Prior to launching a fund, managers typically seek to gauge investor interest and obtain non-binding soft 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 raise time period stalls momentum of the fund makes committed investors uneasy and can eat up valuable allocation time, allowing market forces to shift in ways that can undermine the investment strategy. Fund managers who take some time to gather soft commitments before the fund’s launch date can effect greater results. However, the process of obtaining soft commitments is fraught with potential liability and should be approached carefully and with appropriate documentation.
Pre-launch discussions can present significant liability, especially when such discussions extend to written communication and presentation material. Many prospective fund managers fail to appreciate the extent to which US regulation applies to pre-formation communication.
We often encounter misguided 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 prior to 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 far short of the requirements that should be met when engaging in communications with investors. US securities laws do not provide a safe harbor for communications intended only to garner investor interest. In reality, any communication involving an intent to raise capital will almost assuredly be deemed by US securities law as communication in furtherance of soliciting an offer to purchase securities and should be approached with caution. Individuals can face liability for verbal and written communication that do not meet strict federal and state regulatory requirements.
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, and even if the statement was not made in connection with an actual sale to an investor, and could include statements made to investors who never ultimately invest. Moreover, pre-launch disclosure material is subject to regulatory review, even for funds that are exempt from various registration requirements.
Fund managers who engage in pre-launch discussions with potential New York investors face particular concerns. Unlike most states, which require state regulatory notice filings (known as Form D Blue Sky Filings) only after an investor makes an investment, New York requires fund managers to submit a state notice filing (in New York, the Form D filing is called a “Form 99”) prior to any sale or “offer” to investors. The definition of an “offer” is broadly interpreted and can include certain pre-launch communications seeking pre-launch soft commitments. Moreover, a fund that files its notice filing in New York is required to accompany the Form 99 filing with presentation materials and supporting documents that will be provided to prospective investors.
Commonly, many marketing materials, fund managers will include many disclaimers, such as “these are 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 their materials.
The extent of needed pre-launch disclosures corresponds to the scope of the fund manager’s pre-launch communications. 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.
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 assists prospective fund managers with setting appropriate structures and investment terms that can be critical to the success of the future fund. Our pre-launch services include, among others:
Any communication, whether verbal or written 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 in advance of any discussion with potential fund managers. This is especially crucial when a fund prepares written material in advance of the preparation of comprehensive fund offering documents.
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 gain an in-depth understanding of the intended structure, strategy, manager background, and potential investor base to be able to identify the problematic language and the scope of needed pre-launch disclosure.
Managers engaging in more than general discussions about a potential fund strategy should accompany all communication with carefully prepared pre-launch disclosure language. Most commonly, this is accomplished through the preparation of full offering documents, including a private placement memorandum. However, some emerging managers, particularly those of closed-end vehicles, such as real estate funds, as well as hedge fund managers that need to develop momentum leading up to the fund launch, can benefit from preparing offering documents in stages.
Short-form disclosure documents provide a stepping stone to funds that are in the early process of launching a fund and are 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 prepare the needed regulatory filings. The scope of short-form disclosure documents vary, depending on the scope of the manager’s pre-launch communications, but generally include a summary of anticipated investment terms, an investment strategy overview, a truncated disclosure of risk factors, fund manager bios, and disclosures and disclaimers surrounding key regulatory issues.
In connection with the preparation of the short-form disclosure documents, Capital Fund Law Group assists with the formation of the investment management and fund entities, together with the associated governing documents. Prospective fund managers should consult with investment fund legal counsel on entity formation timing, as the use of legal entities in connection with pre-launch communication can have significant securities law consequences.
Starting with an adequate base of pre-identified potential investors is especially critical for closed-end vehicles, such as real estate private equity funds. Open-end funds are able to gradually grow assets under management (AUM) over time and are able to scale up their investments year over year as additional investment comes into the fund. Closed-end funds, on the other hand, have restricted time periods to secure investment capital (via binding commitments and/or escrowed capital contribution).
The timeline for raising capital for a closed-end-fund, including a real estate fund, differs markedly from that of an open-end fund, or “evergreen fund.” Open-end funds, such as hedge funds trading liquid market assets, are able to 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 funds, 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 (generally 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.
Our flat-fee incubator fund service includes turn-key preparation of all the needed formation documents and governing agreements to operate an incubator fund. An incubator fund provides a cost-effective solution for an emerging manager to develop a marketable trading record and test performance before launching a fully-operative fund.
Read more about our incubator fund formation services here.
Written by the managing partner of Capital Fund Law Group, Forming and Operating a Hedge Fund provides an in-depth guide to assist emerging hedge fund managers through the process of successfully structuring,
Among the key topics discussed are:
This white paper discusses some of the key considerations in forming a private real estate fund, including strategy, structure, and investment terms.
Real estate securities offerings span a broad continuum of size and complexity. At the largest and most complex end of the spectrum are non-traded and traded Real Estate Investment Trusts (REITs), which are pooled investment vehicles requiring a large number of investors to satisfy regulatory and tax requirements and generally requiring a substantial asset base to justify the costs of formation and operation.
The private real estate fund strikes a balance between the two ends of the spectrum, enabling a sponsor to raise capital in a pooled fund without being constrained to do successive securities offerings on a deal-by-deal basis, and without the complexity, scale and substantial regulation of forming a REIT.
Emerging hedge fund managers face a labyrinth of regulatory and tax considerations, investor reporting requirements, and business operation issues. Managers must also balance investor relationships, capital raising, developing their investment strategies, and a myriad of other roles. Operating a hedge fund entails significant legal exposure, with substantial liability for improper disclosure. Even inadvertent mistakes can lead to substantial personal liability.
The structure of a hedge fund is dependent on a number of tax, regulatory, and financial considerations. Fund structure is also driven in large part by the fund’s strategy, such as the degree of liquidity of the portfolio investments. The fund structure should be developed based on careful and thorough analysis with the assistance of an experienced fund attorney.