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Private Real Estate Investment Funds
Article #4 – Side Letters and Preferential Terms
In this 6-part series, I explain
private real estate investment funds. You have a real estate
fund when you accept money from passive investors to do
transactions in real estate. A real estate fund is a hedge
fund and it is subject to most laws that apply to hedge
funds, including securities laws and ERISA. Real estate
funds usually are LLCs or limited partnerships, and they
have complex terms for investor rights, manager compensation
and more.
These are the 6 articles in the
series:
In this Article #4, I discuss
the use of a side letter to give preferential terms to a
particularly important investor.
Special Deals
Investors with bargaining strength sometimes demand a
special deal, that is, preferential terms not available to
ordinary investors. The fund might use a side letter for
the special deal. Side letters frequently provide for any
or all of the following:
Reduced management fees,
for example, early investors sometimes demand lower fees to
compensate them for their early-in risk.
Most favored nation status,
meaning that the investor automatically gets all favorable
terms granted to later investors. Usually a most
favored nation clause does not cover future investments that
are greater than the most favored nation’s investment.
This is because the fund manager needs flexibility to give
better terms for future, bigger investments.
Enhanced financial reporting;
in return the fund manager might require a confidentiality
agreement from the investor.
Redemption rights upon
the occurrence of specified events, for example, the
investor has the right to demand his money back at a date
certain.
Disclosure of Side
Letters
The fund’s disclosure documents should
disclose, in the minimum, that the fund has given
preferential terms to some investors. The
circumstances will dictate the nature and extent of the
disclosure.
Be Careful with Side
Letters
Beware that side letters sometimes create a new class of
equity. This may cause unforeseen consequences, for
example, it may cause the application of ERISA law to the
fund. See Article
#6 - ERISA.
Lastly, over time it’s easy for a fund manager to forget
about a side letter, which can lead to a breach of its
terms. Fund managers need a reminder system whenever they
deal with matters covered in side letters.
In my next article, I move on
to the hard stuff –
Securities Law for Real Estate Funds.
Get a Securities Lawyer
Real
estate funds, like all hedge funds, are very complex. This
is not something to learn as you go. You need the help of
accounting, tax and legal counsel who are experienced in the
area.
Call me to schedule a legal consultation:
510-796-9144 | 