In a prior article we outlined the six key component of a private placement memorandum (PPM) – the document that governs the investment offering. It is not uncommon for such document to exceed 100 pages. In addition, most of the document is full of legal and accounting terminology. Therefore, if one is not well versed in reading such documents, it would be worthwhile to hire an attorney to review those as well. The attorney may prepare an Investment Abstract – a table that neatly summarizes key sections and deal aspects an LP needs to be aware of.
In reviewing the PPM documents and comparing it relative to the investment summary, if there are any discrepancies, you can bring those up to the sponsor for a clarification. Usually if there is a conflict between sections (this is why it is important that the sponsor engages an experienced syndication and real estate attorney to handle the documents), the operating agreement will prevail.
As an LP, you are more likely to be concerned about three key areas of the operating agreement.
1. Monetary Rights. The monetary rights spell out the how distributions and distribution waterfalls, tax benefits, and sponsor fees payable before distributions are handled. Specifically the distribution section will outline when distributions begin to accrue, how they will be handled (cumulative or cumulative and compounding or neither), and how the waterfall will flow (typically starting with the preferred return, followed by paying any accrued distributions, and then the profit split). The tax allocation will specify how profits and losses will flow as well as how any depreciation benefits will be allocated (e.g. based on cash contribution amount or percentage interests). Lastly, the sponsor fees (such as acquisition fee, asset management fee, capital event fee, construction management fee, etc.) that are typically paid first before distributions are sent out, will also be clearly spelled out.
2. Information Rights. This section will outline the financial reporting frequency and start date, the annual financials type (audited or unaudited), and timing of the annual K1 filings. While specificity is preferred, it is not uncommon for that section to often state “at the discretion of the sponsor” for some added flexibility. For example, in one of our offering, we intended to start distributions six months after closing, send those on a quarterly basis, and provide monthly reports. However, as we were performing ahead of plan, we decided to start distributions sooner (in month 3 vs. 6) and send those monthly (vs. quarterly) and switch reporting from monthly to quarterly (with more frequent updates available upon request).
3. Transfer Rights and Other Provision. This section will spell out whether shares can be sold or transferred and, if allowed, how that will be handled. Capital call provisions will be clarified herein too. Typically, since syndications are illiquid investments, LPs may not be able to sell or transfer shares and usually such act would require the Manager’s approval. It is not uncommon for the Manager to have the first right of refusal. To the extent a redemption is possible, the redemption price will be defined in the operating agreement. How capital calls are handled will also be specified therein and namely, if a capital contribution is mandatory or not (in many deals it is not) and how and LP’s ownership interest will be impacted if they are not willing or able to participate in the capital call (usually results in dilution of the LP’s ownership share).
Once one understands such key provisions, one can determine if they align with one’s goals and risk tolerance. In addition, based on how the sponsor responds to questions pertaining discrepancies or request for clarification along with that information, one can then determine how to proceed.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.