Start a fund or partner with private money lenders?

Question

Curious which route this community thinks makes more sense: starting a real estate investment fund or working with a bunch of private money lenders?

We have flipped 80+ properties at this point and really want to start growing the business.  Our current cash situation isn't going to scale how we need it to, so we have started kicking around the idea of starting a fund.  Regardless of which path we choose, we will need to create a bunch of new relationships to get either path launched.

I have raised VC money in the past, so I believe my partner and I have the skill set and a legitimate need to go down the "creating a fund" path.  However, is it just easier to partner with a bunch of private money lenders?

The pro's of creating a fund is access to large amounts of money instantly (once the fund is raised) to fund your deals, but the cons are the legal, compliance, and costs associated with a fund.

The pro's of the private money solution is a much less complicated relationship than a fund...but the con's are that you have to have a bunch of private lenders ready, willing, and able for every deal you find.

Curious what the BP community would advise?

Chris Martin · Answer

My 2 cents.

@Ned Carey  Ned has the best answers... and questions. "If you have done 80+ deals why is your cash situation not going to grow like you need it to? Can you get bank financing? Are you doing profitable enough deals? If you grow your business will you be able to maintain your margins, as you will Need to do deals not just cherry pick the best ones."

A commercial lender is probably the best answer, unless there is something really wrong with your business. At 80+ flips, you've touched millions of dollars. Either your business makes money or not. Millions in sales should translate into some tangible earnings somewhere. Banks want to lend. That's what they do. But only to people who retain income, verified and accountable.

As for other people "pooling" funds for you, I looked at this "problem" several (about 3 now) years ago. My conclusion is 180 degrees from what you describe. Here's what I mean. If someone wants to benefit from lending, that institution or individual should:

- be able to bring enough capital to the table as a first position lienholder- be capable of understanding (and mitigating) the risks of the investment, like an accredited investor

So why should the burden be on the (theoretically) successful developer?  My scenario was this: - individuals may or may not be able to bring enough capital to the table at any time - my activities(**) had multiple individuals interested at any given time - individuals were both accredited and non-accredited with a wide variety of lending capabilities at a given time ($200K+ to <10K)- I refused to accept a "pool" of individuals as an "investor" unless accredited

My conclusion was this: - I would point individuals in the right direction to create their investment pool, or "club", for investing - I let them know I would use their LLC but in the big picture they needed to "vet" other borrowers  - The implementation was via a multi-member LLC with an assist from a good attorney- The LLC could invest in any market, any deal, any person according to their agreement(s) - Like minded people could contribute capital to their LLC, then lend to me or anyone - I, individually or via my company, would interface with their LLC, borrowing with a first position lien or whatever they agreed to, just like other borrowers

In the end, the market made my decision easy. For me, "deals" died out as immature REI swamped the market, paying premiums for junk and keeping people like me at bay waiting for more profitable ventures. Capitalism at work. And here we are. My primary venue is and has been commercial lenders. They are great resources when you've (historically) done tons of deals and remained loyal to them (and they to you) through a few market cycles. At 80+ deals, commercial lenders should be interested.

In the end, the market made my decision easy. For me, "deals" died out as immature REI swamped the market, paying premiums for junk and keeping people like me at bay waiting for more profitable ventures. Capitalism at work.

And here we are. My primary venue is and has been commercial lenders. They are great resources when you've (historically) done tons of deals and remained loyal to them (and they to you) through a few market cycles. At 80+ deals, commercial lenders should be interested.

Bryan Kunka · Answer

@Ned Carey Thanks again for your feedback and general guidance - it is exactly what I am looking for from this post!

Ned Carey · Answer

@Bryan Kunka I am not giving a specific recommendation as I am not an attorney and some of what you ask regards legal matters. I am trying to give you general information to help you learn so that you can better interact with legal or other professionals.

Many Gurus have said that "Pooling"  money requires following SEC regulations and that one lender per deal does not. My study of the laws does not seem to confirm that is the case. The word "Pooling" or the number of investors, is  not in the definition of a security in the 1933 securities act.

My gut feeling is that 1 lender per deal is a safer approach.

Ned Carey · Answer

Both situations may require adherence to securities laws but certainly a fund would and would more likely to hit the radar of SEC authorities.

If you have a fund you create a need to keep that capital at work.  It may increase your cost of capital as you have the expense of securities compliance, opportunity cost of capital not deployed, and you may find yourself doing more less profitable deals in an effort to keep the capital working.

If you have done 80+ deals why is your cash situation not going to grow like you need it to? Can you get bank financing? Are you doing profitable enough deals? If you grow your business will you be able to maintain your margins, as you will Need to do deals not just cherry pick the best ones.

Arpan Patel · Answer

@Bryan Kunka: There would be two points I would consider. The first is what you stated in that of the people you have spoken to already, what do they look like they could invest versus their net worth. If they lend you 50k and all they have the in the world is 50k then I don't think the fund would work because there are some basic criteria that you need to hit for the investor profiles to be able to invest in the fund; plus, I'm always concerned when someone wants to put a high percentage of their net worth with me - that's a lot of concentrated risk for them. The fund is pretty specifically geared to sophisticated investors (people who are worth 1 million in assets less the equity of their principal residence if positive but included if they are upside down, or make I think 250k a year for the past two years and can reasonably expect to make the same this year or 350k for married with the same criteria) but a perk that comes out of the fund is the ability to market for investors in the form of general solicitation (new print, flyers, radio, etc.). I think that falls under the 506(c) but you'll have to contact a securities lawyer for all that. In general, if you have just a handful of people that can satisfy your financing needs then I'd go the private money route. If you want to aggressively pursue raising capital and don't have just a few people who are close to you that can satisfy your private lending needs then I'd take a look at the fund and use the solicitation angle to raise funds from people you don't currently know. I hope that framework helps you make a decision. You can PM me or call me to discuss further.

David Zheng · Answer

If you have done 80+ deals, you should have more than enough street cred to find a wealthy private investor. Can't you do it like the flip and flop folks who just have one rich friend who basically funds all the deals in cash but gets half the profits? Im sure someone has a couple hundred thousand they can continually fund you with as long as you return it in a couple months with tens of thousands in profits. rinse and repeat?

Jay Hinrichs · Answer

ya know a good HML that's local to you may be a good way to go... I have done this for many years when I find a high volume successful flipper .. we simply set up a facility for them.. and then cookie cutter it... by the time you pay for fund structure and all that goes with it.. the ease of having a really good capable lender might be easier for you...  Just a thought.

Levi T. · Answer

Running a fund has a lot of on going legal all the time, your going to have to raise a hell of a lot of money to make it worth your time. LPs (Limited Partners) are just business partners. You already have them, they are called family. You just need to convert your LPs form blood relatives, to friends.

I highly recommend reading a booked called "How To Win Friends & Influence People". While it does not talk about raising money, it will talk about how to win friends. Strangers don't invest in strangers, they invest in friends they trust. After that, your just setting up an LLP like you would any old day with a friend. First round or two you likely want an attorney to write out the framework, but once you get it down, just file the paperwork yourself using the paperwork your attorney provided. It's real simple. Read that book, it will change your view on life!

Bryan Kunka · Answer

Would love to hear from anyone that went through and started the fund.  Pro's & con's and if looking back you would have just gone the direct relationship route instead of setting up the more formalized approach?

I imagine its much like a private company vs a public company.  The private company has lots of benefits and freedoms, but the public company is stricter, more formal, but also has a legitimacy that helps out tremendously.

Start a fund or partner with private money lenders?

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