Episode 129 – How to Structure a Debt Fund: Real Estate Syndication & PPM Best Practices

Structuring a debt fund requires a clear understanding of both the legal and financial aspects. So, when you’re trying to figure it out, you have to ask a few questions. First off, what is a debt fund? A debt fund is a pool of money from investors where you’re acting kind of like a bank. You’re lending out that money for a specific purpose, usually tied to some kind of security like real estate.

Then, the next question is, what are the legal considerations? First, you need to have a private placement memorandum (PPM) that explains everything to the investors. It outlines the strategy, the risks, the return structure, and all the legal disclaimers to keep you protected. You’ll also need an operating agreement or a limited partnership agreement, depending on how you set up the fund.

Financial structuring is critical too. You have to decide things like what the minimum investment is, how returns are distributed, and whether there’s a preferred return. Also, you need to figure out if there are management fees or other fees you’re taking off the top.

Another big factor is your investor classes. Are you just having one class of investors where everyone gets the same terms, or do you want to have different classes, like Class A and Class B, where they get different returns or different priorities?

Collateral management is another piece. You’ll be making loans and you have to make sure that you’re properly securing those loans, probably through mortgages or deeds of trust if it’s real estate.

Regulation D is important because you want to be exempt from full SEC registration. You’ll likely use Rule 506(b) or Rule 506(c), and depending on which one, there are rules about how you advertise and who you can take money from.

Risk management is something to think about too. What happens if a borrower defaults? Do you have the ability to take over the property? What’s the process? All of this should be outlined up front.

Common mistakes? One of the biggest ones is not properly explaining the risks to investors. You have to be really upfront about it in the PPM. Another mistake is being too loose with lending standards. You need a clear underwriting policy to protect your investors’ money.

At the end of the day, structuring a debt fund is all about being crystal clear with investors, protecting yourself legally, and setting up strong financial practices. Done right, it can be a very powerful way to raise money and deploy it profitably.