Fund Management 101: Fund Type Considerations When Structuring Your Fund

Once you have decided to make the transition to a Fund structure, the hard work starts.  The first challenge is figuring out how to structure your fund. Among the multitude of considerations, the top questions include what type of fund would work best with your asset strategy and how will fund structure maximize your opportunity to raise capital?

In this first installment we will discuss the overall structural consideration: the type of fund.  This is a big question and will depend greatly on your asset strategy, your financial modelling and your capital raise strategy – all of which you should have figured out prior to deciding to make the transition. In relation to the type of fund, you should consider three main points:

Offering Type

The most popular fund type we work with is a 506(c) fund, which is exempt from securities registration with the SEC (but must still file a Form D). Unlike a 506(b) fund, these funds do not have significant restrictions on solicitation and advertisement to investors, including having to have a prior business relationship with your investors. However, in a 506(c) fund you are limited to accredited investors, whereas a 506(b) can have up to 35 non-accredited investors.  You must also take reasonable to steps to verify that each investor is accredited, which is more difficult than you may currently be thinking.

Open vs Closed Fund

Open-ended funds are characterized by a fluctuating unit price, with capital being raised and deployed throughout the life of the fund. Closed-ended funds on the other hand, have a fixed unit price and are defined by a finite capital raise and investment period, each with a specified end date.

Certain asset models are better suited to each type, so consider your asset strategy before making this decision. A model with a high volume of transactions and good velocity of assets may be better suited to operate as an open-ended fund (for example, a mortgage pool fund), and those strategies characterized by longer hold periods and uneven asset realizations may be better suited to a closed-ended structure (such as a deep value-add real estate fund).

Capital Structure

There are two types of offerings we generally see in funds, equity and debt. In an equity offering, your investors become members (owners of the fund) and are issued equity interests on a fluctuating (open-ended) or static (closed-ended) unit price. Principles of fair and equitable treatment of equity investors apply, in relation to issues such as redemptions and expense recognition, and in an open-ended fund, unit price calculations add a layer of complexity to this.

The other option is debt, where the fund borrows money from investors, who are called note holders. The rates and terms of notes may vary within the fund, depending on factors such as how much capital an individual investor is contributing or length of maturity for an investor’s note.

Before deciding on the type of fund, you must have an asset model with some volume, have a variable-driven financial model, and have a game plan for raising capital. These three factors will dictate the type of fund which will work best for you and your goals. For more on specific considerations see the Six Considerations When Structuring Your Fund.

Lance Pederson

Redwood works with open and closed-ended funds across the country, with a wide variety of asset strategies and capital structures. If you have questions on structuring or running your fund, please feel free to reach out to Lance Pederson at lance.pederson@redwoodrea.com with questions.

 

 

Nothing in this article is intended to be or should be construed to be legal, accounting, or other professional advice that requires a license to provide.  Anyone acting on the information contained in this article should consult with independent professional advisors.  As part of Redwood’s advisory practice, all of our fund creation clients enter into an attorney/client relationship with qualified securities counsel.