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Syndication Part 3: How to Create and Manage a Note-Buying Fund

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signsOur previous two lessons about syndication have covered a lot of hard-hitting material.

First, Susan Lassister-Lyons (aka. “The Madam of Money”) introduced the concept of syndication in a thorough exploration of Raising "Pooled" Capital for Real Estate. Susan has been a real estate investor since 1994, has raised $26.2 million in private money since 2004, and has participated in 600 real estate transactions – and in this seminal lesson she explained why she loves the private money “pool” so much.

Then, in our follow-up to Susan’s introduction, we dug deeper into her business of choice by briefly examining The 11 Ways to Profit from "Pooling" Capital in your own syndicated note-buying fund.

Today, building upon the foundation laid in these previous lessons, it’s time to roll up your sleeves in preparation for some real action as Susan explains EXACTLY how to create your own note-buying fund …

Step #1: Set-Up the Management LLC

First you need to set up the Management LLC.

The Management LLC:

  • Manages the fund
  • Makes investment decisions for the fund
  • Collects fees
  • Manages accounting and tax reporting
  • Ensures government compliance

You will also want to hire a real estate securities attorney, CPA, bookkeeper and loan servicing company to help you run your Management LLC.

Step #2: Set-Up the Ownership LLC

Next, you are going to want to set-up the Ownership LLC.

The Ownership LLC:

  • Collects investor cash
  • Holds title
  • Pays investors
  • Pays the fund manager

chefStep #3: Choose the Notes in Which You Want to Invest

Now it’s time to actually choose the notes in which you want to invest.  You should go to the smaller, local or regional banks and credit unions to get access to these different types of notes and target the portfolio lenders.

There are two places to find portfolio lenders:

You should find all the banks that are registered with the FDIC in a certain state that specialize in providing mortgages.  You should then contact the banks to see if they have any nonperforming notes.  (These are the notes in which you are going to want to invest!)

Step #4: Structure the Deal

Now that you’ve set-up both your Management and Ownership LLCs and found the notes in which you want to invest, it’s time to structure the deal you will present to your investors.

The SEC exempts private securities offerings, so you have some rules to follow when setting up your deals.  All deals should be structured in a Regulation “D” offering.

Regulation “D” Considerations:  There are three Reg. “D” offering structures from which to choose when structuring your deals …

  • Rule 504 – For Small Deals (Raising $1 million in 12 months)
    • Allows for accredited investors only.  The investor’s net worth must be at least $1 million excluding their primary residence or they make more than $200,000 a year or jointly with their spouse they make $300,000 a year.
    • You cannot have any blind pool fund raising.  Meaning you can't solicit funds without having the actual investment identified.
    • A Private Placement Memorandum (PPM) is required.
    • Under Rule 504 you are not exempt from the state's securities laws “Blue Sky laws.”
  • Rule 505 – For Medium Deals (Raising up to $5 million in 12 months)
    • Allows for unlimited accredited investors.
    • There can be up to 35 non-accredited investors.
    • A PPM is required.
    • Not exempt from the state's securities laws “Blue Sky laws.”
  • Rule 506 – Highly Recommended Structure
    • Exempt from the state's securities “Blue Sky laws” – you only have to follow the Federal Securities laws allowing you to pool money from all over the country.
    • No limits on the amount of money you can raise.
    • Unlimited amount of accredited investors.
    • It is recommend to have a maximum of 35 sophisticated investors.
    • PPM is recommended.

capitalCapital Structure Considerations:  Will you provide a debt offering or an equity offering? (ie. “How will you pay your investors?”)

Now that you’ve set-up your fund, picked your notes and structured your deal, it’s time to decide how you will pay your investors.  Will you provide a “debt” offering or an “equity” offering?

You will want to ask yourself the following questions:

  • How are you going to structure the deal?
  • What are you going to pay your investors?
  • What can you afford to pay your investors?
  • Do you want to attract debt investors?
  • Do you want to attract equity investors?
  • Do you want to attract a hybrid?

Debt Investors

If you decide to provide a debt offering, then your investors will have the following structure:

  • The return on their investment will be based on a set schedule.
  • The investor is not entitled to any equity or profit from the deal.
  • The structure is just like the regular lender model.
  • You must generally pay debt an interest rate ranging from 4% to 10%.

Tip: One magic question to ask your potential debt investor is: “What interest rate is your money currently earning? What if I could double it?”

(This question will help you to recruit your debt investors, and we will explain more on this topic in our upcoming lesson about “Marketing Your Note-Buying Fund”.)

Equity Investors

If you decide to provide an equity offering, then your investors will have the following deal structure:

  • The investor will receive a variable return on their investment, based on the performance of the deal.
  • The investor is entitled to a portion of the equity and profit from the deal.
  • There are over 100 different ways to pay equity investors.  For example, 50-75% of the cash flow and/or 50-75% of the equity profits, if they are contributing 100% of the funds.
  • Equity investors can also be paid via preferred returns, subordinated returns, performance bonuses, etc.

budgetHere’s the Bottom Line: Pay What You Can Afford To Pay

You have to crunch the numbers and know what’s going to make the most sense for your investor and for you…

…and this leads to the most important question to ask when you are setting up your own note-buying fund.

The Personal Income Question: “What Should You Pay Yourself?”

As noted in our previous lesson, 11 Ways to Profit from "Pooling" Capital, there are many ways to pay yourself.

For example, you can receive:

  • 15-50% of the equity profits
  • 15-50% of the cash flow
  • 25% profit + management fees
  • 20% cash flow + management fees
  • 50% of the cash flow + acquisition fee
  • (And almost any other combination ...)

Step #5: Prepare the Documents for Your Offering

Now you are all ready to put pen to paper and prepare the documents for your fund offering.

The offering package will include:

  • A Private Placement Memorandum (PPM)
    • Have your attorney draw this up
    • The PPM includes:
      • A description of the business
      • Offering terms
      • Risks
      • Suitability standards
      • Sources and uses of the money
      • Conflicts of interest
      • Distributions and fees
      • Note/Property information
      • Managers
      • Liquidity
      • Dispute resolution
  • Two Operating Agreements
    • One for your Management LLC
    • One for your Ownership LLC
  • Subscription Agreement
  • Investor Questionnaire

easyIt’s Easier Than It Looks!

Now, I’m sure this all might have your head spinning but it’s a lot easier than it looks.  Once you finish these few steps and get the paperwork out of the way, you will be off and running with your note buying fund.

In our next lesson, Susan Lassiter-Lyons will demonstrate exactly how to market your syndicated note-buying fund, so that you can attract as many investors as possible.  (Because, as we all know, without a pool of investors no matter how well you set up your note-buying fund, you will never make a penny in the note buying fund business!)

But before we close today’s lesson, let’s review exactly what you need to do to create your own note-buying fund …


Do It To It! Immediate Action Steps

Create – Set-Up your Management LLC and Ownership LLC.

Choose – Choose the notes in which you will invest.

Structure – Structure the deal. (Remember Rule 506 – the highly recommended structure!)

Decision #1 – Decide how to pay your investors. (Debt vs. Equity)

Decision #2 – Decide how to pay yourself!

Prepare – Prepare the documents for your offering.

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