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How to Structure Your Capital Investment Vehicle When Raising Money

by Ankit Duggal on April 25, 2014 · 9 comments

  
How to Structure Raising Private Money

Mo Money, Mo Problems” as The Notorious B.I.G. says in his now famous song.

The “Mo Problem” arises around the question on how to structure an investment vehicle to take in their capital investors funds. Structuring a capital investment vehicle will be driven by the way you bring capital partners into the investment (i.e. debt or equity security). Investor capital can be secured as a debt or an equity investment within the investment stack.

Capital Investment Partners – Debt

Bringing a capital investor as a debt investors means securing their capital through a first mortgage on the subject asset and providing them a fixed rate of return.  If you have one major capital investor who will give all the funds needed then you simply give them a mortgage and the note on the asset and you can take in their capital.

The complexity arises when you cannot find one investors but must have multiple investors involved to achieve the needed capital requirement for the deal.  So how can you setup it up?

The diagram below will illustrate how to structure a Debt Capital LLC vehicle to take in debt investment capital:

Ankit 1

As indicated by the diagram above, you must setup a separate Limited Liability Corporation that will take in capital from each of the multiple capital investors. Each investor will get a share/membership unit percentage relative to the total capital stack.  For example, if a capital investor invests $10,000 on a $100,000 total capital stack then they will receive a membership interest of 10%.

RelatedCapital Investors: How to Reduce Risk Investing in Syndicates and Funds

The Debt Capital LLC will provide the capital to the Investment Ownership LLC typically owned a 100% by the real estate investor and in return receive two documents:

  1. a mortgage which helps securitize the interest on the investment asset and
  2. a note contractually securing the return obligation i.e. the interest rate owed to the Debt Capital LLC from Investment Ownership LLC regardless of the asset performance.

The real estate investor will own a 100% of the Investment Ownership LLC and in turn receive all upside that the asset produces but also be responsible for any and all downside involved in the project.

Capital Investment Partners – Equity

Equity capital investors are true investment partners to the equity investor as their return profile is variable and tied to the performance of the asset and the real estate operator. As a real estate investor it is your job to protect their capital and setup the right investment structure to secure their interest.

The diagram below illustrates how to structure a Equity Capital Investment LLC to take in equity investment capital:

Ankit 2

Equity investors are true investment partners as their returns are variable to the performance of the investment and the real estate investor management skills. The end mechanics are still the same as the investors provide you capital and receive shares/membership units in the Investment Opportunity LLC.

The key difference is that instead of receiving a note from the Investment Ownership LLC; the equity investors and GP receive an operating agreement which is the framework that describes the relationship, the obligations for all people involved (Equity Investors and GP) and returns division to both sides.

I would recommend having your first operating agreement drafted by a good corporate attorney who understands establishing partnerships and the associated nuisances of returns, risks and dispute situations.

RelatedPartnerships: The Benefits of Teaming Up in Real Estate Investing

Raising capital can lead to Mo Problems unless you structure and bring in capital investors in a manner that is the most advantageous for the investment asset and the capital investor’s interests.

Any questions, please feel free to comment below and I will answer any and all questions as I know that this can be confusing at first glance.

Happy Investing!

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{ 9 comments… read them below or add one }

Adrian Tilley April 25, 2014 at 8:57 am

Great article. The only thing I would mention is that I would NOT make this a DIY project unless you have significant competence in this area. I’m a licensed attorney and I can fake my way through entity topics, but I would never attempt something like this without help from a good attorney.

Reply

Ankit Duggal April 29, 2014 at 4:03 pm

Thanks Adrian. I would agree as to not make this a DIY unless you are a lawyer and have experience in partnership structuring and agreements.

Happy Investing!

Reply

Curt April 25, 2014 at 11:14 am

“I would recommend having your first operating agreement drafted by a good corporate attorney who understands establishing partnerships and the associated nuisances of returns, risks and dispute situations.”

I would change that paragraph to say “SEC attorney who also drafts the LLC opperating agreement, subscription agreement (important), disclosure and PPM”.

Only some states have an SEC exemption from SEC registration when one investor on one property on a 1st lien. Multiple investors is definitely an SEC registration and PPM (fancy disclosure doc). It makes sense to be safe when taking folks cash to do so within an SEC registered PPM.

On of the better SEC attorneys has posted on BP a few times and giving alot of talks that can be googled. Jillian Sidoti.

Reply

Ankit Duggal April 29, 2014 at 4:07 pm

Thanks Curt. Great points and thanks for providing the readers a reference Jillian Sidoti. She is a part of Trowbridge now which is a great SEC/Syndication firm.

Happy Investing!

Reply

Liam G April 25, 2014 at 5:58 pm

Ankit, Thanks for the article. Very helpful to see the setup of the two investment vehicles visually. I’ve been kicking around how exactly to set up an investment from multiple sources and your diagram above is perfect, and I now understand the very basics as to how to do this.

No worries, you don’t have to scold me, I will use an attorney to handle the paperwork, but this is perfect. Thanks.

Liam

Reply

Ankit Duggal April 29, 2014 at 4:08 pm

I am glad that this be useful.

Happy Investing!

Reply

Tara Piantanida-Kelly April 28, 2014 at 9:27 am

Great article! The visuals really help! Thanks for posting!

Reply

Ankit Duggal April 29, 2014 at 4:09 pm

Thanks. I am glad it was helpful.

Happy Investing!

Reply

Jake May 10, 2014 at 9:58 pm

Thanks for the article. Very helpful. I have a question about a simpler deal structure. A family member has agreed to fund a flip for myself and another partner. We will split the profits equally 3 ways. We will use my LLC as the business entity and the funds will come from a HELOC. I am the only member of the LLC. How should a deal like this be structured and how should the profits be distributed?

Thanks!

Reply

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