The Importance of Obtaining Pre-Launch Soft Commitments
Before launching a closed-end investment vehicle, such as a private equity real estate fund, managers typically seek to gauge investor interest and obtain soft, non-binding commitments from potential investors. A successful launch of an investment fund depends heavily on the manager's ability to properly garner a critical mass of pre-launch soft commitments, that is, nonbinding expressed interest in the forthcoming fund offering.
After the fund has launched, an extended capital-raising period stalls the fund's momentum and creates unease in the committed investors. Moreover, it can waste valuable allocation time, allowing market forces to shift in ways that may undermine the investment strategy.
Fund managers who take some time to gather soft commitments before the fund's launch date can affect more significant results. However, obtaining soft commitments is fraught with potential liability and should be approached carefully and with appropriate documentation.
Pre-Launch Liability Concerns
Pre-launch discussions can present significant liability, especially when such discussions extend to written communication and presentation material. Prospective fund managers need to appreciate the extent to which US regulation applies to pre-formation communication.
Unfortunately, it is common to encounter fund managers who, before engaging with legal counsel, have actively prepared and presented pitch decks, executive summaries, and in extreme cases, even websites in efforts to garner interest in the fund before launch. Most often, these include inadequate legal disclaimers, stating that the communication is not a solicitation, that the fund has yet to launch, and investors should not rely upon any information conflicting with the subsequent fund launch.
These well-meaning disclaimers fall short of meeting the requirements when communicating with investors. US securities laws do not provide a safe harbor for communications intended only to garner investor interest. In reality, any communication that intends to raise capital will almost assuredly be deemed communication in furtherance of soliciting an offer to purchase securities by US securities law. Individuals can face liability for verbal and written communication that does not meet strict federal and state regulatory requirements.
Unique Pre-Launch Liability for Managers of Pooled Investments
Managers of pooled investment vehicles (fund managers) face potential liability in pre-launch offering material at a scope beyond that of an operating company raising direct capital in a private placement offering. For example, the Investment Advisers Act imposes liability on managers of pooled investment vehicles for omissions or misstatements, even when the error was not willful. Suppose a statement to an investor is made to garner interest in an offering. In that case, it can still be deemed a violation even if it is not made in connection with an actual sale or to an investor who never ultimately invests. Moreover, before launch, marketing material is subject to regulatory review, including funds exempt from various registration requirements.
In many marketing materials, fund managers commonly include many disclaimers, such as "this is not an offering," "performance results may vary," etc., believing that this will alleviate them from liability in their marketing materials. However, the SEC has certain disclosure materials that must be included in such materials. In addition, fund managers have a fiduciary duty to provide accurate, compliant, and factual materials to potential investors.
The extent of necessary pre-launch disclosures corresponds to the fund manager's pre-launch communications scope. As securities attorneys often repeat: "You don't always have to open your mouth, but once you do, you have to open it all the way." The more details a fund manager provides in pre-launch communications, the more robust the necessary disclosures must be.
Critical Timing Issues for Closed-End Funds
Starting with an adequate base of pre-identified potential investors is especially critical for closed-end vehicles like real estate private equity funds. Open-end funds can gradually grow assets under management (AUM) over time and scale their investments yearly as additional investment comes into the fund. Conversely, closed-end funds have restricted time periods to secure investment capital (via binding commitments or escrowed capital contribution).
The timeline for raising capital for a closed-end fund, including a real estate fund, differs markedly from an open-end or "evergreen" fund. Open-end funds, such as hedge funds trading liquid market assets, can grow their AUM over time within a single fund. Startup hedge funds with a relatively modest initial asset base can scale up their strategy as they add investors, year over year. By contrast, sponsors of illiquid assets, such as real estate assets, generally operate multiple closed-end vehicles with a finite size within a family of funds, which generally have a projected duration of 5-7 years (typically with two-year extensions). Closed-end real estate sponsors grow their AUM over time by adding additional fund vehicles, ideally with an increasingly larger AUM.
Client-Tailored Pre-Launch Services
Capital Fund Law Group provides pre-launch fund managers with the needed advice and disclosure documentation to enable managers to engage with potential investors to obtain pre-launch soft commitments properly. In addition to assisting with the necessary documentation, Capital Fund Law Group helps prospective fund managers set appropriate structures and investment terms that can be critical to the success of the future fund. Please visit our pre-launch services page to read more and schedule your consultation with one of our attorneys. Our pre-launch services include, but are not limited to:
- review of pre-launch communication and promotional material;
- advise on the pre-launch memorandum of disclosure document; and
- investment management company formation or incubator fund structuring (additional information on incubator fund formation services here)
Pre-Launch Memorandum of Disclosure & Management Company Formation
Managers engaging in more than general discussions about a potential fund strategy should accompany all communication with carefully prepared pre-launch disclosure language. Generally, this is accomplished by preparing full offering documents, including a private placement memorandum. However, some emerging managers, particularly those of closed-end vehicles, such as real estate funds, need to develop momentum leading up to the fund launch and can benefit from preparing the offering documents in stages.
Memorandum of DisclosureThe memorandum of disclosure (the "MOD") provides a stepping stone to funds in the early process of launching a fund and is solely seeking soft commitments. Once the fund is ready to secure binding capital commitments or contributions, fund counsel can complete the more time-intensive process of providing full offering documents and preparing the required regulatory filings. The scope of the MOD may vary, depending on the scope of the manager's pre-launch communications, but typically includes a summary of anticipated investment terms, an investment strategy overview, a truncated disclosure of risk factors, fund manager bios, and disclosures and disclaimers surrounding critical regulatory issues.
Management Company FormationIn connection with the preparation of the MOD, Capital Fund Law Group assists with forming the investment management company and the associated governing documents. Prospective fund managers should consult with investment fund legal counsel on entity formation timing. Using legal entities in connection with pre-launch communication can have significant consequences for securities law, as discussed throughout this article.
Review of Communication & Promotional Materials
Any verbal or written communication that indicates a potential intent to raise capital should be carefully discussed with securities legal counsel. Legal counsel should review all written communication and presentation material before any discussion with potential investors; this is especially crucial when a fund prepares written material before preparing comprehensive fund offering documents.
- improper identification of the status of the future fund and management company;
- inappropriate statements or wording that could be considered representations or warranties;
- potentially misleading, incomplete, or overstated management bios;
- improper disclosure and identification of investment returns and forecasts;
- potentially misleading photographs, graphical representations, and data summary; and
- inaccurate or premature discussions of investment terms and structure.
Disclaimers added to marketing materials, while necessary and helpful, do not neutralize the effects of non-compliant statements or make up for omissions that should have been included in light of the scope of communication. When reviewing the communications, legal counsel must take the time to understand the intended structure, strategy, manager background, and potential investor base to identify the problematic language and the scope of needed pre-launch disclosure.
Our Firm is well-versed in pre-launch disclosure services for early-stage managers. Visit our Contact Us page to schedule a complimentary consultation with one of our experienced attorneys to discuss if our pre-launch services are right for you.
Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.