If you’re putting together a syndication or fund, you may be worried about a situation where an investor wants to get their money out before the end of the fund or syndication. It could be part of a redemption, or they might have a life event and need to get their money back. How do we deal with that? What does a syndication attorney think about it? Let’s talk about it.
When I have a client come to me and we start putting together their package of operating agreement, subscription agreement, and private placement memorandum, one of the items we always discuss is whether or not there should be an included “redemption.” This is a mechanism for the investor to be able to get their money back as a normal part of the transaction in the fund. If that works in the context of their fund, typically in a fund and not in a syndication, then we’ll build that in. But many times it doesn’t work, and there is a general concern about what happens.
As an aside, as part of Regulation D, there is a prohibition on resale. What the SEC is trying to prevent is investors being able to create a market themselves. They don’t want to make it so that someone is buying a part of your syndication in order to create a market and start selling these out as it appreciates in value. That behavior is prohibited, but selling your own shares or units, whatever the denomination is, is typical and happens frequently.
Now, if there is no redemption, normally we’ll look at the operating agreement itself and determine whether or not there’s a “right of first refusal.” If there is, what typically happens is the investor will say, “I found my friend Joe Smith, who would like to buy my units for $1,000 a unit.” Before Joe Smith can buy those and before the manager could approve them, the manager needs to look at the language of the right of first refusal. It might be that the company has the right of first refusal, or the managers have it, or all the investors have it, or some combination of the three. If there is that right, it needs to follow the rules dictated in the operating agreement.
If there isn’t a right of first refusal, not to worry, the investor still has the right to sell. But most of the time, probably all of the time, the manager has the right to approve or disapprove whether or not the new person is able to come into the fund itself.
It’s definitely a best practice for managers and sponsors to work with their investors when they want to sell their units. Not only does it provide better service to that investor and reduce the likelihood of complaints, but also your investors may want more shares. If you’ve been doing a good job, they probably do want more of the deal you’re working on.
If this happens, you should coordinate closely with that investor to ensure everything’s happening in a manner that’s not only compliant with the operating agreement but also in the best interest of all investors. When it happens with a third party, it’ll typically look like an agreement written between those two people, and then you as manager will sign off on it and approve the transaction.
I hope that helps. When this happens to you, and it happens in nearly every syndication at some point, don’t fret. There are solutions for your investor. They don’t need to be freaking out about how it’s going to happen. You can help them, and the best thing to do really is give your syndication attorney a call. If that’s me, we’re always happy to help.