Happy Friday, Funds Family!

Today we’re going to answer a common question asked by investment managers:

Should you:

1. Syndication: Raise a new vehicle each time you find a new deal?

   or

2. Fund: Raise one vehicle you can use to invest in many deals?

Quick note on terminology 👀 

You might hear other people (including myself) refer to syndications as SPVs (special purpose vehicles). Here, we’ll use “SPV” and “Syndication” interchangeably. They both mean a pooled investment vehicle where you buy one thing (as opposed to a Fund where you invest in multiple deals).

Let’s dive into the pros and cons of funds and syndications. 🏊️ 

But first…a final call for our free summer webinar, where we’ll walk through:

• Timeline of how the funds work

• Steps to take before launching a fund

• Duration of the fundraising period

• Lifespan of the fund

• Detailed timeline of a closed-end investment fund

Event Details:

• Date: July 30, 2024 (next Tuesday)

• Time: 10:30 am PT

• Location: Online – Link to be provided upon registration

Please register and submit any questions by clicking on the button below:

Back to funds and syndications! 👇️ 

Single-Asset Syndications

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

Example use cases of a syndication include:

• Buying an apartment building

• Buying an HVAC company

• Investing in the Series B round of a technology company

• Extending one large loan to a company or real estate developer

📈 Advantages of syndications

In many ways, raising “deal by deal” is better than raising a fund.

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 do diligence on the asset.

🏨 For example, if you’re buying a mixed-use building, 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 visit the property themselves (this isn’t typical, but it’s possible!).

💻️ Potential LPs for a syndication to purchase shares in a startup’s Series C round have the opportunity to review company information. They can visit the company’s website and potentially try out the business’s products and services for themselves.

The ability for investors to investigate themselves 🔎 aids fundraising, as LPs can determine whether they like the specific asset they’re considering investing in.

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 LPA (limited partnership agreement) for a simple syndication is around 40 pages long. On the other hand, the LPA for an investment fund may be as long as 80-100 pages…or even more!

Admitting investors is usually (but not always) simpler in syndications. In funds, it’s typical to admit investors over a 1-2 year period ⏱️ called the fundraising period and deploy the capital over a 3-5 year period ⏱️ called the investment period.

Syndications, on the other hand, often raise all the money at once and deploy it immediately. This might not always be the case, but it happens frequently.

Overall, syndications typically require less work (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:

1. First, investors (LPs) get their money back

2. Second, LPs get a preferred return (in some asset classes)

3. Thereafter, the remaining profits are split between the LPs and the investment manager (GP)

Let’s say a GP raised three syndications to invest, and each syndication invested $100. Let’s also assume the LPs put in all the money (no GP commitment). Let’s say each syndication lasts five years.

If 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, the GP would earn profits after the $100 LP investment is returned and the preferred return (let’s say $40 - a simple 8% for five years) is paid. The remaining $160 would be distributed between the LPs and the GP. In a common waterfall, the GP would get $32 (20%) and the LPs would get $128 (80%). 💰️ 

As we’ll see below, this 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 have to fundraise each time you have a deal

Few GPs want to spend all their time fundraising. They want to find deals and manage assets!

If you form a new vehicle each time you want to invest in a deal, you’ll have to raise money…over and over and over again. Now you’re a professional fundraiser instead of a professional investor. 😕 

Not only is this not fun (for many), but it can be risky! You might assume your cohort of LPs will re-up each deal, but they might change their mind. After investing in your first two syndications, they might suddenly have “liquidity issues” to attend to. Trying to find that last $2 million for your deal is rarely a delightful task.

2. You can’t deploy capital as quickly as funds can

If you have 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 have to (i) call your lawyer to get documents going, (ii) call your investors to see if they’re interested, and (iii) get everyone to sign everything and wire the money ASAP. 🤯 

It’s certainly doable, but it takes time. As we’ll see, 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, a large number of single-asset syndications can get complicated quickly.

Instead of having one LLC or limited partnership holding investor funds, you might have six separate syndications, each with its own legal documents, bank accounts, tax returns, etc.

In short, you might end up like this:

Multi-Asset Funds

With a fund, you can use a single entity (typically a limited partnership or an LLC) to invest in many deals.

Common examples include:

• A private equity fund investing in small and medium businesses

• A venture capital fund investing in early-stage software companies

• A real estate fund investing in multifamily buildings in Texas

📈 Advantages of funds

Funds are better than syndications in many ways.

1. You fundraise once…and then you’re done

When you raise a fund, you fundraise once. Then, once you’ve closed the fund, you can focus on acquiring, managing, and selling investments.

Fundraising is a grind. Anything you can do to decrease the percentage of your time asking 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 for each deal.

However, many investment managers absolutely love their lawyers ❤️ and would see this decrease in interaction as a clear negative. Right…?

2. You can act with lightning speed ⚡️ 

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

Many fund LPAs give LPs 10 business days to send money after the GP calls capital to make an investment - this is much faster than needing to form and close an entire syndication. 🏃 

Capital Call Facilities

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

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

3. Fewer entities to manage

This is mentioned in Syndication Disadvantage #3 above.

Making all investments through the same fund can reduce operational complexity and keep your life just a little bit simpler. ☺️ 

📉 Disadvantages of funds

Why not everyone forms a fund…

1. Netted waterfalls may decrease GP compensation

Let’s revisit the example in Syndication Advantage #3 above.

In a typical multi-asset fund, the returns of the various deals are netted (crossed). 🔀 

In other words, distributions to investors might look something like this:

1. First, investors (LPs) get their money back from all deals made by the fund

2. Second, LPs get a preferred return (in some asset classes)

3. Thereafter, the remaining profits are split between the LPs and the investment manager (GP)

In the example above, there are three investments of $100 each. As a result, the $300 the fund has available to distribute would go 100% to LPs, because step 1 of the waterfall requires a return of all investor capital ($100 × 3 = $300).

So, with the exact same deals as the syndicator in the example above (who had three separate syndications), the fund manager makes $0 from carried interest. 😥 

Note on American Waterfalls

Some funds have what’s called an “American Waterfall” for distributions. Unlike the example above (which has a “European Waterfall”), an American waterfall distributes money deal-by-deal and largely mimics how distributions would work if each deal were in a separate syndication.

We will explain this more in a future article, but note that American waterfalls are much less common than European waterfalls in the market (even in America).

2. Harder to raise money

This is mentioned in Syndication Advantage #1 above.

Funds are “blind pooled” vehicles, which means investors pool their money with the GP but don’t know what the GP will invest in.

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 clout 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 full fund once they have investors beating down the door.

3. Pressure to deploy capital at all costs

As mentioned above, at the beginning of the fund’s life, nobody knows the exact investments it will make. The actual investments will depend on market conditions, pricing, and opportunities. 📊 

Illustration: 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 companies are trash?

In many cases, the GP will feel compelled to invest the $100 million into companies regardless of whether the deals are exceptional. It’s unusual 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 manager invested on a deal-by-deal basis and handpicked only the very best deals.

🤔 What do most investment managers do?

A common route for aspiring GPs goes like this:

1. First, invest your own money and see if you’re any good at investing.

2. Second, raise money from friends and family for single-asset syndications.

3. Third, after you have a few syndications under your belt, raise a small fund. Your syndication investors often make up a large portion of your LP base.

4. Fourth, 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 3. Many people stop at step 1 once they realize investing won’t be their life’s work.

💡 Note on raising money from family and friends

Many GPs start by raising capital from their friends and family. Super common. If you’ve been able to impress 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 friends, your potential deal (or fund) probably isn’t very compelling. You may want to refine your pitch before reaching out to additional potential investors.

Thanks for reading, everyone.

Have a great weekend!

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.