The Debate over the SEC’s Proposed Increase of the Wealth Threshold Requirements of the Accredited Investor Definition

It’s no surprise that investors and regulators don’t always see eye to eye. One major point of contention that continues to spark debate is the Securities and Exchange Commission’s (SEC) definition of “accredited investor.” This issue heated up again recently due to the SEC’s April 2023 proposed increase in the wealth threshold requirements for the “accredited investor” definition.

Not so long ago the SEC broadened the definition of accredited investor to include, among other categories, “knowledgeable employees” and “family offices.” By expanding the definition of accredited investor in this way, the SEC widened the investment opportunities for individuals and entities looking to invest in private equity deals.

During the debates over the SEC’s 2020 changes to expand the definition of “accredited investor” to include new categories of individuals, the fact that wealth alone is not the only or even the most valid, indicator of a person’s investment sophistication, was stressed by regulators and investors alike.   

The 2020 amendments to the SEC’s definition of “accredited investor” enabled potential investors to qualify as an accredited investor based not only on income or net worth but upon defined measurements of professional knowledge, experience, or certifications — expanding the number of investors who can participate in private equity while at the same time carrying out the SEC’s mission to protect investors. 

This time, however, the SEC’s proposed changes will move the needle in the opposite direction. 

According to reports, the SEC will be changing the definition of “accredited investor” to increase the wealth threshold requirements that must be met for individuals or entities to qualify as an accredited investor. 

As we will discuss in more detail below, critics say that this will severely limit who may receive an accredited investor status certificate, narrowing the field of potential investors and making it harder for companies trying to raise capital to figure out how to find and verify accredited investors. 

The Current Definition of “Accredited Investor.”

The Securities Act of 1933 (“Securities Act” or “the Act”) requires that every public offering of a security be registered with the SEC. Registering securities with the SEC protects investors, but it is a burdensome, time-consuming, and expensive process for businesses. As a result, over the years, the SEC developed some exceptions to the rule in order to ease the regulatory burden that registration places on small businesses.

Most notably, private placements under Regulation D (“Reg. D”) are not required to comply with the SEC’s comprehensive public disclosure requirements that apply to registered offerings. For investors, this means that they can participate in private offerings — SO LONG AS — the investor is either an “accredited investor” or the number of non-accredited investors is limited to 35 (see, Reg. D 506(c).). 

The SEC’s definition of “accredited investor” contains both net worth and income requirements to protect investors from fraud. It also includes other indices of financial sophistication. For the most part, the SEC’s definition of “accredited investor” hasn’t changed significantly since 1982. 

The current wealth threshold for its definition of “accredited investor,” found in Rule 501 of Reg. D, requires that an individual be able to show that in the most recent two-year period he or she individually had an income in excess of $200,000 or a net worth (excluding a primary residence) of over $1 million. Alternatively, an investor can qualify if he or she had a joint income (in the past 2 years) with his/her spouse (or spousal equivalent) in excess of $300,000, and he/she has a reasonable expectation of reaching that same income level in the upcoming year. 

Regarding the indices of sophistication, in 2020, the SEC broadened the definition of accredited investor to include: 

• knowledgeable employees,

• registered investment advisors, exempt reporting advisers, and rural business investment companies, 

• a catch-all provision for entities that own more than $50 million, and

• family offices and family clients.

One of the major advantages of being an “accredited investor” is that it opens up investing opportunities that are not available to non-accredited investors. For example, while non-accredited investors can invest in mutual funds unless an offering meets an exemption, non-accredited investors either cannot participate at all, or only 35 non-accredited investors can participate, in a private equity offering.

By changing the definition of “accredited investor” to include more individuals with sophisticated investment experience, the SEC broadened investing to reach more investors. At the same time, however, the SEC required that issuers offering Reg. D securities verify accredited investor status for each one of their investors.  

Increasing the Accredited Investor Wealth Threshold, Decreasing the Number of Accredited Investors.

Having expanded the indices of sophistication in 2020, thus allowing more people to participate in investing, the SEC’s proposed 2023 changes to the definition of accredited investor will raise the required wealth threshold. 

This latest proposed expansion of the definition of “accredited investor” is causing quite a stir in the investment community.

Under Chairman Gary Gensler, the SEC intends to amend “the accredited investor definition by increasing the annual income and net worth thresholds.”

What dollar amount the wealth threshold will increase to has not been announced yet by the SEC. However, according to some reports, it is possible that the SEC might link the wealth metric to inflation. If that does happen, it is believed that the threshold requirement could triple — drastically diminishing the pool of accredited investors. 

Opponents of the SEC’s proposed reforms to Regulation D (“Reg. D”), including increasing the wealth threshold for “accredited investors,” argue that these reforms will increase costs, complexity, and liability exposure of companies attempting to raise capital under the Reg. D exemptions. 

Angel investors posit that the proposed changes will severely reduce the number of wealthy individuals who can participate in investment opportunities. This, they say, will have a national effect that would be devastating to start-ups that rely on angel investors to raise capital, because the increased wealth thresholds will reduce the pool of angel investors able to meet the new thresholds. 

Other arguments are that the SEC’s changes will unfairly limit access to those who do not have excessive wealth, thereby increasing a lack of diversity in investing. Many object to the SEC’s proposals as being overly paternalistic and interfering with an individual’s right to decide for himself/herself whether to invest or not. 

Opponents of the change point out that Rule 506(b) and the less frequently used 506(c), play a significant role in raising capital for small businesses. According to reports, between July 1, 2021 and June 30, 2022, Rule 506(b) offerings raised more money than all registered offerings ($2.3 trillion), while even the less used Rule 506(c) offerings raised more money than IPOs.  

And yet, despite this significant impact, the SEC’s current wealth threshold, as expressed in its current definition of “accredited investor,” already prevents over 90% of American households from participating in these offerings. 

Increasing that threshold even further, opponents argue, will serve only to increase that gap. In addition, opponents point out that being wealthy is not the same as being “financially sophisticated.” Lottery winners have money, but that does not mean that they are “financially sophisticated” or are experienced investors. Nevertheless, the SEC’s new proposed changes would allow financially unsophisticated investors to participate in riskier private offerings, while eliminating experienced but less wealthy investors from doing so. Given all this, opponents say that the SEC’s definition of “accredited investor” is flawed because it places more emphasis on how much money a person has rather than how much education or investment experience he or she has. 

In defense of the change, U.S. Securities and Exchange Commission (SEC) Commissioner Caroline Crenshaw indicated in a recent talk that Reg. D was intended as a limited exception but over time, it has gotten out of hand. 

From the SEC’s point of view, a number of reforms are necessary to protect investors. 

According to the SEC Commissioner, over the years, the use of Reg. D has caused a “bloating effect” on private issuers — allowing private companies to raise billions of dollars to fund their growth without the regulatory oversight necessary to protect investors. The concern is that the lack of information about private businesses and the minimal regulatory oversight makes private equity investments riskier for investors — putting even sophisticated investors at a disadvantage. Increasing the wealth threshold, according to the SEC, will protect the vast number of investors from being in a situation where they receive little to no disclosures. 

According to the SEC Commissioner, financial sophistication does not adequately protect investors in the same way that disclosures and regulatory oversight do.  

Changes Are Coming. 

Whichever side of the debate you land on, one thing is for sure: you can expect to see some changes in the near future to the SEC’s definition of “accredited investor.” 

While the emphasis for accredited investor criteria has always included an income test and a certain level of wealth, both sides of the debate have indicated that it’s not only about how much money a person has — there should be some more definitive way of assessing an individual’s investment experience, knowledge, and sophistication. 

In the meantime, accredited investors and issuers can rely on VerifyInvestor.com for accredited investor status verification. At VerifyInvestor.com, we offer a world-class accredited investor verification service. Our services are fast, efficient, cost-effective, confidential, and reliable. We help companies fully and easily comply with their legal obligations to verify investors as accredited investors.

Seasonal Greetings

Estate Planning and Veterans: Securing Your Legacy

Whether you are a veteran, active military, or a civilian, estate planning is critical for securing your legacy. It allows you to direct how your property should be distributed at death and to prepare for unexpected events like becoming incapacitated. 

It does not matter what level of income you have, your investor criteria, what assets you have, or how you provide proof of assets, all adults over the age of 18 should have an estate plan. An “estate” for estate planning purposes is made up of an individual’s tangible and intangible property. Any adult who owns any type of property — a car, a home, a bank account, cryptocurrency, a website, etc. — has an “estate” for estate planning purposes.  

But estate planning is much more than just passing on one’s property. 

It focuses on an individual’s specific financial and personal situation to provide for your family’s future and minimize taxes as much as possible. In addition, estate planning helps you to anticipate and prepare for what might happen if you become incapacitated and unable to make decisions for yourself. 

Estate planning attorneys use a variety of legal tools and documents to help people plan for the future so that individuals do not have to rely on statutory law or the court system to make their most important decisions for them. 

Overall, estate planning is one of the best ways to plan and prepare for the future.

Why Estate Planning is Essential for Veterans

While everyone can benefit from having an estate plan, it can be even more essential for active military and veterans. 

Why?

Because those who serve in the military are in a unique situation. 

Members of the military move frequently. They also put their lives on the line during wars. Even during peacetime, many military jobs subject personnel to highly dangerous conditions. These factors make it more likely that veterans and active military may become injured or suffer serious permanent disabilities due to their work or work environment. It is this inherent precariousness in military service that makes it imperative for members of the military to have an estate plan in place.

In addition, veterans have access to a number of government benefits. These benefits can make estate planning for veterans more complicated as government benefits are frequently subject to unusual tax rules.

Veterans need to understand how their benefits impact their estate and estate taxes, so they can plan and provide for their families and their future.

For example, veterans may be eligible for benefits such as:

• life insurance coverage for the veterans and their families

• survivor benefits if the veteran dies due to service-related illness or injury.

• pension plans, or

• disability compensation.

Various government benefits can significantly affect your future and the financial futures of your loved ones. Planning how to pass on these benefits is critical but complicated due to eligibility requirements, so be certain to consult with an experienced trusts and estate or probate attorney where you live to assist you. 

Another important consideration is what happens if you die or become incapacitated and you don’t have an estate plan in place. 

If you die without having made an estate plan (in other words, you die “intestate”), then your estate must go through probate. Probate is the court-supervised process of distributing a person’s property. It’s an expensive and time-consuming process. 

When a person dies intestate, the court will use the intestacy laws to decide who gets what and how much of your property. 

Even worse, if you don’t have the right documents in place and you become incapacitated, the court and the statutory law of your state will decide who should take over your finances and make decisions for you. This could be someone you know, or it could be a complete stranger. 

Becoming a “ward of the state” and having the court appoint a guardian for your person and/or property is something you want to avoid at all costs. It is a well-known secret that this area of probate, known as “guardianship,” is fraught with serious fraud and abuse. 

All in all, estate planning is essential for everyone, but especially for veterans and active military personnel.

What Goes into Securing Your Legacy? 

To address the myriad life-impacting issues that could arise in a person’s future, estate planning relies on a variety of legal documents and estate planning strategies. 

The most commonly known — and often the most misunderstood — legal documents are the Last Will and Testament (“Will”) and Revocable Living Trust (“Trust”).

Wills and Trusts are both legal documents that assist in directing and carrying out an individual’s estate plan. 

Although separate and stand-alone documents, Wills and Trusts work together; much like peanut butter and jelly. 

Hold on, we can explain.

Think of it this way: You can have a sandwich with just peanut butter. Or you can have one with just jelly. Either one will be fine. But together, peanut butter and jelly make the perfect — and complete — sandwich. 

Wills and Trusts are a bit like that.

You can have just a Will for your entire estate plan, or you can have just a Trust. But when your estate plan has both, all bases are covered, and you have a more complete estate plan. 

Why is it best to have both a Will and a Trust?

Because a Will can do some things that a Trust cannot, and visa versa.

So, what are the differences between a Will and a Trust?

Basically, a Will is a formal legal document that directs the disposition of your property (both tangible and intangible) after your death. To be valid, a Will must comply with all the legal formalities of your state. The most basic of these are that:

• the person making the Will (the “testator”) must have legal capacity,

• the Will must be in writing,

• it must be signed by the testator, and 

• the testator’s signature must be witnessed.

The specific Will formalities vary by state, so be sure to consult your state’s laws. However, these are the most frequently seen formal requirements for Wills. 

While a Will can dispose of many different types of property, it cannot dispose of all property. For example, a Will can only pass on property that is titled in your name. A Will cannot pass on:

• joint property

• life insurance policies or other property with beneficiary designations

• payable upon death accounts

• retirement plan accounts, or

• employee death benefits. 

Additionally, passing on certain digital assets through your Will — like email accounts or cryptocurrency — can be problematic due to security and transferability issues. 

Also, a Will does not come into effect until you die.

On the other hand, in your Will, you can appoint the person whom you want to administer your estate at your death. You can also decide who will take care of your children in the event of your death or incapacitation. Your Will can be used to decide when your children (or other beneficiaries) are allowed to receive their inheritance. This can be especially helpful if you have small children and you don’t want them to receive their entire inheritance until they reach the age of maturity or another age where you deem they will be mature enough to handle it. 

Unlike relying on the intestacy laws, when you have a validly executed Will, you are the one who makes all the important decisions — not a judge or impersonal law. 

In contrast, a Trust is also a legal document, but the trust document creates a legal entity (the “trust”). This legal entity is created by agreement between the trust maker (“trustor,” “grantor,” or “settlor”), and the trustee (the person who will manage the trust) for the benefit of certain individuals (the “beneficiaries” of the trust). 

In a trust, the trustee holds title to the trust property and manages it for the benefit of the beneficiaries.

A trust, because it is a legal entity, can hold and own property. A Will cannot do this. All a Will can do is pass on property.

Most assets can be titled in a trust, but because the laws vary by state, there may be important exceptions to this, so always be certain to consult with experienced estate planning counsel where you live.

Trusts can be revocable or irrevocable. As their names suggest, a revocable trust can be changed during the lifetime of the settlor whereas, (with few exceptions), an irrevocable trust cannot be.

Most estate plans use “revocable living trusts.” Unlike a Will, the Trust comes into being and operates during the lifetime of the settlor or grantor. 

If the living trust is revocable, it can be changed or revoked at any time during the settlor’s lifetime. 

In most cases, the trustee of the Trust is also the grantor or settlor. He (or she) then manages the Trust during his/her lifetime, and at the time of death, a successor trustee takes over. The successor trustee is then responsible for managing and ultimately distributing the property to the beneficiaries following the Trust’s terms.

Because they are flexible estate planning tools, Trusts are greatly favored by many estate planning attorneys as part of a comprehensive estate plan. But they are not the only estate planning tool. As mentioned, most estate plans make use of both a Will and a Trust.

What is best for you will depend entirely on your specific situation.

Some Important Documents Beyond a Will and Trust

As noted previously, an estate plan anticipates more than just property distribution at the time of your death. One of the significant issues it takes into account is what might happen if you become incapacitated and unable to make decisions for yourself.

Preparing for possible incapacitation is critical to do. Without the necessary documents in place, if you should become incapacitated, for example, due to a stroke or accident, no one can act on your behalf. This means that even your spouse cannot sign documents on your behalf.

Plus, as we have seen time and time again, family disputes over medical interventions for those who do not have health care directives or powers of attorney in place can quickly turn into emotionally charged, expensive, and prolonged legal battles. The sad cases of Terri Schiavo and Karen Ann Quinlan are just two examples of this. 

To address the situation of a possible incapacitation, there are two common estate planning documents beyond a Will and a Trust, that every veteran should have in place. These are a power of attorney and a health care directive (also called a “health care surrogate designation” “medical power of attorney,” or “advance health care directive”).

A power of attorney is a legal document in which you appoint a person of your choice to act as your agent. You decide the extent of the authority your agent can have, but generally, a power of attorney gives someone the authority to pay your bills, purchase property, and make other legal and financial decisions for you.

A health care directive appoints a person you trust to make medical decisions for you if you should become incapacitated. This legal document gives your chosen individual the power to decide what life-prolonging medical interventions you will or will not receive. 

If you are a veteran and don’t have an estate plan in place, don’t wait any longer. Get one. Estate planning is essential for everyone, and, most importantly, for veterans. Securing your legacy isn’t hard to do. It may not be exciting, but it is something that every veteran should do. 

For more information on this and other important topics, go to VerifyInvestor.com.

VA Home Loans: Your Path to Homeownership

Owning your own home is not only the American dream, it’s a great investment. But with soaring housing costs and ever-increasing interest rates, buying a home can be quite challenging for most people.

For veterans, servicemen, and their survivors, the path to homeownership is made a bit easier due to Veteran Administration (“VA”) home loans. 

VA home loans offer better terms than most traditional mortgage loans and certain benefits — like no down payment — that are unavailable to civilians.  

There are specific eligibility requirements that must be met, of course, but for most veterans and their families, VA home loans are the entry point and path to homeownership.

About VA Home Loans

VA home loans are government-backed home loans. What this means is that, for veterans, servicemen, and their eligible surviving spouses, the U.S. Department of Veterans Affairs guarantees a private money mortgage loan (up to a certain amount of the total loan). For private lenders making home loans to veterans, this guarantee ensures that they will get some money back even if the homeowner defaults on the loan.

This home loan benefit for veterans and servicemen grew out of the Servicemen's Readjustment Act of 1944 (also known as the “GI Bill” or “GI Bill of Rights”).  The purpose of the GI Bill of Rights was to assist veterans to readjust to civilian life after returning from World War II. 

VA home loans are available to veterans and active military who meet certain qualifications. 

But before we dive into the benefits and different types of VA home loans, it is important to know what VA home loans are not intended to be used for.

To foster the purpose of the GI Bill, VA home loans are designed to help veterans purchase a single-family home or condominium that they will be living in. 

VA home loans are not intended to be used solely for investment purposes. Thus, VA home loans cannot be used primarily to purchase investment properties, vacation homes, rental properties, or other income-producing properties. 

As with other exemptions provided by law, like those created by the JOBS Act, and Rule 506(c), it is critical to stay within the law’s specifications. 

Even with the no-investment home limitation, however, VA home loans provide several benefits for veterans seeking to purchase a home. 

Types of VA Home Loans 

There are several different types of VA home loans.

These include (may not be limited to):

• purchase money loans

• cash-out refinance loans

• interest rate reduction refinance loans

• Native American direct loans

• adaptive housing loans for disabled veterans

Each different type of loan program offers a variety of loan benefits for veterans that can help you save money and buy, renovate, adapt, or refinance your home. 

The Benefits of a VA Home Loan 

Perhaps the most attractive aspect of VA home loans is that, unlike conventional home loans, they do not require a down payment.

This benefit is enormous. For example, if you live in California, the average amount required for a down payment on a house is between 15% to 20% of the purchase price. Given that most house prices in California can easily reach $1,500,000 or more, not having to put down a down payment can save you anywhere from $225,000 to $300,000 on average. That’s an unbeatable benefit.

Even with a more traditional and far lower 5% down payment rate often used throughout the rest of the country, a house that costs $300,000 will require a down payment of $15,000.00. So having a $0 percent down payment is a fantastic benefit.

One cautionary point here: while the VA does not require a downpayment on a VA home loan, some private lenders may require a down payment. 

Another major benefit of VA home loans is that borrowers are not required to carry mortgage insurance. This can save veterans thousands of dollars.

Among some of the other benefits of a VA home loan are:

• competitive interest rates

• foreclosure assistance

• no prepayment penalties for paying off the mortgage early, and 

• reduced closing costs.

Buying (or refinancing) a home with a VA-backed home loan offers veterans and active military alike a path to homeownership. But, as with most things, there is more to know. 

Chief among these important factors to understand is that you must qualify for a VA home loan. 

So let’s take a look next at eligibility requirements.

VA Home Loan Qualifications

As noted above, there are different types of VA home loans, and each loan may have different requirements. In addition, to qualify for a home loan, you must provide your lender with a Certificate of Eligibility.  

The first step, then, is to determine whether you are eligible for a VA home loan.

To be eligible to apply for a VA home loan, a serviceman, veteran, or spouse must be able to establish that he or she: 

• has at least 90 days of active-duty service, 

• served for at least six years of service in the Reserves or National Guard, 

• served at least 181 days of active-duty service during peacetime,

• has 90 days of cumulative service under Title 10, or 90 days of service (with at least 30 of those being consecutive service) under Title 32, 

• is the spouse of a military service member who died in the line of duty, or due to a service-related disability.

Bear in mind that not only do you need to be eligible for the VA home loan, but, as noted above, the loan itself must be for an eligible purpose. Thus, to fully qualify, you must intend to occupy the premises as your home and the loan amount cannot exceed the appraisal value of the property.

Tips for Veterans Looking to Purchase a Home

Purchasing a home is a complicated process for anyone. However, when the government is involved, things can get even trickier due to government rules and regulations. 

So here are a few tips for veterans looking to purchase a home with the help of a VA home loan.

Tip Number 1: Get the Right Lender and the Right Real Estate Agent.

Not all real estate agents are familiar with the demands of military life or the rules surrounding VA loans. Thus, you must find a real estate agent who has experience working with VA borrowers. 

Throughout the process, there will be specific paperwork and certain requirements that must be met, and an agent experienced in this area can do much to help you avoid unnecessary delays or homes that don’t meet the minimum standards.

In the same way that you need the right real estate agent, you also will need the right lender. VA-backed home loans are made by private lenders, like banks, mortgage companies or savings and loan associations. 

Tip Number 2: Get a Copy of Your Credit Report and Review it.

The first thing a lender will do before deciding whether or not to make a loan is a credit check of the potential borrower. For veterans looking for VA home loans, it is essential to be aware that your credit history will be an important focus of the home-buying process.

Your credit doesn’t have to be perfect to get a loan, but having a high credit score will do much to help you get approved for the home loan that you want. 

Before you apply for a loan, one of the things you will want to do is to get a free copy of your credit report and review it for any errors. 

Tip Number 3: Don’t Forget About Closing Costs.

Just because you won’t need to come up with a down payment if you get a VA home loan, that does not mean that there are no costs associated with buying a home. Of course, there are.

There will be additional costs such as closing costs, property taxes, and insurance to be paid. So make sure you have enough money to cover those costs before you start the process.

And finally, don’t be lulled into forgetting that this is a loan, not a gift. 

That means you have to repay the loan. Every month. You may “qualify” for more than you can manage to pay back every month, so before you take a loan, be certain your income is sufficient to make the monthly mortgage payments. 

Tip Number 4: Make Sure You Can Meet the Occupancy Requirements.

While having access to VA-backed home loans may be an advantage on the path to home purchase, an area of home buying that can prove difficult for servicemen is the occupancy requirement of VA home loans.

These loans are intended to help veterans get into a single-family residence. As such, VA home loans require that the purchaser be living in the home as his or her primary residence within 60 days of closing. 

This can prove difficult for military personnel at times but do the right thing. Make sure your intentions are aligned with the purpose of the loan and that you will be living in the house as your primary residence after purchase.

Tip Number 5: Start Saving. 

If you are a veteran looking to get into the housing market, you should not wait to start saving for your dream house. Even with the help of a VA-backed home loan, purchasing a house can be costly. 

The loan is just one piece of the home-buying puzzle. There are other fixed costs you will need to be prepared for like hazard insurance, closing costs, pre-paid taxes, and title insurance. 

The sooner you start saving, the better.

Tip Number 6: Do Your Homework.

Finally, do your own due diligence. 

Look into VA home loan requirements and limitations. Talk to experienced professionals who can help you analyze your options and take the time to educate yourself about mortgages, interest rates, and housing costs.

Having a VA home loan can get you started down the path to homeownership, but it is up to you to make sure you are fully prepared to become a homeowner.

Making well-informed decisions is critical when you are buying your first home. Your home is an investment in your future, so do your best to make the best possible decisions. For more information on this and other important topics, go to VerifyInvestor.com.

Choosing the Right Syndicator: Tips for Real Estate Investors

The JOBS Act provided a breakthrough for real estate investing, lifting capital restrictions and allowing more private shareholders—this regulatory shift unlocked access to large property deals previously out of reach for many accredited investors.

Vantage Market Research projects that the global real estate crowdfunding market will have a compound annual growth rate (CAGR) of 45.9% between 2023 and 2030, underscoring the growth and opportunity in this area. But simply having access is not enough. Choosing the right syndication partner is a make-or-break for mitigating risks and maximizing returns.

Seasoned sponsors with proven track records offer the experience and capabilities to steer these complex deals to success.

Why Syndicator Selection Matters

Fantastic investment opportunities can only succeed if the real estate syndicator has sound risk management and operational processes.

The recent collapse of several properties in Applesway Investment Group's portfolio highlights the importance of vetting sponsors. Investors in several of the company's syndicated properties lost all their capital in asset foreclosure.

Applesway used risky financing strategies to generate higher returns in their real estate syndication. This approach then became unsustainable with the rise in interest rates.

Cases like this underscore the importance of fully vetting a syndicator's capabilities, experience, and risk management practices before investing.

What to Look For In Syndicator

To understand how to choose a syndicator, we suggest starting with the following six areas to assess their experience and potential for generating positive returns in real estate investing.

1. Verify a Proven Track Record

The syndicator’s previous experience should be your top consideration. Look at how many successful deals the sponsor has completed. More investment projects indicate greater experience in structuring and executing real estate syndications.

Examine their overall record of success. What percentage of deals met or exceeded projected returns? Higher percentages demonstrate strong underwriting skills.

Property Types

What types of commercial real estate have they syndicated - multifamily, office, retail, industrial, etc.? The range of property types indicates whether a syndicator specializes in a particular niche or takes an opportunistic approach across different asset classes.

Investors should evaluate whether the syndicator's approach aligns with their own investment preferences and objectives. For example, for investors focused solely on returns, a syndicator with experience across various asset classes may better suit your objectives.

Geographic Market

What specific geographic markets have they invested in? Does the syndicator focus on a market they know deeply, or do they pursue deals across different regions? Passive investors should determine which approach suits their priorities and interests more.

2. Expertise

In addition to evaluating a syndicator's performance history, examine the expertise of their team. A dream syndication team will have deep real estate chops and proven experience excelling at real estate investments.

Team Credentials

When examining the real estate investment team's credentials, look at:

• What are the background and credentials of key team members? Do they have advanced degrees or professional certifications related to real estate investing?

• What is their tenure and experience in the industry? Have they worked on major commercial real estate projects before launching their syndication firm?

• What financial knowledge and background do they have? Do they understand complex real estate financial analysis and structuring?

Deal Velocity

Ask about the number of deals a syndicator closes annually compared to the size of their team. High throughput of deals with a small staff could indicate they are not adequately vetting potential investments. Do they have the capacity to conduct comprehensive due diligence for each real estate syndication?

Market Knowledge

The syndicator should possess deep knowledge of their specific real estate markets. Look for expertise in market conditions, demand drivers, and supply factors.

Asset Management

The real estate syndicator should have a solid plan to oversee and manage real estate assets. Evaluate if the syndicator has experience directly managing properties or relationships with top property management firms. Their involvement in day-to-day operations should match their stated strategy.

3. Align Investment Approaches and Objectives

Look beyond surface-level credentials and understand the real estate syndicator investment philosophy and strategy. It provides critical insights into how they approach structuring deals and managing risk.

Value-Add vs Core

Does the syndicator specialize in value-added properties or core assets? Value-add deals reposition underperforming properties while core assets generate income from stable operations. Does the real estate syndicator have proven experience executing the specific deals they propose?

Target Returns

Investors should also carefully evaluate targeted returns. Sky-high promises could mean they're swinging for the fences with investor money. Use average sector returns to provide context for benchmarking expectations. Overly optimistic targets are a major red flag.

Investment Criteria

Evaluating the investment criteria a syndicator uses provides insights into their deal filtering process. Is their due diligence sufficiently rigorous? Conservative underwriting, local market factors, risk analysis, and stress testing should all inform their deal evaluation process.

Risk Mitigation

How does the syndicator keep risks in check, like rising interest rates, construction delays, or budget mishaps? Smart underwriting, contingency funds, and having a game plan helps keep passive investors protected if things go sideways.

4. Understand Fee Structures and Incentives

Evaluate the syndicator's fee structure and be wary of syndicators who charge excessive fees that eat into passive investor returns. Areas to analyze are:

Acquisition and Disposition Fees

Review the amount of any acquisition or disposition fees charged on properties purchased or sold. Typical market rates range from 1-3% for these one-time fees. Higher fees reduce investor returns, so gauge against comparable syndicators.

Asset Management Fee

Evaluate the amount of any recurring asset management fee, which covers overhead and services. These regular fees based on gross rents typically range from 1-2%. Compare to industry norms and understand what services the fee includes.

Preferred Return

Review the preferred return threshold at which the syndicator begins sharing in profits. Measure the preferred return rate against comparable deals. Understand the incentive structure and if the split encourages sustainable growth versus short-term gains.

Profit Sharing

Determine if there are any incentive or profit share fees based on asset performance. Confirming the structure helps to align syndicator incentives with your interests as a passive investor. Understand the waterfall split of profits above any preferred return thresholds.

5. Ensure Open Communication and Reporting

Select a real estate syndicator that provides investors with regular progress and performance updates.

Frequency of Updates

• How often does the syndicator provide performance updates to limited partners?

• What communication channels and methods do they use?

Content of Updates

• Do updates provide visibility into deal progress and asset performance?

• Is the level of detail and transparency sufficient?

Responsiveness

• Also, see how they field investor questions or concerns. Are they Johnny-on-the-spot or dragging their feet?

• Are they available to address issues in a timely manner?

6. Evaluate Strategic Networks and Relationships

A syndicator's network of partnerships and vendors can give you the inside scoop on their expertise.

Lending Partners

What lending institutions do they use for financing? Do they have relationships that provide access to competitive rates/terms? And how extensive are their lending relationships? Multiple partners can give flexibility to secure attractive financing.

Property Management Partners

Which management companies do they partner with? Do these companies have a strong performance record? Do they use a single property manager or multiple partners?

Contractors and Builders

For value-added or development deals, what contractors/builders do they use? Are these experienced firms that lower project execution risks?

Other Service Providers

What are their relationships with providers like insurance carriers, staffing agencies, etc? Established relationships equal reduced transaction costs and higher real estate syndication project profitability.

Red Flags to Watch Out For

Investors should watch for unverifiable or exaggerated claims about past performance. Vague investment approaches needing more specifics or transparency into deals should also raise concerns.

Performance Concerns

Exaggerated or unverifiable performance claims. For example, a sponsor claims "20% returns on all deals" but can't provide documented financial reports on past projects with verified returns.

Questionable Fees

Unjustified fees well above industry average rates. For instance, the syndicator charges acquisition fees of 5%, well above the typical 1-3% range.

Investment Strategy Issues

Deals in highly speculative or unproven markets. For example, development sites in an emerging neighborhood with no traction. Weak investment criteria that lack rigorous analysis, like failing to stress-test assumptions, is also a red flag.

Operational Weaknesses

• Insufficient or no "skin in the game" and not investing capital alongside passive investors.

• Lack of communication and engagement with limited partners, such as ignoring investor inquiries.

• Underperforming partnerships and vendor relationships, such as deals with unqualified contractors.

While one potential yellow flag may be understandable, multiple issues should give individual investors pause before committing funds.

Performing Due Diligence on Syndicators

So you've spotlighted some potential all-star real estate syndication projects - great!  But hold on before moving forward with the real estate deal and make sure to:

• Have a real estate attorney review the private placement memorandum and operating agreements. Identify any loopholes or areas of concern around the real estate syndication.

• Have an introductory call with the sponsor. Assess communication skills and transparency. Their responsiveness can indicate how they will engage once you finalize a partnership via real estate syndication.

• Speak with multiple investors, including current and past. Ask probing questions about the syndicator's transparency, expertise, and dealings.

• Verify achievement claims and past performance data through public records and independent research.

• Ask detailed questions about the investment opportunity fee structures, fund economics, investment criteria, due diligence processes, and risk management strategies. Comprehensive questioning can help you uncover red flags.

• Carefully reviewing the investment thesis, assumptions, and projections for potential deals can help assess the sensibility of the real estate syndicator's pipeline.

• Confirm "skin in the game" and if the syndicator plans to invest meaningful capital alongside other investors.

Vetting potential sponsors is essential for successful real estate syndication deals. Accredited investors have greater access to these private syndicated deals but must exercise due diligence.

VerifyInvestor.com provides accredited investor verification services that add an extra layer of protection. Our efficient, cost-effective verifications enable compliant fundraising and empower investors to access exclusive opportunities.

Update on Sam Bankman-Fried Case

In what the New York Times reported prosecuting attorney, Damian Williams, said was nothing more than “old-fashioned embezzlement” that caused “one of the largest financial crimes in American history,” The criminal trial of Sam Bankman-Fried (dubbed “SBF”) continues to rock the cryptocurrency exchange and investment world.

Many of our blog posts focus on issues such as Reg D 506(b) vs. Rule 506(c), or crowdfunding trends, but in this update on the SBF case, we will review what happened to propel Sam Bankman-Fried’s company, FTX, into bankruptcy and the resulting fallout of criminal and civil litigations against SBF. We will then take a look at the legal tumult surrounding SBF’s decision to testify at his criminal trial, what that testimony was, and how it all ended for SBF. 

So let’s get started. 

What Was FTX and What Happened?

At one time valued at $32 billion, FTX Exchange (“FTX”) was once the largest cryptocurrency exchange company in the world. Sam Bankman-Fried founded FTX and was the company’s CEO. That is, until he resigned after FTX’s spectacular collapse in November 2022. 

As a cryptocurrency exchange, FTX provides a platform for its customers to trade one digital currency for another or for traditional money. FTX also had a native cryptocurrency called FTT. 

In addition to being the founder and CEO (now former CEO) of FTX, SBF co-founded a crypto trading platform called “Alameda Research” (“Alameda”).

Despite the fact that FTX and Alameda Research were two independent companies, the relationship between the two was “unusually close” as illustrated in part by the fact that Alameda’s balance sheet was made up primarily of FTT— FTX’s native cryptocurrency.  

In early November 2022, CoinDesk published a post calling into question the stability of FTX. Shortly after that post appeared, Changpeng Zhao (“Zhao”), the CEO of Binance, the world’s largest crypto exchange, expressed concerns about FTX’s financial stability. Acting on his concern about the stability of FTT, Zhao liquidated approximately $530 million worth of FTT. This triggered other investors to pull out of FTT as well. In 72 hours, FTX was faced with $6 billion in withdrawals.

Matters went from bad to worse for FTX when Binance, after triggering the fallout, offered to save FTX by buying the company but then pulled out of the deal in a matter of days, citing due diligence findings that indicated that FTX was under federal investigation and had mishandled customer funds. 

By November 11, 2022, SBF had resigned as CEO of FTX, and the company had filed for bankruptcy. 

FTX’s Collapse Leads to Criminal Charges and Civil Lawsuits Against SBF

The collapse of FTX led to further investigations by the Justice Department and the Securities Exchange Commission (SEC) into the company’s operations and the issue of whether FTX improperly used customer funds to fund Alameda Research. SBF was accused of diverting billions of dollars from FTX customers to fund Alameda. 

In December 2022, SBF was arrested. After being extradited from the Bahamas, SBF was charged with seven (7) criminal counts of wire fraud, securities fraud, money laundering, and conspiracy. If convicted, he could face up to 100 years in prison. 

That’s a massive prison sentence. 

But will he be sentenced to 100 years in prison if convicted? 

Not very likely. 

Some legal authorities suggest that it is far more realistic that he would be sentenced to somewhere around 10 to 20 years in jail. But that’s still a long time.

Prosecutors allege that, along with his co-conspirators, SBF stole billions of dollars from FTX customers and used the money to make personal investments and fund his crypto-focused hedge fund, Alameda.   

While SBF’s criminal trial may be his most pressing legal concern, it is not his only one. 

In addition to the criminal charges, the  SEC brought separate charges against SBF on behalf of defrauded investors. 

In its complaint, the SEC alleges that SBF orchestrated “… a massive, years-long fraud, diverting billions of dollars of the trading platform’s customer funds for his benefit and to help grow his crypto empire.” 

The SEC’s complaint also alleges that SBF made misleading statements to equity investors, failed to disclose Alameda’s preferential treatment, and made material misrepresentations to FTX investors regarding the risks of investing in FTX.  

The SEC’s complaint seeks monetary penalties against SBF in addition to “disgorgement” of all “ill-gotten gains” and interest. The SEC also seeks an order that would prevent SBF from ever acting again as an officer or director of any company selling securities — in addition to having him barred from participating in any way in the public offer or sale of securities, including crypto-securities.

Additional legal woes for SBF commenced when investors in Florida filed a class action lawsuit against SBF and a number of other defendants — including celebrities — who are accused of promoting and assisting in the sale of unregistered securities. 

As of the writing of this post, no less than seven (7) class actions have been filed against SBF. 

Further, the Commodity Futures Trade Commission filed a lawsuit against SBF and FTX. 

And Then SBF’s Parents Were Sued by FTX.

In a twisted quirk of fate, FTX sued Sam Bankman-Fried’s parents seeking to “claw back” millions of dollars they allegedly received from their son. The complaint alleges that SBF’s parents “siphoned off” millions of dollars from FTX customers to enrich themselves and support certain charities. 

SBF’s parents are accused of receiving $10 million in cash from their son, and a $16.4 million home in the Bahamas that was purchased by FTX. The complaint by FTX also alleges that SBF’s father helped to cover up allegations that FTX engaged in money laundering and price fixing.

SBF’s Criminal Trial Continues to Shock and Scandalize.   

SBF’s criminal trial has been chock-full of drama. 

After being extradited from the Bahamas, where FTX was located, SBF posted a $250 million bond and was put on house arrest in California, in his parent’s home. Bail was revoked after SBF was caught tampering with witnesses. Instead of awaiting trial in his parents’ luxurious home in Palo Alto, California, he was sent to the Metropolitan Detention Center in Brooklyn — a jail with the reputation for being “one of the worst jails in America.” 

The trial commenced on October 3, 2023, and reports indicate that the evidence against SBF has been damning. Three former FTX and Alameda executives — including SBF’s former girlfriend — pleaded guilty to criminal charges and have testified at the trial as prosecution witnesses.   

The executives who pleaded guilty and have been cooperating with the prosecution are:

• Nishad Singh was a co-founder of FTX and director of engineering.

• Zixiao "Gary" Wang, co-founder and CTO of FTX, and 

• Caroline Ellison, CEO of Alameda and SBF’s girlfriend.

By all accounts, the testimony of the former FTX and Alameda executives was devastating to SBF’s case.

In part, Nishad Singh testified that Alameda bank accounts were used to store FTX customer funds and that he had personally programmed systems to route FTX user deposits into Alameda bank accounts.

Gary Wang, FTX’s chief technology officer, testified that Alameda privileges, which allowed Alameda to draw on billions of FTX customer funds virtually unchecked, were written right into FTX’s software code.

Caroline Ellison testified that SBF directed her to use FTX customer funds to pay for new investments or political donations or to hide losses on Alameda’s balance sheet. She also testified that FTX customer funds were used to bribe Chinese government officials.

Then came SBF himself. 

In a move that had everyone buzzing, SBF decided to take the stand in his criminal trial. 

Criminal defendants rarely testify at trial. This is because (1) the jury may not take an improper inference against them if they do not testify (so they have nothing to lose), and (2) if they testify, they are subject to cross-examination. Cross-examination opens the door (with limitations) to bring out a number of facts that the defense would rather the jury not know about.  

Nevertheless, SBF decided to, and did, take the stand.

By all accounts, it did not go well for him. 

Over the course of his testimony, it was repeatedly reported that SBF was evasive when answering questions, frequently blaming others for FTX’s woes. 

The consensus appears that SBF contradicted himself throughout his testimony and that his constant evasions, repetitions of “I don’t recall,” and circumlocutions of questions damaged his credibility with the jury. 

After 15 days of trial, closing arguments were presented on November 1, 2023. After closing arguments, the court instructed and charged the jury. Following that, the world anxiously awaited the jury’s verdict.

The FTX Case is One of Simple Fraud, Not Crypto Volatility.

One point that keeps getting lost in the stupefaction caused by FTX’s collapse and the resultant drama and notoriety of SBF’s trial, is that the FTX case, while it did involve a cryptocurrency exchange, is not a case primarily about cryptocurrency. 

Rather, as prosecutors repeatedly argued, the case is one of corporate and individual greed, malfeasance, and the misuse of customer funds. FTX investors were defrauded when customer funds were taken without their knowledge and used to fund SBF’s personal investments and Alameda Research.

Nevertheless, it is clear that the SBF case will impact the crypto world and may very well lead to new and additional legislation and regulations.

Convicted On All Counts.

The jury was out less than five hours before returning a verdict of guilty on all seven counts of fraud and conspiracy against SBF. 

Prosecuting attorney, Damian Williams, maintained that the SBF trial was not about cryptocurrency, but simply about fraud and corruption. 

SBF potentially faces another trial in February on 5 other counts that were severed from this initial matter.

Sentencing is scheduled for March 28, 2024. While the criminal charges do carry significant time (he could be facing more than 100 years in jail), it is far more likely that SBF will be sentenced to somewhere between 10 and 20 years in jail.

After sentencing, SBF can appeal the jury verdict. Since he testified on his behalf, he had his “day in court” and got an opportunity to tell his side of the story. Further, as he claimed over 140 times on cross-examination that he did not remember his statements or details of events, the credibility of his testimony is highly questionable. As a result, it would appear that any appeal will have to be grounded in legal errors made during the trial or by the presiding judge. 

At VerifyInvestor.com, we offer a world-class accredited investor verification service. Our services are fast, efficient, cost-effective, confidential, and reliable. We help companies fully and easily comply with their legal obligations to verify investors as accredited investors.

Happy Thanksgiving!

Wishing everyone a Happy Thanksgiving! From all of us at VerifyInvestor.com

The Role of Smart Investment Decisions in Achieving Long-Term Financial Stability

Introduction

Navigating the intricate financial landscape, one must uphold the significance of making astute investment choices to secure enduring financial stability. This article delves into intelligent investing, focusing on its role in achieving long-term financial security. Amid this journey, we'll explore various aspects, including strategies to make a paycheck stub work for you. Join us in unraveling the secrets to a financially stable future through insightful and researched perspectives.

I. Undеrstanding thе Basics of Invеstmеnt

• Thе Essеncе of Invеstmеnt

Invеstmеnt, in its purеst form, is thе allocation of rеsourcеs in thе еxpеctation of gеnеrating futurе bеnеfits. It’s thе cornеrstonе of financial planning, rеprеsеnting a commitmеnt to building a sеcurе financial futurе—thе еssеncе of invеstmеnt liеs in thе intеlligеnt allocation of your monеy, timе, and еxpеrtisе in ways that lеad to sustainablе wеalth.

• Risk and Rеward

Thе rеlationship bеtwееn risk and rеward forms thе bеdrock of invеstmеnt dеcisions—put, thе grеatеr thе potеntial rеward, thе highеr thе risk involvеd. It's a concеpt oftеn dеscribеd as thе risk-rеturn tradе-off. Invеstors must wеigh thеir risk tolеrancе, financial goals, and invеstmеnt horizon to strikе thе right balancе bеtwееn safеty and growth.

• Invеstmеnt Vеhiclеs

Undеrstanding thе divеrsе array of invеstmеnt vеhiclеs is pivotal. From thе dynamic world of stocks and bonds to thе tangibility of rеal еstatе and thе allurе of commoditiеs, еach invеstmеnt avеnuе offеrs uniquе advantagеs and risks. A wеll-roundеd portfolio may include a mix of thеsе to еnsurе stability and growth.

• Timе Horizon

Your invеstmеnt journey starts with dеfining clеar financial goals and еstablishing a timе horizon. This time guidеs your invеstmеnt decisions. Short-tеrm goals, likе a vacation, rеquirе a diffеrеnt invеstmеnt approach than long-tеrm goals such as rеtirеmеnt planning. A prеcisе understanding of your timе horizon allows you to align your invеstmеnts with your objectives.

II. Building the Foundation for Financial Stability

• Sеtting Clеar Financial Goals

Building a solid financial foundation commеncеs with еstablishing clеar and achiеvablе goals. Thеsе goals act as your guiding stars, stееring your invеstmеnt choicеs. Whether it's saving for a down paymеnt on a homе, funding your child's еducation, or planning for rеtirеmеnt, sеtting specific financial objеctivеs is thе first crucial stеp.

• Emеrgеncy Funds

Imaginе your financial life as a house. An еmеrgеncy fund is thе robust foundation that еnsurеs your financial housе can withstand unеxpеctеd storms. This fund is a safеty nеt, providing pеacе of mind during unforеsееn crisеs, such as mеdical еmеrgеnciеs, job loss, or unеxpеctеd homе rеpairs. Idеally, your еmеrgеncy fund should covеr at lеast thrее to six months of living еxpеnsеs.

• Dеbt Managеmеnt

Dеbt can be a formidablе obstaclе on your path to financial stability. Effеctivе dеbt managеmеnt is about undеrstanding thе typеs of dеbt you havе, thе intеrеst ratеs associatеd with еach, and crafting a plan to rеpay thеm. Rеducing high-intеrеst dеbt, likе crеdit card balancеs, should be a priority. A balancеd approach to dеbt managеmеnt can frее up morе funds for invеstmеnt.

• Budgеting

Budgеting is thе compass that hеlps you navigatе your financial journey. Crafting a budget lets you monitor your income, expenses, and savings. It's a proactive tool that еnsurеs your financial decisions align with your goals. By budgеting, you are not just kееping track of your monеy; you are tеlling it whеrе to go.

III. Divеrsification and Risk Management

• Divеrsification Stratеgiеs

Divеrsification is akin to not putting all your еggs in onе baskеt. It's a risk managеmеnt tеchniquе whеrе you sprеad your invеstmеnts across a variety of assеt classеs. It hеlps rеducе thе impact of poor pеrformancе in onе arеa of your portfolio. Kеy divеrsification stratеgiеs includе:

- Assеt Class Divеrsification: Divеrsify across diffеrеnt assеt classеs likе stocks, bonds, rеal еstatе, and commoditiеs to rеducе risk. For example, if you become an accredited investor you may invest in exclusive private placement opportunities only available to that type of investor.

- Gеographical Divеrsification: Invеst in various gеographical rеgions to limit еxposurе to rеgional еconomic risks.

- Sеctor Divеrsification: Sprеad invеstmеnts across diffеrеnt sеctors (е.g., tеchnology, hеalthcarе) to minimizе sеctor-spеcific risks.

• Assеt Allocation

Assеt allocation involvеs dеtеrmining how your invеstmеnts arе distributеd among various assеt classеs. The proper assеt allocation is a crucial componеnt of risk management. Your risk tolеrancе, financial goals, and timе horizon arе kеy factors in dеtеrmining thе right assеt mix; it's about striking a balance between growth potential and safety.

• Risk Tolеrancе

Undеrstanding your risk tolеrancе is fundamеntal to making informеd invеstmеnt decisions. It's not just about how much risk you can handlе еmotionally, but also how much trouble your financial goals can еndurе. Risk tolеrancе is a spеctrum, and it varies from pеrson to pеrson. It's crucial to assess your comfort lеvеl with markеt fluctuations and align your invеstmеnts accordingly.

Divеrsification and risk managеmеnt sеrvе as thе bеdrock of any sound invеstmеnt stratеgy.

IV. Thе Powеr of Compounding

• Compound Intеrеst

At thе, hеart of building long-tеrm wеalth liеs thе incrеdiblе powеr of compounding. Compound intеrеst is thе snowball еffеct that occurs whеn your еarnings gеnеratе еvеn morе еarnings ovеr timе. It's thе magic of rеinvеsting your rеturns, allowing your monеy to grow еxponеntially. Kеy points about compound intеrеst includе:

- Thе Timе Factor: Thе longеr your monеy is invеstеd, thе morе it can compound. Timе is thе most significant drivеr of compounding.

- Rеgular Contributions: Consistеntly adding to your invеstmеnts can further boost compounding.

- Rеinvеstmеnt of Rеturns: Rеinvеsting dividеnds and intеrеst allows your invеstmеnts to grow fastеr.

- Starting Early: Starting to invеst as еarly as possible is thе most еffеctivе way to harnеss thе full potential of compounding.

• Long-Tеrm Pеrspеctivе

A long-tеrm pеrspеctivе is еssеntial for rеaping thе full bеnеfits of compounding. This approach involves bеing patiеnt and staying invеstеd еvеn whеn markеts fluctuatе. By focusing on thе long tеrm, you can wеathеr thе short-tеrm ups and downs and achiеvе your financial goals with grеatеr еasе.

Compound intеrеst is akin to a multipliеr that can significantly amplify your wеalth ovеr timе. 

V. Advancеd Invеstmеnt Stratеgiеs

• Rеsеarch and Analysis

In thе world of invеstmеnts, knowlеdgе is powеr. In-dеpth rеsеarch and analysis arе fundamеntal to informеd invеstmеnt dеcisions. Hеrе's how you can еnhancе your invеstmеnt stratеgy through rеsеarch and analysis:

- Fundamеntal Analysis: Assеssing a company's financial hеalth, its compеtitivе position, and growth prospеcts can help you make informеd decisions about individual stocks.

- Tеchnical Analysis: Analyzing historical pricе and volumе data can assist in identifying trends and еntry/еxit points.

- Economic and Markеt Analysis: Understanding broadеr еconomic trends and markеt conditions can help in assеt allocation decisions.

• Markеt Timing vs. Timе in thе Markеt

Thе dеbatе bеtwееn markеt timing and timе in thе markеt is a critical one in thе invеstmеnt world.

- Markеt Timing: Trying to prеdict short-tеrm markеt movеmеnts is a challеnging еndеavor. Markеt timing oftеn lеads to еmotional dеcision-making and can rеsult in missеd opportunitiеs.

- Timе in thе Markеt: Historically, invеstors who stay invеstеd through markеt fluctuations bеnеfit from thе long-tеrm upward trajеctory of markеts. This approach minimizеs transaction costs and reduces the impact of timing еrrors.

• Tax-Efficiеnt Invеsting

Taxеs can еrodе your invеstmеnt rеturns if not managed carefully. Tax-еfficiеnt invеsting is about minimizing tax implications on your invеstmеnts. Stratеgiеs to consider include:

- Tax-Advantagеd Accounts: Utilizе tax-advantagеd accounts likе IRAs and 401(k)s to rеducе your taxablе incomе.

- Tax-Loss Harvеsting: Offsеt gains with lossеs by sеlling invеstmеnts at a loss to minimizе capital gains tax.

- Long-Tеrm Capital Gains: Holding invеstmеnts for thе long tеrm can lеad to lowеr capital gains tax ratеs.

Advancеd invеstmеnt stratеgiеs involvе a blеnd of financial еxpеrtisе, informеd dеcision-making, and tax-еfficiеnt planning. 

VI. Profеssional Guidancе and Sеlf-Dirеctеd Invеsting

• Financial Advisors

Financial advisors can play a crucial role in your invеstmеnt journey. Hеrе's a brеakdown of thе pros and cons of sееking professional guidancе:

✓ Pros of Financial Advisors:

   - Expеrtisе: Advisors have in-depth knowledge of financial markеts and can provide tailorеd invеstmеnt stratеgiеs.

   - Customization: Thеy can crеatе a pеrsonalizеd invеstmеnt plan that aligns with your financial goals and risk tolеrancе.

   - Emotional Support: Advisors can help you stay calm during markеt volatility and prеvеnt hasty decisions.

✓ Cons of Financial Advisors:

   - Fееs: Advisors oftеn chargе fееs, which can rеducе your ovеrall rеturns.

   - Conflicts of interest: Some advisors may have conflicts of interest, such as commissions for rеcommеnding certain products.

   - Limitеd Control: You may havе lеss control ovеr your invеstmеnts and dеcisions.

• Sеlf-Dirеctеd Invеsting

Sеlf-dirеctеd invеsting offеrs morе control and indеpеndеncе. Hеrе's what you nееd to know:

✓ Pros of Sеlf-Dirеctеd Invеsting:

  - Control: You have complete control over your invеstmеnt decisions, buying and selling based on your rеsеarch and convictions.

   - Cost Savings: You can potentially rеducе fееs by managing your invеstmеnts directly.

   - Lеarning Opportunity: Sеlf-dirеctеd invеsting can bе a valuablе lеarning еxpеriеncе, incrеasing your financial litеracy.

✓ Cons of Sеlf-Dirеctеd Invеsting:

- Risk: Sеlf-dirеctеd invеsting rеquirеs substantial knowlеdgе and can bе riskiеr for inеxpеriеncеd invеstors.

   - Timе-Consuming: Managing your invеstmеnts can bе timе-intеnsivе.

   - Emotional Challеngеs: Emotional decision-making can lead to impulsivе actions.

Thе choicе bеtwееn professional guidancе and sеlf-dirеctеd invеsting dеpеnds on factors such as your knowledge, comfort lеvеl, and financial goals. 

VII. Monitoring and Adjusting Your Portfolio

• Rеgular Portfolio Rеviеw

Rеgularly rеviеwing your invеstmеnt portfolio is a kеy еlеmеnt of long-tеrm financial succеss. Hеrе's why it's crucial:

- Tracking Progrеss: Portfolio rеviеws allow you to assеss whеthеr you'rе making progrеss towards your financial goals.

- Risk Management: Monitoring helps you identify invеstmеnts that may no longer align with your risk tolеrancе or goals.

- Capitalizing on Opportunitiеs: It allows you to spot opportunities to buy or sell assеts based on markеt conditions.

- Staying Informеd: Rеgular rеviеws kееp you informеd about thе pеrformancе of your invеstmеnts.

• Rеbalancing

Rеbalancing involvеs rеstoring your portfolio to its targеt assеt allocation. It's еssеntial for maintaining thе risk lеvеl you'rе comfortable with. Kеy points include:

- Why Rеbalancе: Ovеr timе, some invеstmеnts may outpеrform or undеrpеrform, causing your portfolio to drift from its intеndеd allocation.

- Balancing Risk and Rеturn: Rеbalancing еnsurеs you don't bеcomе ovеrly еxposеd to high-risk or low-risk assеts, hеlping you maintain your dеsirеd risk-rеturn profilе.

- How Oftеn to Rеbalancе: Thе frеquеncy of rеbalancing can vary, but it's typically donе annually or when your portfolio dеviatеs significantly from your targеt allocation.

- Tax Considеrations: Bе mindful of tax implications whеn rеbalancing, as sеlling invеstmеnts can triggеr capital gains taxеs.

Monitoring and adjusting your portfolio is an ongoing process that еnsurеs your invеstmеnts rеmain alignеd with your goals and risk tolеrancе. 

VIII. Rеal-Lifе Succеss Storiеs

• Casе Studiеs

Rеal-lifе succеss storiеs sеrvе as a sourcе of inspiration and practical lеssons for anyone aiming to achiеvе long-term financial stability. Hеrе arе a fеw casе studiеs that illustratе how individuals havе succееdеd through smart invеstmеnt dеcisions:

✓ Thе Early Invеstor - Sarah, a young profеssional, started invеsting in her 20s. By consistently contributing to hеr rеtirеmеnt accounts and maintaining a divеrsifiеd portfolio, shе watch hеr invеstmеnts grow substantially ovеr thе yеars. Hеr еarly start and long-tеrm pеrspеctivе allowеd hеr to sеcurе hеr rеtirеmеnt comfortably.

✓ Thе Stratеgic Rеal Estatе Invеstor - John dеcidеd to divеrsify his invеstmеnts by vеnturing into rеal еstatе. Through careful rеsеarch and analysis, hе acquirеd rеntal propеrtiеs that gеnеratеd consistеnt incomе and apprеciatеd in valuе. His smart rеal еstatе invеstmеnts bеcamе a significant sourcе of long-tеrm financial stability.

✓ Thе Disciplinеd Savеr - Sophie, with a modеst incomе, diligеntly savеd and invеstеd a portion of hеr еarnings. Shе managеd hеr budgеt and avoidеd dеbt, allowing hеr invеstmеnts to compound ovеr timе. Hеr disciplinеd approach lеd to financial indеpеndеncе and еarly rеtirеmеnt.

Thеsе casе studiеs undеrscorе thе importancе of consistеncy, divеrsification, and long-tеrm thinking in achiеving financial stability. Rеal-lifе succеss storiеs offеr valuablе insights for invеstors looking to еmbark on thеir invеstmеnt journеy. 

IX. Pitfalls to Avoid

• Common Invеstmеnt Mistakеs

In thе world of invеstmеnts, avoiding common pitfalls is oftеn as crucial as making thе suitable choicеs. Hеrе arе somе of thе most frеquеnt mistakеs that invеstors should stееr clеar of:

- Emotional Dеcision-Making: Allowing fеar and grееd to drivе invеstmеnt dеcisions can lеad to buying high and sеlling low. Emotional dеcision-making oftеn rеsults in lossеs.

- Lack of Divеrsification: Putting all your money into a single invеstmеnt or assеt class can еxposе you to significant risks. Divеrsification is kеy to managing risk еffеctivеly.

- Chasing Hot Trеnds: Trying to invеst in thе latеst hot trеnds without propеr rеsеarch can lеad to lossеs. Markеt fads oftеn fizzlе out quickly.

- Nеglеcting Rеsеarch: Failing to rеsеarch invеstmеnts thoroughly can rеsult in poor decisions. In-dеpth rеsеarch is еssеntial for making informеd choices.

- Timing thе Markеt: Attеmpting to prеdict markеt movеmеnts and timе your invеstmеnts is a challеnging and oftеn futilе еndеavor. Markеt timing can lеad to missеd opportunitiеs and lossеs.

• Psychological Biasеs

Invеstors arе not always rational bеings. Psychological biasеs can cloud judgment and lead to poor invеstmеnt decisions. Hеrе arе a fеw common biasеs to bе awarе of:

- Ovеrconfidеncе Bias: Ovеrеstimating your ability to prеdict markеt movеmеnts can lеad to еxcеssivе trading and lossеs.

- Loss Avеrsion: Bеing morе sеnsitivе to lossеs than gains can lеad to hasty sеll-offs during markеt downturns.

- Confirmation Bias: Sееking out information that confirms еxisting bеliеfs while ignoring contradictory data can lead to poor decisions.

- Herd Mentality: Following the crowd can lead to buying assets at inflated prices and selling at lows during market bubbles and crashes.

Rеcognizing and avoiding thеsе pitfalls and biasеs is еssеntial for sеcuring your financial futurе еffеctivеly. By stееring clеar of thеsе traps, you can improve your chancеs of achieving long-term financial stability.

In conclusion, making smart invеstmеnt dеcisions, understanding thе basics, and implеmеnting advancеd stratеgiеs can pavе thе way for a financially sеcurе futurе. Monitoring your invеstmеnts, lеarning from rеal-lifе succеss storiеs, and avoiding common pitfalls arе all intеgral parts of this journey. For more information on finance, investing, and economics be sure to browse the VerifyInvestor.com Blog. 

Legal Structures in Private Equity: Limited Partnerships vs. Limited Liability Companies

Private equity (PE) investments continue to make a strong showing in the alternative investment space. For accredited investors, they provide a significant return on investment and are an excellent means of diversifying an investment portfolio. 

The legal structures in private equity deals are usually either a Limited Partnership (LP) or a Limited Liability Company (LLC). 

Which legal structure is utilized to establish and manage a private equity fund can play a crucial role in maximizing returns and minimizing taxes for private equity investors.

In this post, we will look at LPs and LLCs and discuss the advantages and disadvantages of each for purposes of private equity investment. 

Of course, there are other legal business structures that can be used for private equity funds, but our discussion will focus on the two most common: Limited Partnerships and Limited Liability Companies.

Bear in mind that choosing the correct legal structure for a PE fund requires significant time, analysis, and research. The parties establishing the fund must undertake a detailed and careful analysis of the specific facts and goals of each PE transaction before determining which structure will work best for them. Investors also need to assess the potential impact a fund’s legal structure will have on taxes and return on investment over the life of the investment.  

These are complex considerations for both fund creators and investors. Yet both fund creators and investors need to understand the impact the fund’s legal structure may have. Thus, it is essential that both fund creators and potential investors consult with experienced legal professionals, tax professionals, accountants, and other professionals, to determine what is right for their individual situation. 

Our aim here is not to tell you which structure to use. That’s for you to decide. Rather, our purpose is to provide general educational information that can be used as a springboard for further investigation and analysis. 

A Little Background on Private Equity

Private equity (PE) investments are an alternative to traditional investment vehicles. The term “alternative investments” refers to investing in the private market, and describes an enormous range of assets and investment strategies. While the products can vary widely, one common aspect of alternative investments is that they are not publicly traded. 

Private equity is only one type of alternative investment. Frequently grouped with other alternative investment vehicles like venture capital (VC) and hedge funds, PE funds are distinct from both of these investment vehicles. PE’s distinguishing feature is that it affords accredited investors an alternative means of investing by providing opportunities for them to invest in privately held companies. 

Since its beginnings in 1981, private equity has weathered a number of economic storms, reaching historic heights in 2021 before being thrown into flux by high inflation, rising interest rates, and war in Europe. Nevertheless, many believe that despite the many hurdles and downturns, ultimately, the future of private equity looks promising, and private equity is here to stay.  

PE investments are typically held for long periods of time (often 5 to 10 years or more), making them illiquid investments. 

In addition, because they are investments in private as opposed to public companies, PE funds are not registered with the Securities and Exchange Commission (SEC) and cannot be publicly traded. This means that the capital raised from accredited investors by PE firms and funds must come within one of the exemptions in the Securities Act of 1933.

Although a PE fund itself is not registered with the SEC, the Investment Advisors Act of 1940 regulates fund advisers. The Investment Advisors Act of 1940 requires fund advisors to register with the SEC.   

The Most Common Private Equity Structures

As touched on above, private equity funds purchase and sell private companies. To do this, there are two main legal business structures generally used to create private equity funds. They are:

1. The Limited Partnership (LP), and

2. The Limited Liability Company (LLC).

While these two legal structures have some features in common, they are distinct legal business structures. 

Partnerships are governed by state law.

A “partnership” is simply a business structure where two or more people agree to co-own and operate a business. The individual partners in the business can vary ownership interests, but the total percentages of all interests must equal 100 percent. 

Partnerships can take several forms. Partnerships can be:

• general partnerships (GP),

• limited partnerships (LP), or

• limited liability partnerships (LLP).

As can be seen, a limited partnership (LP) is just one form of partnership. 

Each type of partnership varies with regard to the liability of the participants and the active management that each partner assumes. 

For example, in a general partnership, all partners are general partners, and each takes an active role in the management of the business.

In contrast, limited partnerships are made up of both general partners and limited partners. The general partners run and manage the business. The limited partners have very little if any say in how the business is run and have almost nothing to do with the day-to-day operations. While the general partners make all the decisions regarding the business enterprise in an LP, they also have unlimited liability for the business’s obligations and debts. In contrast, limited partners have only limited liability. 

LPs and LLCs have some features in common. These include:

• ease of setting up the business (LP or LLC) 

• limited liability for members or partners

• flexibility in assigning members’ or partners’ rights and responsibilities

• both are pass-through structures for tax purposes

• less formal requirements for documenting meetings  

• profit-sharing availability

These commonalities render both LPs and LLCs favorable structures for PE firms and funds.

Private equity funds are individual entities separate from the PE firm (most often the general partner) that establishes the fund. 

Which business structure a fund takes, or should take, is a highly complex and complicated decision that can only be made by the parties establishing the fund.

But let’s take a closer look now at each one of these business structures to get a feeling for how they fit the needs of PE funds.

Limited Partnership (LP) Structure  

To be a limited partnership, the business structure has to have at least one general partner, and at least one limited partner (frequently there are more of each). 

For purposes of PE funds, the general partner is, in most cases, the PE firm that has the authority to make decisions for the fund and a management company (usually a subsidiary of the PE firm) that manages the fund. The investors are the limited partners.

The general partner is responsible for running the day-to-day operations of the fund and for making all decisions regarding the fund’s management. 

The limited partners, on the other hand, share in the profits and losses, but typically have little to no say in how the fund is managed or run. Their participation is limited to providing capital for the fund. 

In addition to being responsible for running the fund, general partners have unlimited liability for the debts and obligations of the fund. If, for example, there is a lawsuit or the fund incurs debts and obligations it cannot meet, the general partners will be held personally liable. That means that the personal assets (homes, cars, boats, etc.) of the fund’s general partners can be reached to pay the fund’s obligations.

On the other hand, the investors, as limited partners, have no personal liability exposure. Each limited partner’s liability is limited to the amount of his or her investment in the fund.

Limited partnerships, which are governed by state law, can be created in any state. With the exception of Louisiana, most states follow the Uniform Limited Partnership Act, which dictates what documentation is required, what registration fees must be paid, and what the reporting requirements are for limited partnerships.   

In addition to registering the LP, a limited partnership must have a Limited Partnership Agreement (LPA). The LPA does not have to be filed with the state, but it is a critical document. The LPA is the organization’s operating agreement. It defines the rights and obligations of all the partners — both general partners and limited partners — in the limited partnership. Anyone investing in a PE firm that uses a limited partnership structure should pay careful attention to the LPA because it contains the full agreement between the parties regarding all aspects of the PE limited partnership. 

Advantages of an LP Structure

Perhaps the most important advantage of an LP is the limited personal liability protection it affords to limited partners. In an LP, only the general partners have complete liability exposure. The limited partners (i.e., the investors) are liable only up to the amount of capital they invested in the fund. 

Another major advantage of an LP is its pass-through (or flow-through) tax status. Rather than being taxed as an entity in and of itself, PE funds formed as limited partnerships “pass-through” their taxes to the partners (both general and limited) in the fund. This generally avoids a “double taxation” problem on investment returns.   

In addition, because they are not active members of the business, limited partners do not have to pay self-employment taxes.

As noted previously, other advantages of an LP include the ease of forming the entity. In addition, unlike corporations, LPs do not have to comply with strict meeting and reporting requirements.

Disadvantages of an LP Structure

The same factor that is a benefit for investors — their limited partner status — can also be seen as a detriment. 

Limited partners have little to no say in how the fund is managed or run. They are not allowed to participate in the day-to-day management of the business. As a result, investors unhappy with how the fund is being managed, probably can’t do much about it.   

The downside for general partners in an LP is their unlimited liability. A general partner in an LP has no liability protection, thus putting his or her (or its) personal property at risk if liability is incurred.

Another potential downside is that the limited partnership structure can make it more difficult to transfer ownership or change management roles.

Limited Liability Company (LLC) Structure

The second most common fund structure for PE funds is that of the LLC. 

An LLC is simply a business structure that affords limited liability to all owners (called “members”) of the company. An LLC is something between a corporation and a sole proprietorship. 

Unlike an LP, which provides liability protection only for limited partners, all members in a limited liability company enjoy limited liability. Thus, if the company incurs debts or obligations it cannot meet, or incurs some other form of liability, each member’s liability is limited to his/her/its investment in the LLC.  

Another difference between LLCs and limited partnerships is that all members of an LLC may participate in the management of the business. 

State law governs the creation and operation of an LLC. Most states require an LLC to file a Certificate of Formation or Articles of Organization (or similar document) and to pay various filing fees. Yearly fees may also be required in some states. 

Although not required in most states, an LLC should also have an Operating Agreement. This document defines the LLC’s purpose and addresses other important aspects of the business including (not limited to) business financials, members’ roles, and the rules for running the business. 

Advantages of an LLC Structure

Again, the limited liability of an LLC is a major advantage of this legal business structure. Unlike an LP, LLCs have the additional advantage of providing limited liability for all members, not just some of them. 

LLCs also have the advantage of being a pass-through (or flow-through) structure for tax purposes. In addition, LLCs are able to elect whether to be taxed as a corporation, partnership, or “disregarded entity.” 

The flexibility of the Operating Agreement is another advantage of an LLC. Because it can be written to fit individual circumstances, the Operating Agreement works well for PE funds. It can be used to specify how the fund will operate, how profits and losses will be distributed, and when members can sell their interests.

Like LPs, LLCs are easy to establish and have less formal administration requirements (meetings, annual reports, minutes, etc.).

Disadvantages of an LLC Structure
Despite the pass-through advantages LLCs provide, they do pose a tax disadvantage. This is because LLCs are subject to self-employment tax. Owners employed by the LLC must pay self-employment tax on their share of the LLC profits — which can end up costing even more than taxes incurred as an employee. 

Another disadvantage of an LLC is that a change in membership can cause the dissolution of the LLC. Unless specifically addressed in the Operating Agreement, in some states, if a member dies, declares bankruptcy or leaves, the LLC will be dissolved.

Finally, some investors do not like LLCs because they will be taxed on the LLC’s profits even if they receive no cash distribution personally. 

The Right PE Investment Vehicle

Forming a PE fund is a complex and complicated endeavor. Choosing the right structure for your PE fund is a critical decision for owners and accredited investors alike. Every situation is unique, so be certain to consult with a securities lawyer and other necessary professionals.   

At VerifyInvestor.com, we offer accredited investor verification services. As a leading resource for verification of accredited investor status in accordance with federal law, we make it easy for issuers to ensure that every single investor participating in their offering is an accredited investor. Our services are simple, confidential, secure, and reliable.

Demystifying Private Equity: A Comprehensive Guide for Beginners

Investing is a smart way to increase your net worth and build the future of your dreams. Investment options for accredited investors are many and varied. Some of the more common investment vehicles include stocks, bonds, certificates of deposit, mutual funds, and buying real estate.

But for investors who want a diversified portfolio, and a rate of return that far surpasses benchmark stock indexes, there are other, exciting — if riskier — investment opportunities to consider. 

What are they?

Alternative investments. 

These types of investments — generally hedge funds, venture capital, and private equity (PE) — are not the common, traditional investment vehicles. 

In this discussion, we will focus on one type of alternative investment — private equity investments. 

Our purpose here is to demystify PE investments and provide a comprehensive guide for beginner investors. 

As with any investment — whether it is traditional or alternative — there is a lot for an investor to know. And plenty to be wary of. This overview of PE investments will highlight the most important aspects of PE investing, but before you invest, do your due diligence and consult all legal, tax, accounting, and other professionals as needed. 

Alternative Investments in a Nutshell

The investment landscape is ever-changing. Traditionally, a portfolio made up of 60% large-cap stocks and 40% bonds was a solid investment strategy. In our current economic uncertainties and given the financial changes caused by the effects of COVID-19, that’s no longer the case. Today, an entirely different approach to investing is required.  

In response to the variable financial conditions, many investors are turning to alternative investments to realize significant returns on investment and diversify their portfolios. Some of the more commonly known alternative investments include hedge funds, venture capital, and private equity. 

Alternative investments can be unique physical assets like artwork, or they can be funds that acquire and run companies — like private equity funds. Some alternative investments are available only to accredited investors. 

Almost any investment in private assets (other than cash, stocks, or bonds) can be an “alternative investment.” Alternative funds, and private equity funds, in particular, deal in privately owned assets. These funds are not traded in the public market. They exist only in the private sector. 

According to Bloomberg, alternative investments — including private equity (discussed more fully below) — offer higher returns than investments in the public market. Plus, they provide greater portfolio diversification. These investments are not without their risks of course, but they do offer a “huge and highly varied” opportunity for sophisticated and accredited investors. 

But investing in private markets isn’t so easy to do. Most private investment opportunities are accessed through exclusive channels such as wealth management firms or between high-net-worth individual investors. 

For the most part, the high minimum investment requirements for private equity investing, which can range anywhere from hundreds of thousands of dollars to several millions — make PE investing realistic only for institutional investors such as pension funds or private equity firms, or very high-net-worth individuals.  

Nevertheless, PE investing is a very popular alternative investment.

But what, exactly, is private equity (PE), and how does it fit into the investment landscape?

Let’s see.

Private Equity Defined

At its core, private equity (PE) refers to investing in private companies that are not traded on the public stock exchange. Typically, this involves investing in private equity firms that buy and manage the companies and then sell them.   

A private equity fund is considered  a “pooled investment.” This means that the fund adviser (i.e., the PE firm) pools the capital provided by investors in the fund and uses that money to make investments on behalf of the fund. 

Unlike other investments, (for example, venture capital or hedge funds), PE funds create value by purchasing private companies or businesses, running them to increase their value, and then selling them for a profit. This typical business model differentiates PE funds from other alternative investments.

It also makes PE investing a long-term investment. 

In most PE investments, investors are required to hold onto their investments for several years — in some cases as much as 10 years or more — before they see a return on investment. 

In addition, a private equity adviser must be registered with the Securities Exchange Commission (SEC). The fund itself, however, is not registered with the SEC. This means that there will  be limited public disclosures regarding the fund itself. The impact of this is that investors do not have the same level of protections they would have if they were investing in a registered security. That’s because in addition to investor disclosures, registered securities require public disclosures regarding the fund itself and regular reporting to the SEC. In contrast, because PE funds are not registered with the SEC, the funds are not heavily regulated by the SEC and they have few, if any, standard disclosures or performance reports. Private equity investors do receive disclosures in the offering documents, of course, but PE funds are currently not required to make additional reports or disclosures throughout the lifetime of the investment. While there are proposals to require fund advisors to make periodic reports to correct for this, currently PE investments tend to be riskier than other types of investments.     

So, how does all this work?

Briefly, there are several main players in a PE fund. They are the general manager (usually the firm that establishes the fund), the fund manager, and the investors.

Typically, PE funds are set up and managed by private equity firms which are structured as Limited Partnerships (LPs). The PE firm takes on the role of general partner in the LP. Any subsidiary that manages and advises the fund is the fund manager. Finally, the investors are the limited partners. 

In short, to create the fund, a private equity firm raises capital from accredited investors. It then manages the fund on behalf of the investors in accordance with the terms and conditions specified in the limited partnership agreement (LPA), which controls the fund’s purpose and how it will be carried out. 

The general partner makes all final decisions regarding the fund’s operations. The manager is responsible for seeking out investment opportunities and developing a strategy. The limited partners (i.e., the investors), on the other hand, have no involvement in the running of the fund. Their role is limited to providing capital.

The general partners charge management fees and transaction or deal fees for the services they provide to the fund. These fees generate enormous wealth for the general partners. Investors need to be aware of these fees and how they are used. 

The Role of Private Equity in the Investment Landscape

The private equity industry has grown rapidly through the years despite economic uncertainties and downturns. The growing interest in PE stems from its potential to earn investors superior long-term returns when compared to public investments.

While the beginnings of private equity can be traced to the early 19th century, most modern PE firms emerged on the investment scene in the early 1970s. Private equity deals garnered significant attention throughout the 1970s and 1980s, and the private equity market reached its height in the 2000s.

In the years following 2000, private equity has taken a downturn and came under closer scrutiny from the SEC. Nevertheless, private equity investments continue to play a significant role in the investment landscape.  

While many feel that private equity deals have run their course and are not as attractive as they once were, at least one analyst believes that the long-term outlook for private equity may be getting even better than it was in 2021 when private equity buyouts totaled a record $1.1 trillion. 

Knowledgeable analysts believe that alternative funds provide access to the global market and the widest possible class of assets and continue to be a central part of the financial landscape.  

Who Can Participate in Private Equity Opportunities?

Private equity funds are generally only available to accredited investors and qualified clients.

Accredited investors can be entities or individuals.  

Qualified clients can include: 

• institutional investors

• university endowments

• pension funds, and  

• high income and high-net-worth individuals.

The reason PE opportunities tend to be limited to these categories of investors is that the initial investment for a private equity deal is almost always extremely high. It can range from hundreds of thousands to several million dollars. 

Additionally, PE investments may require a “capital call” or “drawdown” from investors. A “capital call” or “draw down” refers to the practice of a fund-collecting capital from the limited partners (i.e., the investors) as the need arises. Capital calls require PE investors to be able to provide the agreed-upon capital whenever it is called for — meaning, of course, that a PE investor must be able to have the necessary funds available at any time.

How is Private Equity Different from Other Investments?

As noted previously, private equity investments are considered “alternative investments.” They are not traditional investments like stocks and bonds or mutual funds.

What makes private equity investments different from other investments?

Quite a few things as it turns out. 

Here are just some of the main differences between PE investments and other typical investments: 

• Private Assets - First, one of the more obvious differences between PE investments and other investments is expressed in the name of this investment category. PE investments are investments made in privately held assets. 

While other investments are made in publicly traded stocks or bonds, PE investments are made in strictly private assets. In most cases, these private assets are privately held companies.   

• How the Fund is Structured - Private equity investments are also structured differently than traditional investments. 

Most PE business models consist of a PE firm that raises capital and invests that capital into a fund. The fund is frequently set up as a fixed-term limited partnership. The fund is then managed by the general partners (GP). The general partners are usually the firms that set up the fund. The investors who provide capital for the fund are the limited partners. The limited partners have very little say in how the fund is managed. Their role is simply to provide the capital for the fund to conduct its business. Limited partners agree to pay fees and provide capital for the fund. 

Most private equity deals are designed to take over a private company, run that company for a number of years to increase its value, and then to “exit” the deal — in other words, sell the company. At that point, the fund returns the proceeds from the sale to the investors — minus 20%.  

• Capital Calls - Unlike other fund investments, for example, mutual funds, private equity investments require investors to commit to provide a certain amount of money to the fund throughout the lifetime of the fund. Known as a “capital call,” (see above) investors agree up-front to provide capital (up to a specified amount) whenever the firm calls upon them to do so.

• Illiquidity - Another major difference between private equity investments and traditional investments is the amount of time required to hold the investment. 

Because private equity firms or funds most often buy, run, and sell private businesses, PE investments are long-term investments. It can take 10 years or more before an investor will see a return on investment. And during that time, the fund may call on its investors to provide capital at different intervals as needed. 

This combination of the longer holding periods and the capital calls makes PE investments illiquid.

• Lack of Required or Periodic Disclosures by the Fund - Yet another major difference between private equity funds and other typical investments is that because the PE funds themselves are not registered with the SEC there is less regulation of these funds. This means that PE funds typically do not have to meet the SEC public reporting requirements. PE investors do, of course, receive disclosures regarding the fund in offering documents. However, unlike publicly traded mutual funds, PE funds do not have mandatory standard disclosures or periodic reporting requirements (for example, detailed quarterly reports or disclosures regarding expenses). This renders disclosure regarding the fund’s performance during the lifetime of the fund discretionary with the general partners. 

Further, because they are privately held, the companies themselves which are the subject of the investments, are not subject to public scrutiny. That means that it can be difficult to find out much about the company itself or the PE fund. This lack of transparency and lack of disclosure makes investing in private equity risky.   

Private equity investments provide a wide range of opportunities and can be an effective tool for diversifying an investment portfolio. But they are not without their risks.

Thinking of Investing in Private Equity? Some Facts to be Aware of.

While there are plenty of factors to be considered before investing in private equity, let’s look at just some of the issues a first-time investor should be aware of before jumping into an investment opportunity. 

This isn’t a comprehensive list by any means. There are plenty of other factors an investor should consider, so be sure to consult with your securities counsel and other professionals before you invest. Do your best to educate yourself on all aspects of private equity investing and always conduct your own due diligence. 

With all that said, let’s take a look at some additional factors to consider before investing in PE. 

Capital Calls and Illiquidity of PE Investments  

Some of the same things that make PE investments different from other typical investments are the very issues an investor needs to be aware of before participating in a PE opportunity.

As mentioned above, PE investments require capital calls and are illiquid investments.

Liquid assets or investments are ones that can easily be converted to cash without materially affecting their value.  

Because private equity investments are long-term investments, it can be as much as 5 to 10 years before one will see a return on investment. Since the investor’s ability to sell is severely restricted, private equity investments are considered to be “illiquid.”   

Another fact to consider is that PE investments require investors to agree upfront to provide a certain amount of money throughout the investment period for “capital calls.”  This means that the investor must keep money available for the PE fund to use as needed.

Investors are Limited Partners

Another aspect to consider if thinking about investing in private equity is the role an investor plays in PE funds. 

Most PE funds are structured as limited partnerships (LPs). The firm establishing the PE fund is usually the general partner, relegating all investors to the role of limited partners. 

Although this structure limits the personal liability of an investor, it also means that investors have little to no say in how the fund is managed.

Fees and Charges

Another major issue that arises with PE investments is that of fees charged by the fund and conflicts of interest.

Investors in a PE fund agree up-front to pay certain fees and expenses. These fees and expenses are generally disclosed in the offering documents. However, investors need to be vigilant about what fees and expenses they are being charged and exactly how those costs are being applied to the fund they are participating in.

Not all companies fully disclose the fees and costs they are charging. In addition, fund managers may shift costs from one fund to another. 

Quite often fund managers will manage a number of funds. This can create conflicts of interest that are not disclosed to the investors. It can also lead to the misapplication of fees and charges as they get shifted from one fund to another.

Private equity investment has steadily risen in popularity over the years. Many PE deals have provided their investors with unparalleled returns on investment. However, investing in PE is not without its risks and limitations. 

Accredited investors need to be aware of the advantages and disadvantages of investing in private equity. At VerifyInvestor.com, we offer a world-class accredited investor verification service. Our services are fast, efficient, cost-effective, confidential, and reliable. We help companies fully and easily comply with their legal obligations to verify investors as accredited investors.