How to Structure Your Capital Investment Vehicle When Raising Money
“Mo Money, Mo Problems” as The Notorious B.I.G. says in his now famous song.
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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:
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%.
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:
- a mortgage which helps securitize the interest on the investment asset and
- 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:
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.
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.