One question every sponsor of a syndication or fund should think about for themselves is: What are the consequences if the fund or syndication does not make money or loses a considerable amount of money? My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group specializing in Regulation D Rule 506b and 506c offerings. Today, we’re going to address that question.
Obviously, it’s a worst-case scenario. You’ve raised all this money and gained the trust of your investors, who’ve given you a substantial amount to put into this investment, be it real estate or a business. It can happen, though, that the business or real estate deal loses money or loses a considerable amount of money, or perhaps it just doesn’t meet expectations. Maybe you thought it would have a great return, and it just didn’t meet the mark that investors and you had hoped for.
It’s unfortunate that this does happen, but investments have risks. Hopefully, it doesn’t ever happen to you, but it is a possibility. So if that were to happen, what are the consequences to you?
If you’ve structured your deal correctly, in a way where you’ve conveyed all of the risks properly to your investors, and you’ve set up a structure that’s fair – and I should definitely add an asterisk here – as long as you have not committed fraud, because obviously, that would be an enormous problem. If you are somebody who would do that, I hope you’re not watching this video, and please don’t do syndications or private equity funds at all.
But outside of fraud, it is within the realm of possibility that an investment will lose money. Things do not always go up. We’ve seen deals in the recent past fall apart, and investors have lost a lot of money. Every now and then, I do get calls from investors who have lost money. Most of the time when I talk to them, there’s nothing I can do because it’s not part of my practice to be a plaintiff’s attorney working with people who lost money in a syndication. But I do like to talk to them to understand what happened and get a feel for the situation. I’m always thinking in the back of my mind if there’s somebody I can refer these people to, but most of the time there isn’t.
When I hear about these deals, most of the time it’s something that was foreseeable that fell apart. In today’s market, there’s obviously a mortgage interest rate risk. If there is a spike, or if the interest rate itself is variable, then a lot of people started losing money when interest rates started naturally climbing. That would have made the deal less and less viable, to the point where some of these deals have clearly completely collapsed.
Now, if all that risk was discussed with investors, there’s probably not much chance that they’re going to recover from the syndicator or the fund sponsor themselves. But if those risks weren’t properly discussed in a private placement memorandum, and the rules of what to do in that situation weren’t set up in the operating agreement, then there’s a very real possibility that those injured investors would have some recourse to collect money back.
The bottom line is this: if you are a sponsor, your risk is very low, as long as you’ve talked about all those risks, all those consequences that may happen by your investors investing in this project, and all the conflicts of interest that naturally occur. That’s why you need somebody who is really thorough and a very competent syndication attorney who can walk you through setting up what is as close to a bulletproof private placement memorandum as you can make.
Sure, it can still fall apart because things can happen. But the whole goal is to make such a document that your investors very much know what they’re getting into. They know that these risks are out there, and as long as they’ve been described adequately in a way that they can understand, then you’ll be protected.
I hope that explains the answer to this question, and we’ll talk again soon.