What Syndicators Don't Want You To Know

Question

The syndications that are going belly up are getting a ton of attention in these forums. Despite this, there’s still a ton of appetite for participation. I am sure BiggerPockets recognized this with the rollout of PassivePockets which should help educate potential LP’s before investing. Selecting the syndication can be daunting with so many options available, so here’s some information that may help potential LP's arrive at a short list to consider. Important to note, this advice is geared towards those writing smaller LP equity checks as I suspect that’s where most interested investors reading these forums fit.  For the purpose of this exercise, I would  like to start by separating syndications into two categories: (1) smaller capital raises that will only attract the friends and family sized checks because they require too much brain damage for those with the larger check writing capabilities;  and (2) syndications with capital raises large enough to fit within the investment parameters of true private equity/family office check writing capabilities.

Smaller Syndications: These GP’s have no option besides raising smaller check sizes. No matter how good of a deal, it is quite difficult to raise capital from larger check writers who often have minimums they abide by. If you are a smaller check writer, it’s still important to conduct adequate diligence on the deal and the GP but there shouldn’t be any alarm signals going off solely related to the investment minimums.

Larger Syndications: When you see the syndicators achieving the larger raises that can attract the checks written by the private equity/family offices but are instead raising those funds in smaller friends and family check sizes, that would give me immediate pause. At the end of the day, ask yourself why these GP's are exerting additional effort in pursuit of the smaller check sizes instead of obtaining the larger checks. There's a few possible reasons:

1. The GP or the deal doesn't pass the sniff test and the smaller less sophisticated investors won't conduct the same level of diligence

2. Greater control

3. Favorable Fees and Profit Splits

4. Less skin in the game & delegating responsibilities such as guarantee, GP equity with less scrutiny

As an LP who can only write smaller checks, why go with the GP who falls under the larger syndication category? There's a reason why they target you, and its not out of kindness and generosity. Keep in mind they will also spend far more time raising capital and diverting their attention outside of managing the investment which is adverse to your objectives.  There's  nothing wrong with investing in syndications if you are writing smaller checks but perhaps invest with the syndicator who is chasing your checks because you are the only option, not the preferred option.

Ian Ippolito · Answer

Syndication sponsors with extraordinarily successful track records (i.e. one or more full-real-estate cycles with little to no money lost) typically do larger deals (and often much larger than $30M). And many of these will still accept accredited investors (in addition to family offices/private equity etc.) and will often have a target for AIs.

The problem for a sponsor with taking all the money from one source (like a family office) is that it usually comes with strings attached. And if a family office will demand more power and ability to change things to their own liking. And if the sponsor wants to retain control they will usually diversify their investor bases and accept multiple types of investors.

Evan Polaski · Answer

@Stuart Udis, I generally agree with the skepticism.  I share it too.  But I will counter some.

When we talk larger checks, there is a lot of variability in what that means.  $10mm equity is still very small for many large investors.  I have spoken to several groups where $50mm is about their minimum check.  But semantics aside.

Many more institutional groups want to see tenure.  Larger checks often want longer track records.  2014 founding doesn't cut it when these same investors have access to groups with 1998 founded companies, with more deals and similarly consistent returns.

Co-investment: Larger checks often do require significant co-investment.  10% of equity is common.  So $10mm raise, means $1mm co-investment.  $30mm raise means $3mm.  Not to say this is bad, but depending on where a company is in their lifecycle, there are groups that can raise $10+mm and have never gone full cycle in a deal, thereby making it challenging to have $1mm of liquid capital available.

Timing of closing: again, many larger check investors have multiple sign-offs.  There is a relationship team sourcing deals, then due diligence teams to perform DD, and ultimately investment committee meetings and sign off.  This can be a 30+ day process.  For many syndications, particularly single deals, that timeline doesn't exist.  Syndicator is burned if they commit to one LP and then investment committee kills deal.  And LP is burned if syndicator hedges and shops multiple groups who are interested and spending money on DD ultimately not get the deal.

Reliance on single relationship: again, larger checks mean few LPs for syndicator.  Fewer LPs mean less working relationships.  And unfortunately, even when a syndicator is performing above projections, if the stock market comes down, that LP is likely going to stop investing based on asset allocation rules.  And, in reality, it is far easier to replace a $100k investor than it is to replace a $10mm investor.

Now, are the fees and waterfalls typically far more GP friendly for groups focused on the $25k investor?  Yes.

Are these groups often required to put a lot less skin in the game, from a direct equity contribution?  Yes.

But, also, as we are seeing: are syndicators that accept $25k much more open to public scrutiny?  Yes.  You don't see the CIO of an endowment putting their sponsors on blast for the entire internet to see (at least that I know of).

Brian Burke · Answer

Like most advice surrounding passive investing, this advice may apply in certain cases but the answer really lies in due diligence on the sponsor rather than a broad-brush rule.

As a longtime syndicate sponsor I've been funded by both HNW equity and institutional LPs, so I've seen both sides of this first hand.  Most of the deals I've done, and likely the ones I'll will do in the future, have been funded by HNW investors, by choice.

Institutional LPs aren't always what they are cracked-up to be.  @Evan Polaski outlined a good case for this above and I agree with what he wrote.

I've seen cases where the LP backed out of the deal at the last minute, not only leaving the operator at the closing table without the capital, but causing the sponsor to lose their earnest money deposit.  I had this happen to me once, but fortunately the LP backed out early enough for us to pivot and raise all the equity from our HNW clients.  We sold that deal a couple years later for nearly double what we paid, and the LP that backed out later admitted to me that they regret not doing that deal.

An institutional LP can also exercise their control rights to force a sale at a time that may be inopportune for the operator's equity.  It wouldn't feel good to lose your equity because the 800-lb gorilla that you are partnered with wishes to rebalance their portfolio and you are powerless to persuade them otherwise.

One time I had an institutional LP in a deal and they were a total pain in the you-know-what.  Despite blowing through all performance projections it was just an endless stream of ridiculous requests for reports and information (beyond what was agreed to in the operating agreement) only to satisfy a junior analyst that probably hadn't stepped foot on a property in his very young life.  Thankfully I had negotiated a pre-determined buy-out right where I could buy them out at a fixed IRR at any time.  I raised additional money from our HNW investors and bought the LP out per the terms of the agreement.  This turned out to be a great decision for us and our investors, because a few months after the buyout was complete we sold the property for a massive gain, and our investors received profits that would otherwise have been allocated to the institutional LP had they still been in the deal.

For these reasons but not only these reasons we choose to raise capital from our base of HNW investors.  Yes, it's more work up front, but we have an investor relations team dedicated to performing that work so it doesn't distract us from operations.  We do get a better fee/split structure, and that's a fair trade for the extra work of managing a large investor base and it's associated extra accounting and tax reporting overhead.

I also find the advice in the OP to be contradictory.  On one hand, you advise investors to avoid a GP that "doesn't pass the sniff test", and then on the other hand, you advocate that "there's nothing wrong with investing...with the syndicator who is chasing your checks because you are the only option..."  Do you really want to invest with an operator that is un-investable to professional LPs?

Chris Seveney · Answer

We raise money from institutional through broker dealer channels as well as retail investors through regulation A+.

I don’t see any problem with this as if you ever read the book blue ocean strategy - this is our strategy. We market very differently and have different sales/IR team as well.

For the institutional we have a factright report they can review about us and for our retail investors we try and educate and be transparent.

For retail investors I would be more worried about what the sponsor does vs who they are raising from - when I see a fund start branching out and doing something not in their strike zone whether it’s crypto, oil and gas, MF, debt and mobile home parks etc that to me is a red flag - especially if they are also spending their time traveling the Public Relations circuit selling mentorship’s vs managing assets.

One last thing to add, I know iof someone who had one investor for 25 million. That investor decided they wanted to pull out at an inopportune time, and has put that person out of business as they had never raised other funds before and now struggle mightily to do it because raising money is not as easy as people make it out to be.

Stuart Udis · Answer

@Arn Cenedella The larger syndications that are raising their funds through smaller check writers is a red flag in my opinion. As a hypothetical, let's say there's a syndication seeking capital....Total capitalization $30M, Equity raise $10M....clearly this falls within the boundaries of where a family office, private equity etc. check writer would become involved if the deal has merit. Why then exert the time and effort to raise those funds in smaller $25,000-$50,000 intervals from 200+ investors? There's a reason why the GP wants those smaller checks, what's the reason? I can't think of a reason in this scenario that would align GP's objectives with that of an LP.

I am not saying all smaller syndications are good places to park your money, and all larger syndications are bad but the smaller syndications who are in pursuit of the smaller checks are doing so because they are the only viable check writer for their projects, not the preferred check writer. Again  as an LP, ask yourself why you are the preferred check writer over the more sophisticated and more natural equity contributor?

Arn Cenedella · Answer

@Stuart Udis

Sorry I’m a little confused as to your point.

Are you saying smaller check writing passive investors should invest in smaller syndication deals or larger ones?

Does 506b v 506c enter into your thinking?

Just want to make sure I understand the point you are trying to make.

Thank you

Arn

Stuart Udis · Answer

@Arn Cenedella If you are raising up to $3M in equity, its going to be difficult to attract the larger check writer,  so its logical for you to pursue the smaller checks.  To your point, yes the larger check writers want more of the upside, control and will also do a more thorough look at the sponsor to understand where the GP equity is coming from, who is guaranteeing the debt etc. etc.  They are simply more sophisticated and have greater resources to conduct more thorough diligence. To avoid this, some GP's find it worthwhile to spend more of their time, energy and resources on raising equity in smaller increments. Again, can't think of a single reason why this would align LP's interests with that of a GP.

Arn Cenedella · Answer

@Stuart Udis

Thank you for the clarification. I understand what you are saying.

At Spark Investment Group, we do smaller 506b syndications with a typical $25,000 minimum with capital raises typically in the range of $1.5M to $3M.

That being said ( and I will be interested to hear from some of the larger syndication groups ), I have found larger check writers (family offices hedge funds pref equity groups etc) often want some element of control and higher returns for their investment and so perhaps that is why larger operators accept smaller checks too.

As you note, there are good large syndicators and there can also be bad small syndicators, so it’s also a case by case evaluation.

Thank you

Arn

What Syndicators Don't Want You To Know

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