Crowdfunding Lawyers

Fractional Ownership: Understanding the Investors and an Important Legal Caveat

August 18, 2023
Fractional Ownership: Understanding the Investors and an Important Legal Caveat

Fractional ownership offers an interesting way to create a scalable platform that offers sustainable growth over the long term. And when you couple that with the benefits that Regulation A brings to the table, you’ll find that you’re able to get the word out about your deal in more ways to more people. But who is the audience here?

While Regulation A ensures that you’re able to reach 90% of Americans, fractional ownership is more than a little bit different. We’ll discuss what you need to know in the post below.

Who’s the Audience?

Fractional ownership deals enjoy access to the same audience as other Reg A deals. That is – almost everyone. You are also free to market your deal in multiple ways that you cannot with Reg D, including through social media and email. You don’t need a preexisting relationship with those audience members, either.

So, what’s the difference? To understand that we need to back up a bit.

Problems with Conventional Reg A Deals

Reg A is often touted as one of the most flexible options for dealmakers, and it is. However, it does have some shortcomings. One of those is tied to its high dollar cap. You’re allowed to raise $75 million with your offering.

But getting that much money takes a lot of time. And your investors will have questions, such as why should I give you my money now? Why shouldn’t I kick back and watch what you do and how you perform before putting my money in?

Those are valid concerns, certainly, but they do nothing to accelerate your ability to reach that $75 million mark.

The fractional ownership model solves that issue.

Now suddenly, it may be a $75 million offering, but now you’re raising $2-5 million, $10 million, $15 million per tranche at a time, without having to recreate the wheel every time you move forward.

Generally, it’s done with unique investments and unique assets. But a way that now allows you to create different offerings, different investor terms, different structures, and do it on a fractional percentage of that total $75 million that you can raise.

Of course, fractional ownership deals are in their infancy. There are only a few happening. But it’s like that mushroom that’s just growing and expanding, and eventually, the light bulb’s going to go off, and you know what, this is the way that everybody’s going to be doing it, just not quite yet.

Now, people do funds, and it’s generally that all the capital is going into the company, all the funds are going into the company and with a blind pool, meaning that it’s a regular fund, to go buy assets to go build the business.

The investors that come in are interested in absolutely everything that is being done, which is a far cry difference from every investor having an interest in exactly what they invest in. They don’t have an interest in anything else whatsoever. At least in the syndication, the particular asset acquisition models to go from being able to raise money from around 10% of America to nearly 100% of America is just a phenomenal development.

The Investment Company Act – A Caveat

While fractional ownership can be an incredible benefit, there is one caveat – the Investment Company Act. When it comes to these fractionalized platforms getting put together, you must pay attention to what you’re buying, how you’re structuring it, and making sure that you’re avoiding the Investment Company Act.

That doesn’t mean you cannot acquire businesses. It just means that you need to follow the right strategy. One of the most important things to avoid here is buying pieces of other companies. You cannot do that with fractional ownership platforms. Instead, you must buy most of the company.

If you’re acquiring the majority of the businesses, you can do this through these fractional ownership processes or real estate. It’s a non-issue as long as you’re buying it directly. But no matter what, this becomes a big concern.

Here’s another one. Can you start a venture capital firm and use the fractional ownership model? It’s a funny concept because even though it’s very specifically called out as a venture capital company, it is very much like a VC where buyers take a large majority-size securities interest. It’s truly not just passive, but you’re bringing to the table the management, consulting on all the different areas, and more.

So, there’s a level of control that even if it’s not your company, at the end of the day, you have an oversized influence on it, which is why the venture companies are an exemption. You must own 51% of any subsidiaries as you’re in a majority position.

To qualify for the exemption and to have control if you’re remaining as a passive owner, you’ve got to ask for 51% of anybody you finance. If you have active management and active controls, and you have your corporate voting structure in such a way that even if you don’t have 51%, you have active control over it, it still qualifies. There’s a standard for some voting, and corporations fall into the less-than-a-majority category. So, if you have a level of control sufficient to influence in addition to some management controls, it still qualifies.

In Conclusion

Fractional ownership offers unique advantages, along with the ability to create deals that scale into the future. However, they require a great deal of expertise to put together correctly. If you’re interested in learning whether this is the right option for your deal, contact Crowdfunding Lawyers today to schedule a free consultation.

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