Evaluating a debt fund investment from someone with 20 years in equity but no origination track record

A gate means the fund can limit how much comes out in any one redemption window. So if a lot of LPs ask for money back in the same quarter, the fund pays out up to a cap, say 5 percent of net asset value, and everyone gets a pro rata slice of that cap with the rest queued to the next quarter. It exists because the fund's assets are loans that mature on their own schedule and can't be sold quickly at par. Which means quarterly liquidity is real in a normal quarter and gone in the quarter it would be most wanted. Ask for the exact gate language and the notice period, in writing.

"He's an equity guy who hired someone who has done this" and the hire hasn't been met yet. Meet the hire. That's not optional at $100k.

Some questions worth answering before committing capital to something like this, and it pays to ask a lot of them before doing anything. How are the loans priced and how does a 9 percent distribution to the investor come out of the borrower rate? If borrowers pay 11 and the fund charges 1 percent plus takes carry over an 8 percent pref, work out where the 9 comes from and whether it survives one loan going bad. Is the fund using a credit facility to boost returns? A debt fund borrowing to lend changes the risk profile substantially, and that detail is often in the documents rather than the pitch. What's the concentration limit per borrower and per loan? One loan at 8 percent of the fund is a different risk than one at 25 percent. What does the loan to value get measured against, the as-is value or the stabilized value? 70 percent of a stabilized appraisal on a building that isn't stabilized yet is a much thinner cushion than it sounds.

@ehernandez74 that last point is the one I'd underline. As-is versus as-completed changes the whole meaning of 65 to 70 percent, and different lenders use the terms loosely in marketing material.

I'm reading everything twice at the moment and this thread is helping. Can someone explain the difference between the 9 percent current pay and the 8 percent pref? They sound like the same number to me but they're both listed.

@kevin_lombard the 8 percent pref is the hurdle. LPs get paid up to 8 percent a year before the manager takes any share of profit. The 9 percent current pay is what the fund is aiming to distribute in cash each quarter. So if they hit 9, the first 8 goes to LPs alone and the manager starts sharing above that. If they only earn 6, the manager gets nothing on carry and the shortfall may or may not accrue depending on whether the pref is cumulative. @monica_tran3 it's worth finding out whether it's cumulative, that word matters.

Is 9 percent good? I have no reference point, so I genuinely can't tell. Compared to what?

@jessreyes12 compared to what can be gotten on senior secured multifamily paper from someone with an actual origination history, which is the whole point. A first-time manager offering the same headline number as an established one is asking an investor to take extra risk for the same pay. That's the argument to have with him, and it's the strongest position @monica_tran3 has raised, since the client relationship runs both ways.

The quarterly cash is why this appeals, and the appeal is understandable. But the question to ask is whether the distributions are paid out of interest actually collected or out of accrued interest that hasn't arrived. Some bridge loans capitalize interest, which means the borrower isn't paying monthly and the fund is distributing cash from somewhere else. That works until it doesn't.

Fourteen months of profit from a business you run yourself, into a first time fund managed by a client. Think about what happens to the client relationship if the fund underperforms and you're both sitting on that. The usual version of this story ends with the account gone and the money taking something like three years to come back, and the account is often the more expensive loss of the two.

Halve it. If the minimum is $100k, ask whether he'll take $50k from you as a smaller commitment, and if he won't, that also tells you something about how the raise is going. Patience is usually free in this business.

@karen_whitfield I'd read a hard no on that differently. On a $50M raise, a sponsor holding the minimum firm across 100 plus investors is normal administration, not desperation.

@monica_tran3 here's what I'd push on: get the loan tape from whatever he's done so far, even if it's warehoused loans made off his balance sheet before the fund closed. First-time funds often season a few deals first. Two or three actual loans with real borrowers and real payment histories is worth more than the whole deck. And have a securities attorney read the documents before you commit anything.