first from any interest accrued but not yet paid on the Note, and to the extent such accrued and unpaid interest does not cover the entire penalty amount, the remainder of the penalty amount shall be reduced from the principal amount of the Note.

Redemption upon Your Death

At the written request of the executor of your estate or, if your Note is held jointly with another investor, the surviving joint holder, but subject to the subordination provisions, we will redeem any Note at any time after death for a redemption price equal to the principal amount plus unpaid interest equal to the stated rate of interest, without any penalty. We will seek to honor any such redemption request as soon as reasonably possible based on our cash situation at the time, but generally within two weeks of the request. In order for a Note to be redeemed upon your death, the Note to be redeemed must have been registered in your name since the date of issuance.

Extension at Maturity

Unless we offer (which we are not required to do), and you accept in writing, a renewal option, the maturity of a Note will not be extended from the original maturity date. We will provide you notice of the maturity date of your Note at least 30 days, but not more than 60 days, prior to the original maturity date. Our notice may also describe the redemption/renewal options (most likely at an interest rate different from your interest rate) we are then offering and the action(s) you must take to exercise a redemption or renewal option.

No Restrictions on Additional Debt or Business

The indenture does not restrict us from issuing additional securities or incurring additional debt (including senior debt or other secured or unsecured obligations) or the manner in which we conduct our business.

 

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Modification of Indenture

We, together with the trustee, may modify the indenture at any time with the consent of the holders of not less than a majority in principal amount of the Notes that are then outstanding. However, we and the trustee may not modify the indenture without the consent of each holder affected if the modification:

 

   

reduces the principal or rate of interest, changes the fixed maturity date or time for payment of interest, or waives any payment of interest on any Note;

   

reduces the percentage of Note holders whose consent to a waiver or modification is required;

   

affects the subordination provisions of the indenture in a manner that adversely affects the rights of any holder; or

   

waives any event of default in the payment of principal of, or interest on, any Note.

Without action by you, we and the trustee may amend the indenture or enter into supplemental indentures to clarify any ambiguity, defect or inconsistency in the indenture, to provide for the assumption of the Notes by any successor to us, to make any change to the indenture that does not adversely affect the legal rights of any Note holders, or to comply with the requirements of the Trust Indenture Act of 1939. We will give written notice to you of any amendment to the indenture.

Place, Method and Time of Payment

We will pay principal and interest on the Notes at our principal executive offices or at such other place as we may designate for that purpose; provided, however, that if we make payments by check, they will be mailed to you at your address appearing in our Note register . Any payment of principal and interest that is due on a non-business day will be payable by us on the next business day immediately following that non-business day.

Events of Default

An event of default is defined in the indenture as follows:

 

   

a default in payment of principal or interest on the Notes when due or payable if such default has not been cured for 30 days;

   

our becoming subject to events of bankruptcy or insolvency; or

   

our failure to comply with any agreements or covenants in or provisions of the Notes or the indenture if such failure is not cured or waived within 60 days after we have received notice of such failure from the trustee or from the holders of at least a majority in principal amount of the outstanding Notes.

If an event of default occurs and is continuing, the trustee or the holders of at least a majority in principal amount of the then-outstanding Notes may declare the principal of and the accrued interest on all outstanding Notes due and payable. If such a declaration is made, we are required to pay the principal of and interest on all outstanding Notes immediately, so long as the senior debt has not matured by lapse of time, acceleration or otherwise. We are required to file annually with the trustee an officers’ certificate that certifies the absence of defaults under the terms of the indenture.

The indenture provides that the holders of a majority of the aggregate principal amount of the Notes at the time outstanding may, on behalf of all holders, waive any existing event of default or compliance with any provision of the indenture or the Notes, except a default in payment of principal or interest on the Notes. In addition, the trustee may waive an existing event of default or compliance with any provision of the indenture or Notes, except in payments of principal or interest on the Notes, if the trustee in good faith determines that a waiver or consent is in the best interests of the holders of the Notes.

If an event of default occurs and is continuing, the trustee is required to exercise the rights and duties vested in it by, and subject to, the indenture and to use the same degree of care and skill as a prudent person would exercise under the circumstances in the conduct of his or her affairs. The trustee however, is under no obligation to perform any duty or exercise any right under the indenture at the request, order or direction of Note holders unless

 

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the trustee receives indemnity satisfactory to it against any loss, liability or expense. Subject to such provisions for the indemnification of the trustee, the holders of a majority in principal amount of the Notes at the time outstanding have the right to direct the time, method and place of conducting any proceeding for any remedy available to the trustee. The indenture effectively limits the right of an individual Note holder to institute legal proceedings in the event of our default.

Satisfaction and Discharge of Indenture

The indenture may be discharged upon the payment of all Notes outstanding thereunder or upon deposit in trust of funds sufficient for such payment and compliance with the formal procedures set forth in the indenture.

Reports

We plan to file annual reports containing audited consolidated financial statements and quarterly reports containing unaudited consolidated financial information for the first three fiscal quarters of each fiscal year with the SEC while the registration statement containing this prospectus is effective and as long thereafter as we are required to do so. Copies of such reports will be sent to any Note holder upon written request.

Service Charges

We reserve the right to assess service charges and fees to issue a replacement interest payment check, and, in the event we permit transfer or assignment in our discretion, to transfer or assign a Note.

Book Entry Record of Your Ownership

The Notes will be issued in uncertificated form. If you purchase a Note, an account showing the principal amount of your Note will be established in your name on our books. Interest accrued on your Note will also be credited to your account. The interest rate on your Note will be determined on the date that your account is established. In determining your interest rate, we will use the rate in effect at the time you: (1) submitted your subscription agreement online; (2) printed the subscription agreement from our website, provided that the rate was offered by us with that maturity in the seven days prior to our receipt of your subscription agreement]; or (3) signed and mailed a subscription agreement, which we mailed to you, provided that the rate was offered by us with that maturity in the seven days prior to our receipt of your subscription agreement. You will not receive any certificate or other instrument evidencing our indebtedness to you. Upon purchase of your Note, we will send you a confirmation, which describes, among other things, the term, interest rate and principal amount.

Transfer

You may not transfer any Note until we (as registrar) have received, among other things, appropriate endorsements and transfer documents and any taxes and fees required by law or permitted by the indenture. We are not required to transfer any Note for a period beginning 15 days before the date notice is mailed of the redemption or the maturity of such Note and ending on the date of redemption of such Note.

Concerning the Trustee

The indenture contains limitations on the trustee’s right, should it become one of our creditors, to obtain payment of claims in certain cases, or to realize on property with respect to any such claim as security or otherwise. The trustee will be permitted to engage in other transactions; however, if it acquires conflicting interests and if any of the indenture securities are in default, it must eliminate such conflict or resign.

PLAN OF DISTRIBUTION

We are offering up to $700,000,000 in aggregate principal amount of the Notes. We will offer the Notes directly to the public without an underwriter or placement agent and on a continuous basis.

We do not intend to have individuals personally soliciting potential purchasers or marketing or selling the Notes on our behalf. We intend to market our Notes in many ways, including but not limited to, publishing the

 

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established features in a newspaper, on billboards, through direct mail in states in which we have properly registered the offering or qualified for an exemption from registration. Viewers of print advertising will be referred to our website at www.shepherdsfinance.com. The established features will be available to investors on our web site at www.shepherdsfinance.com or by calling (        )              (toll free). If, upon review of our website, a potential investor becomes interested in purchasing the Notes, a prospectus will be sent upon request. We may also make oral solicitations in limited circumstances and use other methods of marketing the offering, all in compliance with applicable laws and regulations, including securities laws. Our employees have been instructed not to solicit offers to purchase Notes or provide advice regarding the purchase of the Notes.

While we do not intend to have individuals engaged in selling activities, if we were to need to have an individual engage in those activities, that individual would be our Chief Executive Officer, Daniel M. Wallach. In that event, we would rely on Rule 3a4-1 under the Exchange Act, which permits officers, directors and employees to participate in the sale of the Notes without registering as a broker-dealer under certain circumstances. Mr. Wallach is not subject to a statutory disqualification as such term is defined in Section 3(a)(39) of the Exchange Act. Mr. Wallach serves as an officer and primarily performs substantial duties for or on our behalf otherwise than in connection with transactions in securities and will continue to do so at the end of the offering. He is familiar with the selling practices permitted to officers relying on Rule 3a4-1. Mr. Wallach has not been a broker or dealer, or an associated person of a broker or dealer, within the preceding 12 months, and has not nor will not participate in the sale of securities for any issuer more than once every 12 months, other than on behalf of us in reliance on Rule 3a4-1. Mr. Wallach will not be compensated in connection with any participation in the offering by the payment of commissions or other remuneration based either directly or indirectly on the transactions in the Notes. Mr. Wallach has been instructed in the limitations of the selling practices allowed under Rule 3a4-1.

The information contained on our website is not part of this prospectus. If you have questions about the suitability of an investment in the Notes for you, you should consult with your own investment, tax or other professional financial advisor. Prospective investors will be required to complete an application prior to investing in the Notes. We reserve the right to reject any investment.

You will not know at the time of investment whether we will be successful in completing the sale of any or all of the Notes. We reserve the right to withdraw or cancel the offering at any time. In the event of a withdrawal or cancellation, investments received prior to such withdrawal or cancellation will be irrevocable and will be repaid in accordance with the terms of the Notes.

The Notes are not listed on any securities exchange, and there is no established trading market for the Notes. We do not expect any trading market to develop for the Notes.

CHARITABLE MATCH PROGRAM

We offer a charitable match program for interest payments that you elect to give to a qualifying charity. If you choose to participate in the program and donate all or a portion of your interest payments to charity, when we calculate your interest we will deduct the percentage of interest you selected and keep track of that amount separate from your information. After interest is calculated for all Note holders at the beginning of December of each year, all of the money for each charity will be totaled up and sent in one check to each charity. Each check will have the name and address of each contributor, and the amount each contributed. Our matching portion will be included in the total check. We will match your interest payment donation up to 10% of your interest.

The charity must be an Internal Revenue Code Section 501(c)(3) qualifying organization. We reserve the right to either not match your contribution, or not make payments on your behalf to certain charities with missions contrary to our corporate philosophy. Upon your initial subscription, if you select one of these charities, and we notify you that we will not match your donation to such an organization or will not make a contribution on your behalf, you have the option of refund of your investment, donating without our matching contribution (assuming we are just not willing to match your donation to that charity), or investing and not donating to the organization.

 

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LEGAL MATTERS

The validity of the Notes being offered by this prospectus will be passed upon for us by Baker, Donelson, Bearman, Caldwell & Berkowitz, P.C., Atlanta, Georgia.

EXPERTS

The consolidated financial statements as of and for the years ended December 31, 2011 and 2010 appearing in this prospectus and registration statement have been audited by Carr, Riggs & Ingram, LLC, an independent registered public accounting firm, and are included in reliance upon such report, given on the authority of such firm as experts in accounting and auditing.

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the SEC, Washington, D.C., a registration statement on Form S-1 under the Securities Act with respect to the Notes offered by this prospectus. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules thereto. Certain items are omitted in accordance with the rules and regulations of the SEC. For further information about us and the Notes sold in this offering, refer to the registration statement and the exhibits and schedules filed therewith. Statements contained in this prospectus about the contents of any contract or other document referred to are not necessarily complete and in each instance, if such contract or document is filed as an exhibit, reference is made to the copy of such contract or other documents filed as an exhibit to the registration statement.

A copy of the registration statement, including the exhibits and schedules thereto, may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at www.sec.gov, from which interested persons can electronically access the registration statement, including the exhibits and schedules thereto.

As a result of the offering, we will become subject to the full informational requirements of the Exchange Act. We will fulfill our obligations with respect to such requirements by filing periodic reports and other information with the SEC.

INDEX TO FINANCIAL STATEMENTS

 

Audited Financial Statements:

  

Report of Independent Registered Public Accounting Firm on Financial Statements

     F-1   

Consolidated Balance Sheets as of December 31, 2011 and 2010

     F-2   

Consolidated Statements of Operations for the Years Ended
December 31, 2011 and 2010

     F-3   

Consolidated Statements of Changes in Members’ Capital for the Years Ended
December  31, 2011 and 2010

     F-4   

Consolidated Statements of Cash Flow for the Years Ended December 31, 2011 and 2010

     F-5   

Notes to Consolidated Financial Statements

     F-6   

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Managers and

Members of Shepherd’s Finance, LLC

We have audited the accompanying consolidated balance sheets of Shepherd’s Finance, LLC (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, changes in members’ capital, and cash flows for the years then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Carr, Riggs & Ingram, LLC

March 19, 2012

Enterprise, Alabama

 

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Shepherd’s Finance, LLC

Consolidated Balance Sheets

As of December 31, 2011 and 2010

 

  (in thousands of dollars)    2011      2010  

  Assets

     

Cash and cash equivalents

   $ 50       $ -   

Accrued interest on loans

     2         -   

Prepaid expenses

     26         -   

Loans receivable, net

     4,580         -   

Assets of discontinued operations

     -         10,339   

Total assets

   $         4,658       $         10,339   
                   
                   

  Liabilities and Members’ Capital

     

Customer interest escrow

   $ 450       $ -   

Notes payable unsecured

     1,500         -   

Notes payable related party

     878         -   

Liabilities of discontinued operations

     -         7,863   

Total liabilities

     2,828         7,863   

Commitments and Contingencies (Note 9)

     

Members’ capital

     1,830         2,476   

Total liabilities and members’ capital

   $ 4,658       $ 10,339   
                   
                   

  The accompanying notes are an integral part of these consolidated financial statements.

 

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Shepherd’s Finance, LLC

Consolidated Statements of Operations

For the years ended December 31, 2011 and 2010

 

  (in thousands of dollars)    2011      2010  

  Interest Income

     

Interest and fee income on loans

   $ 5       $ -   

Interest expense

     -         -   

Net interest income (loss)

     5         -   

Less: Loan loss provision

     -         -   

Net interest income

     5         -   

  Non-Interest Expense

     

Selling, general and administrative

     5         -   

  Income (Loss) from continuing operations

     -         -   

  Income from discontinued operations, net

     309         578   

  Net income

   $             309       $             578   
                   
                   

  The accompanying notes are an integral part of these consolidated financial statements.

 

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Shepherd’s Finance, LLC

Consolidated Statements of Changes In Members’ Capital

For the years ended December 31, 2011 and 2010

 

  (in thousands of dollars)    2011     2010  

  Members’ capital, beginning balance

   $ 2,476      $ 2,075   

  Net income

     309        578   

  Distributions to members

     (955     (177 )   

  Members’ capital, ending balance

   $         1,830      $         2,476   
                  
                  

  The accompanying notes are an integral part of these consolidated financial statements.

 

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Shepherd’s Finance, LLC

Consolidated Statements of Cash Flows

For the years ended December 31, 2011 and 2010

 

  (in thousands of dollars)    2011      2010  

  Cash flows from operations

     

Net income (loss)

   $ 309       $ 578   

(Income) from discontinued operations

     (309)         (578)   

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities

     

Net change in operating assets and liabilities

     

Prepaid expenses

     (26)         -   

Accrued interest receivable

     (2)         -   

Customer interest escrow

     450         -   

Net cash provided by (used in) operating activities – continuing operations

     422         -   

Net cash provided by (used in) operating activities – discontinued operations

     57         560   

Net cash provided by (used in) operating activities

     479         560   

  Cash flows from investing activities

     

Purchases of loans

     (1,687)         -   

Originations of loans

     (2,892)         -   

Net cash provided by (used in) investing activities – continuing operations

     (4,579)         -   

Net cash provided by (used in) investing activities – discontinued operations

     4,497         -   

Net cash provided by (used in) investing activities

     (82)         -   

  Cash flows from financing activities

     

Distributions to members

     (955)         (177)   

Proceeds from related party notes

     877         -   

Proceeds from unsecured notes

     1,500         -   

Net cash provided by (used in) financing activities – continuing operations

     1,422         (177)   

Net cash provided by (used in) financing activities – discontinued operations

     (1,781)         (373)   

Net cash provided by (used in) financing activities

     (359)         (550)   

Net increase (decrease) in cash and cash equivalents

     38         10   

  Cash and cash equivalents

     

Beginning of year

     12         2   

End of year

   $ 50       $ 12   
                   
                   

  Supplemental disclosure of cash flow information

     

Cash paid for interest

   $ 512       $             455   

  Supplemental non cash flow disclosure

     

Debt assumed by purchaser of the assets under direct financing leases

   $         4,367       $ -   

Unearned income credited by purchaser against sales price of leased assets

     1,463         -   

  The accompanying notes are an integral part of these consolidated financial statements.

 

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Shepherd’s Finance, LLC

Notes to Consolidated Financial Statements

As of and for the Years Ended December 31, 2011 and 2010

Information presented throughout these notes to consolidated financial statements in thousands of dollars.

1. Description of Business and Basis of Presentation

Description of Business

Structure and Control Environment

84 RE Partners, LLC (“84 RE Partners”), a Pennsylvania Limited Liability Company, was formed on May 10, 2007 to operate on a term through December 31, 2057, unless that term is extended. 84 RE Partners is the sole member in three consolidating subsidiaries, 84 REPA, LLC, 84 RENC, LLC (will be terminated 2012), and 84 REFL, LLC (also will be terminated in 2012). In conjunction with a change in strategic direction, as discussed more fully below, 84 RE Partners, LLC changed its name on December 2, 2011 to Shepherd’s Finance, LLC (the “Company”, “we” or “our”). The Company operates pursuant to an operating agreement by and among Daniel M. Wallach (the “Manager”) and the members of the Company.

The Manager has direct and exclusive control over the management of the Company’s operations. With respect to new loans, the Manager locates potential customers, conducts due diligence, and negotiates and completes the transactions in which the loans are originated. The Manager performs, or arranges for the performance of, the management, advisory and administrative services required for Company operations. Such services include, without limitation, the administration of member accounts, member relations, accounting, and the preparation, review and dissemination of tax and other financial information. In addition, the Manager provides office space, equipment and facilities and other services necessary for Company operations. The Manager also engages and manages the contractual relations with depositories, accountants, attorneys, insurers, banks and others, as required.

Historical Operations

During 2007 and continuing through portions of 2011, the Company was the lessor in three commercial real estate leases (which were accounted for as direct financing leases) with an affiliate, 84 Lumber Company (“84 Lumber”). During the majority of time of the business relationship between 84 RE Partners and 84 Lumber, Daniel M. Wallach was employed by 84 Lumber, while also operating as the Manager of 84 RE Partners. The leased properties were sold to 84 Lumber Company in May and September of 2011, and the leases were thereby terminated. See Note 8. This business model generated consistent profits, positive cash flows and returns to the members for the duration of these financings.

Change in Strategy

In late 2011, management elected to transform our business model. The Company intends to focus most of its future efforts on commercial lending to residential homebuilders to finance construction of single family residential properties. The single family residential construction loans will be extended to residential homebuilders and, as such, are commercial loans. The Company also intends to lend money to residential homebuilders to develop undeveloped land into residential building lots known as acquisition and development loans, which are also considered commercial loans.

Our plans include expanding our lending capacity and funding our business operations by extending debentures to the general public, which will be unsecured subordinated debt. Eventually, the Company intends to repay the debt from affiliates with secured debt from a bank or through other liquidity.

Recent Transactions

On December 30, 2011, the Company originated two new loans and purchased a performing loan to finance construction of single family residential properties.

 

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Shepherd’s Finance, LLC

Notes to Consolidated Financial Statements

As of and for the Years Ended December 31, 2011 and 2010

 

On that same date and to finance the extension of the commercial loans noted above, we executed three new credit facilities. Two of the new credit facilities are secured lines of credit from affiliates; the third is subordinated debt from a borrowing customer of the Company.

Liquidity and Capital Resources

The Company has a limited operating history with our current business model, and our operations are subject to certain risks and uncertainties, particularly related to the concentration of our current operations to a single customer and geographic region, as well as the evolution of the current economic environment and its impact on the United States real estate and housing markets. Both the concentration of risk and the recessionary economic environment could directly or indirectly impact losses related to certain transactions and access to and cost of adequate financing. The Company’s anticipated primary source of liquidity going forward is interest income and/or principal related to the loans, as well as funds borrowed from creditors, all of whom are currently members and affiliates. Therefore, the Company’s ability to fund its operations is dependent upon the sole borrower’s ability to continue paying interest and/or principal and our ability to obtain additional financing, as needed, from the members, general public and other entities.

We did not generate a profit from continuing operations during fiscal year 2011. We also used cash in continuing operations during fiscal year 2011 of approximately $2,735. At December 31, 2011, we had cash on hand of approximately $50 and our outstanding debt totaled $2,378, which was unsecured or payable to related parties.

Our current plan is to expand the commercial lending program by using current liquidity and available funding, while pursuing an initial public offering of debentures. We have anticipated the costs of this expansion and the costs of the offering, and we anticipate generating, through normal operations, the cash flows necessary to meet our operating, investing and financing requirements. As noted above, the two most significant factors driving our current plans are the continued payments of principal and interest by our sole homebuilder customer and the planned public offering. If actual results differ materially from our current plan or if expected financing is not available, we believe we have the ability to discontinue the offering to reduce costs; we also believe we have the ability and intent to obtain funding and generate net worth through additional debt or equity infusions of cash. There can be no assurance, however, that we will be able to implement our strategies or obtain additional financing under favorable terms, if at all.

Basis of Presentation

Principles of Consolidation These consolidated financial statements include the consolidated accounts of each of the Company’s three subsidiaries. All significant intercompany transactions have been eliminated.

Classification The consolidated balance sheets of the Company are presented as unclassified to conform to industry practice for lending entities.

Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. It is reasonably possible that market conditions could deteriorate, which could materially affect our consolidated financial position, results of operations and cash flows. Among other effects, such changes could result in the need to establish an allowance for loan losses.

Operating Segments ASC Topic 280, Segment Reporting, requires that the Company report financial and descriptive information about reportable segments and how these segments were determined. The Manager determines the allocation of resources and performance of business units based on operating income, net income and operating cash

 

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Shepherd’s Finance, LLC

Notes to Consolidated Financial Statements

As of and for the Years Ended December 31, 2011 and 2010

 

flows. Segments are identified and aggregated based on products sold or services provided and the market(s) they served. Based on these factors, the Manager has determined that the Company’s ongoing operations are in one segment, commercial lending.

Discontinued Operations Unless otherwise indicated, information in these notes to consolidated financial statements relates to continuing operations. The direct financing lease asset disposal group was deemed to represent a component of the Company. During 2011, we sold these properties and, as a result, they are classified in the consolidated financial statements and accompanying footnotes as discontinued operations.

The historical presentation of the accounts included in the consolidated balance sheets, statements of operations and cash flows and accompanying footnotes which related to the disposal group has been reclassified to reflect discontinued operations treatment.

2. Summary of Significant Accounting Policies

Revenue Recognition

Interest income generally is recognized on an accrual basis. The accrual of interest is generally discontinued on all loans past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income, unless management believes that the accrued interest is recoverable through liquidation of collateral. Interest received on nonaccrual loans is applied against principal. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status.

Advertising

Advertising costs are expensed as incurred and are included in selling, general and administrative. Advertising e