Do You Want a Multi-Asset “Fund” or Deal-by-Deal “Syndications”?

Now that you have a general overview of what you’ll need to raise a fund or syndication, it’s time to get into the nitty gritty. Beginning with this chapter, we’re going to zoom in on the key decisions you’ll need to make as a fund manager. The first fork in the road is whether you want to form a multi-asset fund or a single-asset syndication.

Multi-asset funds invest in more than one asset, typically over a prolonged investment period. On the other hand, single-asset syndications invest in only one asset (or a pre-packaged group of assets).

The following is a common route for aspiring GPs:

1. First, you invest your own money and see if you’re any good at investing.
2. Second, you raise money from friends and family via single-asset syndications.
3. Third, after you have a few syndications under your belt, you raise a small fund. Your syndication investors often make up a large portion of your LP base.
4. Fourth, you raise a bigger fund that adds family offices and other institutions to your existing LP base of family and friends.

Obviously, everyone is different. Some people decide to stop at Step 2 or Step 3. Many people stop at Step 1 when they realize investing won’t be their life’s work.

If you’re not sure whether to start with a fund or a syndication, this is the chapter for you.

SINGLE-ASSET SYNDICATIONS

Investment managers raise syndications when they want to invest in one thing. Examples include:

• Buying an apartment building
• Buying an HVAC company
• Investing in the Series B round of a technology company
• Loaning a tranche of debt to a single real estate development project

ADVANTAGES OF SYNDICATIONS

In many ways, raising “deal by deal” is better (and easier) than raising a fund. Let’s look at some of those ways.

1. It’s Easier to Raise Money with a Syndication

When you raise money for a syndication, potential investors can tangibly understand what they’re investing in, and they can perform their own diligence on the asset.

For example, if you’re buying an apartment complex, potential LPs can review information about the property and determine for themselves whether they agree with your underwriting. They can review financials, images, and even (theoretically) visit the property.

In another example, potential LPs in a syndication to purchase shares in a startup’s Series B round can review the company’s information. They can visit the company’s website and try out the business’s products and services for themselves.

The ability of investors to perform their own investigations makes fundraising easier. LPs can determine for themselves how they feel about the specific asset they’re considering investing in, requiring less trust in the GP.

2. It’s Less Expensive (and Simpler) to Raise a Syndication

Syndications are less complex than funds. As a result, they’re easier to set up. To illustrate, our standard limited partnership agreement (LPA) for a simple real estate syndication is around thirty-five to forty pages long. On the other hand, the LPA for a middle-of-the-road real estate fund is eighty to one hundred pages.

Admitting investors is also usually (but not always) simpler in syndications. In funds, it’s common to admit investors over a one-to-two-year period, called the “fundraising period,” and deploy the capital over a three-to-five-year period, called the “investment period” (we’ll discuss the lifespan of a closed-end multi-asset fund in Chapter 5). Conversely, syndications often (but not always!) raise all the money at once and deploy it immediately.

Overall, syndications generally require less work than funds (from you, your lawyers, and your accountants), which saves money, time, and mental bandwidth.

3. Syndications Have Separate Distribution Waterfalls

In most syndications, distributions of cash go something like this:

• First, LPs get their money back
• Second, LPs get a preferred return (in some asset classes)
• Thereafter, the remaining profits are split between the LPs and the GP

(Skip to Chapter 7 for a detailed walkthrough of distribution waterfalls, but only after you’ve had your coffee.)

Let’s walk through an example:

• GP raises three syndications, each of which buys one strip mall
• Each syndication invests $100 (all LP capital; no GP capital)
• Each syndication lasts five years

Two syndications are total losses, and the third syndication has a 3x return ($300 to distribute). The GP would receive no carried interest from each of the two syndications with a total loss.

However, for the third syndication (with the 3x return), the GP would earn profits after the $100 LP investment is returned and the preferred return (let’s say $40—a simple 8 percent for five years) is paid.

The remaining $160 ($300 minus $100 return of capital minus $40 preferred return) would be distributed between the LPs and the GP. In a common waterfall, the GP would get $32 (20 percent) and the LPs would get $128 (80 percent). As you’ll see below, the result is much different if all three assets were bought in the same multi-asset fund. Stay tuned.

DISADVANTAGES OF SYNDICATIONS

Alas, there’s no free lunch. Let’s review the downsides of investing deal by deal.

1. You Fundraise 363 Days of the Year (on the Low End)

Few GPs want to spend their whole lives fundraising. They want to find deals and manage assets! If you form a new vehicle each time you find a deal, you have to raise money over and over and over again. Suddenly, you’re a professional fundraiser instead of a professional investor.

Not only is constant fundraising not fun, but it can also be risky! You might assume your loyal cohort of LPs will re-up each deal, but that’s only true until it’s not. After investing in your first two syndications, one of your major LPs might suddenly have “liquidity issues.” Trying to find that last $2 million of allocation is rarely a delightful task.

2. You Can’t Deploy Capital as Quickly as Funds Can

If you need to raise money each time you put a deal together, you can’t act with lightning speed. You may have found a killer asset, but now you must:

• Call your lawyer to get documents going
• Draft new marketing materials
• Call your previous investors to gauge interest
• Get everyone to sign everything and wire the money ASAP

It’s certainly doable, but it takes time (and adds stress). As we’ll see below, funds can act much more quickly.

3. Mo’ Syndications, Mo’ Problems

While forming a single syndication is easier and faster than forming a single fund, maintaining multiple single-asset syndications can get complicated quickly. Instead of having one LLC (or limited partnership) holding investor funds, you might have eight separate syndications, each with its own legal documents, bank accounts, tax returns, investors, etc. In short, you might end up in a state of chaos, wading waist-deep in a swamp of formation certificates, K-1s, and investor lists.

MULTI-ASSET FUNDS

With a fund, you form a single entity (typically a limited partnership or LLC) to invest in multiple deals over time. Common examples include:

• A private equity fund investing in small- and medium-sized businesses
• A venture capital fund investing in early-stage software companies
• A real estate fund investing in multifamily buildings in Texas
• A credit fund loaning to development projects in California

ADVANTAGES OF FUNDS

Funds can have multiple advantages over syndications. Let’s explore the upsides of funds.

1. You Fundraise Once…and Then, You’re Done

When you build a fund, you fundraise once. Once you’ve closed the fund, you can focus on acquiring, managing, and selling investments. You’ll eventually need to raise the next fund, but that’s often years (instead of months) in the future.

Fundraising is a grind. Anything you can do to decrease the percentage of your day spent begging people for money increases your quality of life. You can also avoid calling your lawyer as much, as you won’t need to set up new entities and draft documents for each deal. (However, many investment managers absolutely love their lawyers and would view this reduction in interaction as a clear negative.)

2. You Can Act with Lightning Speed

As a fund manager, when you find a deal, you can buy it immediately. No need to organize documents and get your ducks in a row.

Fund documents typically give LPs ten business days to send money after the GP calls capital to make an investment (we’ll discuss capital calls in detail in Chapter 11)—this is much faster than the time needed to form and close an entire syndication.

Moreover, some funds use “capital call facilities” to make investments. These are revolving credit facilities where funds can borrow money (using the right to call capital from LPs as collateral). If a fund has a capital call facility, it can get cash from a bank quickly, make the investment, and then pay back the loan when the capital contributions from the LPs arrive.

Obviously, not every timeline will be this fast (and GPs need time to do their diligence on each investment), but the ability to act fast is a huge benefit of funds.

3. Fewer Entities to Manage

This is mentioned in the third disadvantage of syndications, above. Making all investments through the same fund can reduce operational complexity and keep your life just a little bit simpler.

DISADVANTAGES OF FUNDS

Funds aren’t for everyone. Let’s consider the drawbacks to forming a fund.

1. Netted Waterfalls May Decrease GP Compensation

Let’s revisit the example in the third listed advantage of syndications (Syndications Have Separate Distribution Waterfalls), above.

In a typical multi-asset fund, the returns of various deals are netted (crossed). In other words, distributions to investors might look something like this:

• First, LPs get their money back from all deals invested in by the fund
• Second, LPs get a preferred return (in some asset classes)
• Thereafter, the remaining profits are split between the LPs and the GP

In the example discussed in the third advantage of syndications, above, there are three investments of $100 each. If all three investments were made in the same fund, the $300 the fund has available to distribute would go 100 percent to LPs because Step 1 of the waterfall requires a return of all investor capital ($100 × 3 = $300).

So, with the exact same deals, the GP managing three separate syndications receives $32 from carried interest, while the GP managing one fund makes $0. Not fun for the GP. The LPs will be happier though!

One important note is that not all investment funds have netted (crossed) distribution waterfalls—also known as “European” waterfalls. Some funds have deal-by-deal waterfalls—also known as “American” waterfalls. In Chapter 7, we’ll learn about European and American waterfalls in detail.

2. Harder to Raise Money

This is mentioned in the first listed advantage of syndications, above. Funds are “blind pooled” vehicles, which means investors pool their money with the GP but don’t know the exact assets the fund will buy. It’s a “trust me” approach to investing.

If LPs know and trust the GP—or the GP has a track record of success—this might not be a problem for fundraising. However, emerging managers often don’t have the reputation to raise a blind-pooled, multi-asset fund right out the gate. To establish a track record and credibility, many emerging managers start out doing deal-by-deal syndications and raise a multi-asset fund only after they’ve proven their investing acumen.

3. Pressure to Deploy Capital at All Costs

As mentioned above, nobody knows the exact investments a typical multi-asset fund will make over its life. The actual investments will depend on market conditions, pricing, and opportunities.

But what if a venture capital fund raises $100 million to invest in Series A rounds of startups, but there aren’t any good deals out there? What if all the investment opportunities are overvalued trash?

Despite their best intentions, the GP may feel compelled to invest the $100 million into companies regardless of the quality of the deals. It’s unusual (though not unheard of) for a fund to leave a large portion of its capital uninvested. As a result, the caliber of a fund’s investments may be lower than if the GP invested on a deal-by-deal basis and only when screaming deals were available.

⚠ FUND TRAP #4: THINKING SYNDICATIONS AREN’T SUBJECT TO THE SAME LAWS AS FUNDS

The laws we’ll discuss in Part II apply to single-asset syndications as well as multi-asset funds. If you’re pooling capital to make investments—even an investment in just one asset—you must comply with a host of laws and regulations. This comes as an unwelcome surprise to many syndicators.

As we’ll discuss in Chapter 14, advisers to venture capital funds enjoy a special exemption from registering as an RIA under the Investment Advisers Act. However, fund managers can only use this exemption if all their managed funds and syndications are venture capital funds (as defined in the Investment Advisers Act).

A client once came to my firm ready to raise their first multi-asset venture capital fund, and they wanted to use the venture capital exemption to the Investment Advisers Act. However, they had previously syndicated a large number of startup investments, and some of these syndications were formed to purchase “secondary” shares (bought from another investor instead of acquired directly from the company).

Unfortunately, under the Investment Advisers Act, a manager cannot use the venture capital exemption if they have any funds or syndications that are not venture capital funds. Under the law, a syndication to purchase secondary shares is not a venture capital fund (much to the chagrin of managers in the venture capital industry). As a result, the GP had blown their venture capital exemption.

To fix the problem, they were forced to sell or otherwise transfer all their secondaries syndications to other GPs so they could take advantage of the venture capital exemption. Not what they had in mind when they formed those secondaries syndications!

NOTE ON RAISING MONEY FROM FAMILY AND FRIENDS

Many GPs start by raising capital from their friends and family. If you’ve impressed these people over the course of a long relationship, that’s a good sign. The opposite is also crucial to acknowledge.

If you can’t raise money from even your family and closest friends, your potential deal (or fund) probably isn’t very compelling (and Thanksgiving is about to get a little more awkward). You may want to refine your pitch before reaching out to potential investors outside your inner circle.

Now that you know the difference between single-asset syndications and multi-asset funds, you can decide which one you want to build. If you choose to form a fund, your next step will be deciding whether to form a closed-end fund or an open-end fund. Turn the page to continue your adventure! If you instead want to raise money in deal-by-deal syndications for now, you can skip to Chapter 6.