There is no shortage of options when it comes to financial tools and investment vehicles. However, one that may not get the attention it deserves is the private equity fund, usually abbreviated as PE funds.
In essence, PE funds are blind pools with a bucket where all the money goes. They’re designed to acquire multiple assets underneath them that all investors participate in and benefit from. These are like mutual funds and hedge funds in that a private equity firm manages the fund, pools all the money together, and then uses that money to invest.
Who Can Invest in Private Equity Funds?
It’s important to understand that not just anyone can invest in private equity funds. Only accredited investors and qualified clients are allowed. What this means for sponsors is that you’re not allowed to market your opportunity to the public, whether that’s through social media and digital marketing techniques or more traditional advertising methods.
Does this mean that private equity funds are regulated by the SEC? No, they are not. While they might be advised by an SEC-registered advisor, the funds themselves don’t fall under the SEC’s purview. That’s good news for some, but it also brings a few additional considerations to the table, such as the fact that PE funds aren’t subject to public disclosure requirements.
How Do Private Equity Funds Operate?
Despite their similarities, private equity funds take a different approach than mutual funds or hedge funds. For instance, mutual and hedge funds focus on the short-term or near-term future. In contrast, private equity funds usually focus on long-term investments with a timeline of 10 years or more. Real estate development often falls into this category, although many other opportunities also exist.
Often, equity funds invest through special purpose entities. Generally, there is a pooled investment vehicle to own 100% of these special-purpose entities. Then, other businesses or other real estate opportunities are acquired through that. Often, it’s a requirement of financing. There are benefits in other areas, as well.
For many people, the appeal of a private equity fund is the sheer breadth of possibilities. It’s quite possible to go anywhere and invest in almost anything. However, that comes with significant challenges. For instance, it becomes exponentially more difficult to sell potential investors on the deal the farther away an investment is. This is true for several different reasons. First, the father away an investment the more complexity and risk rise. This is particularly true for investments in other nations. Second, potential investors question the sponsor’s ability to manage such a fund. What background do they have? What education, experience, and history do they have with similar operations? It is possible to go this route, but it is incredibly challenging.
A better option is to shrink that target acquisition box. For instance, suppose you want to get involved with real estate and you’re located in Texas. Rather than investing in properties in California or Maine, which are far away and difficult to manage, it might be better to focus on things closer at hand – real estate in Texas and Louisiana, for instance.
It goes beyond geographic distance. Investors have a specific risk tolerance, and that speaks to the type of real estate the fund can invest in. For instance, a sponsor might want to invest in rental properties, multi-family properties, and ground-up developments. Those can all be worthwhile options, but many investors will balk simply because of the risk involved with that kind of diversity or because the breadth of investment properties in the portfolio is so far outside the scope that they’re comfortable with.
For example, with multifamily or rental portfolios or built commercial properties, they generally already have tenants, and they’re usually already paying cash flows. Those have a lower risk profile than a rehab project where the fund is buying into a property only partially leased out, or is not stabilized, or requires a ton of improvements. Yes, it’s all about higher risk and higher reward, if the operator and sponsor can get that property stabilized and earning. And then there’s an even higher risk profile/higher reward with ground-up developments, just buying raw land to build buildings for whatever makes sense for the area and leasing or selling them out.
When marketing to investors, just remember they will be considering your experience, history, education, and knowledge. They will want to stick close to your specific area(s) of expertise just for their own peace of mind. Perhaps they will be willing to expand to something adjacent, such as starting with multifamily properties and then branching out to rehab opportunities or high-end apartment properties with high upsides and few costs.
The single-most important thing to remember is this: it’s about the investor, what they’re interested in, and the level of risk they’re comfortable taking on. Those metrics should inform the creation and structure of any real estate fund. So, why would a sponsor bother with an equity fund? Many real estate syndicators and entrepreneurs choose to go through multiple funding rounds and invest in different assets. It’s called a syndication model. With a syndication model, it’s a brand-new entity and brand-new investment each time there’s a new asset.
REASONS FOR USING THE SYNDICATION MODEL
- You’re building confidence and expectations with investors that are not just looking at what you’ve done for them lately.
They’re considering the demographics of the property and the specifics of that property. The focus is less on the operator and more on that property opportunity. Now, if you’re looking to do an equity fund, there’s a great benefit that as you raise capital, you can act quickly when an opportunity arises. You have the cash; you move forward. It’s not about setting up a new whole structure to market or pitch and promote it to new investors. You’re already working on your investor base.
- Funds allow for a diversity of investments.
Let’s say you were a syndicator and targeting 123 Smith Street. You go through syndication, get a fund, and close. It doesn’t go well. Now there’s a foreclosure, the investment is lost, the investors lose 100%, and it’s over. If you had done the same deal through an equity fund, and 123 Smith Street is just one of 10 different properties, and this one property is foreclosed on, the loss is not as severe. It’s never great, but you have yet to lose 100%. In this case, you’ve only lost what’s been invested in the one property; there are nine more to make up for those losses and still get a great return.
CONCLUSION
Syndication and equity funds work together very well. For entrepreneurs, this is a whole new business. Of course, management fees and costs exist when building wealth, but this is an excellent way to leverage your time. It allows sponsors to get off the hamster wheel, so to speak, and get around the limited hours you’re able to work. Many entrepreneurs find they’re able to multiply their income two or even three times while focusing on building their businesses, focusing on their families’ wealth, and growing generational wealth.
Unsure if equity funds are the right option for a specific situation? Contact us today to schedule a free consultation and learn how Crowdfunding Lawyers can guide you forward.