It’s almost a certainty that at some point, you will have an investor in your syndication or your investment fund who wants to redeem themselves out, who wants to get out of that investment, get their money back and be gone. Typically, it’s because of some life event. Now, how do you do it? Is it allowed? Is it not allowed? Let’s go through it.
In order for an investor to get out of your syndication or investment fund, this normally happens in one of three different ways. We like to have this conversation at the get-go, when I start working with clients and understanding what their structure is going to look like, because it’s probably going to be part of the paperwork somewhere.
The three ways that we do it:
First off is redemption. This is extremely common in investment funds, especially open-ended funds, or what I call cyclical funds. Every year, they kind of turn over on a regular interval. So there’ll be an investment period where we say, “Okay, investors can get all of their money back at these defined periods.” It’s in the PPM, typically, and it’ll say they need to give notice or something like that.
Investors need to recognize that this is a revolving fund with people’s money invested, and we can’t prejudice the other investors by people trying to get their money out too early. Things sometimes take a little bit longer than the notice period requires. They have to understand that we’ll do our best to do it. Because they’re your investors, you want to take care of them, and they could very well be in your next fund. Or they may very well be a family member, whatever it is, you want to take good care of your investors.
The second way that investors oftentimes are exiting funds is what I call a sponsor buyout. A sponsored buyout may say something like at the end of each year, we’re going to send a notice out that says this is the amount of money that’s available to redeem any member who wants to withdraw some or all of their money. They can opt in to this period. But there’s only a certain number of dollars that’s available for it.
So our $10 million fund is only going to be setting aside for this year $750,000 for redemptions. If you want to be redeemed, then you raise your hand, you let us know. And we will then allow you, we will buy you out. Now if there is not enough, if there are more people who want more dollars than the fund has made available for this redemption, then we do it pro rata.
This is also kind of the Warren Buffett model. I’ve been told this is the way that he originally did his redemptions for his fund early in his career, and nobody ever took him up on it. But this is a very good model because people feel safe and comfortable about it. But it still gives you as the sponsor the control over the fund and over those redemptions.
The third and final way for investors to get their money back that often happens, probably in the vast majority of cases, is what we call a right of first refusal, or “Hey, I want out.” Here’s how it happens: The member calls up the sponsor and says, “Hey, I’ve just had this life event, I need to get my cash out. I’m in a really bad situation, how can I do it?”
The best method to do is, you tell the member, “Okay, look, I think we’ll probably be able to find out, but I can’t promise anything. Let me go to all the members and see if somebody wants to buy you out. In the meantime, you should look and see if somebody that you know wants to buy out your piece of it as well.”
So you call up and let every member know, “Hey, we’ve got this member who needs to make an exit. Is it a life event? Is anybody interested in buying his shares?” Or it could be that person could also be you. So give them a chance in order to find a replacement. Because at the end of the day, you want that person who’s getting out to be able to get top dollar.
Now what do I mean by top dollar? This is now a market-driven activity. They’re probably going to be selling their spot at a discount because they’re in an urgent situation. It’s just the way it is. So most of the time, they’ll buy it at 90 cents on the dollar. And that will be the buyout. Now that’s just a very rough idea on what it is. But the market itself will take care of it.
It’s negotiated between them. Unless you are the one buying them out, do not get involved in that negotiating process at all. You don’t want anything to do with it. You want it to be entirely between the purchaser and the seller.
My name is Tilden Moschetti. I am a syndication attorney for the Moschetti Syndication Law Group. We focus exclusively on Regulation D and Regulation D offerings, helping sponsors put together compliant offerings for themselves for their investment funds syndications, whether it be for real estate or raising money for their business, or private equity fund or whatever it is, as long as it’s under Regulation D. If we can help you and if you’re interested in putting together a fund or syndication, give my office a call. We’ll set up a time to talk and we can go from there.