As a small investor who raises money for equity in the deals I do and as a self storage coach who helps people get into the self storage business who often have to raise money, I have seen a lot of deals and deal structures.
Of all the training I have attempted to systematize and create, “fundraising” has been the most difficult for me to organize and present in a digestible way.
The “world of fundraising” is a big world.
When entering this world, I heard lots of terms…
- Capital stack.
- Mezzanine debt (mez debt)
- Preferred returns
- Equity tranches
- Class A & Class B equity
- Common members
- Waterfalls
- IRR
And on and on….and on.
I will soon release an online training called Fundraising For The Small Self Storage Investor. Still, I thought a general overview of the fundraising deal structures might be helpful for everyone.
The only way I know how to share ideas is to share, to some degree, the mental process I go through when trying to understand something (my thinking has often proven to be a dangerous place to hang out, so be careful).
In general, I try to take complex ideas and dumb them down so I can understand them.
Let me do that by discussing four main deal structure types, three of which I relate to a fundraising.
Common Equity Deals
Nothing magic about that name. It just makes sense to me, but a private placement attorney or syndication attorney may call this something different.
Technically it is fundraising, but I don’t relate to it like that.
This is a deal where every party, including you, puts in money for equity and shares in the deal’s ownership based on how much money you put in.
Everyone is generally on loan as well.
There is no special way cashflows, refinance proceeds, or sales proceeds are split. Each member gets their prorated portion of the deal.
Example:
| Amount | % of Ownership | |
|---|---|---|
| Deal: | $3,000,000 | |
| Loan: | $2,250,000 | 75% loan to value |
| Equity: | $750,000 | |
| Your Investment: | $375,000 | 50% ownership |
| Partner A: | $375,000 | 50% ownership |
Although technically, you are presenting a deal to Partner A, in essence, you are seeking a partner (or partners) as opposed to an investor. Each will participate equally in the cash investment, the risk, the cash flows, and the upside.
I relate to this as finding a partner, not fundraising.
But it is a common and good deal structure.
For the balance of this series on “fundraising,” I am going to (dumbed down version) discuss three main types of deal structures.
For the most part, these are my terms and may not be the correct legal or technical terms most used by professionals in the fundraising world.
In short, I think there are three main buckets of deal types I have seen people utilize in putting deals together, other than the common equity structure discussed above. I will call them.
- Syndications – one-off deals an investor can say yes or no t
- Joint Ventures.
- Private Placements or Fund Structures.
There are endless variations of each.
In the next three episodes, I will discuss each in more detail, but let me introduce them here.
Syndications
For the small investor, this is the most common type of fundraising I see used. It is what I used to get started.
In general, there are two main types of members in the deal. Usually, you or your team, I will call “sponsors,” and the money people in the deal, the “investors.”
Usually, the sponsors find the deal, underwrite the deal, raise the money, manage or oversee the management of the asset, and manage or oversee the management of the financials and financial reporting to the inventors.
The sponsors are the ones on loan in most cases.
The inventors put in the equity (cash in the deal).
They are usually not on the loan. What they have at risk is their cash. Sponsors are usually responsible for the loan.
In almost all cases, since the investors put up the cash, they get a “preferred return.”
In other words, they get the first cash out from the cash flow, or other liquidity events (events that generate cash such as refinance proceeds or sales proceeds).
Today, it is not uncommon to see an “8% preferred return” on storage deals (I see it going up again as interest rates rise).
So, if the equity raised is $750,000, as in the deal above, the first $60,000 in cash flow goes to the investors.
In most cases, if the project does not spin off $60,000 in cash flow, as is often the case in value-add plays in the first few years, what is not paid to the investors is usually accrued (owed to investors and paid later, but before sponsors get any of the cash flow).
It can be accrued with or without interest. Mostly I see without interest.
There are endless variations to these deal structures such as Class A and Class B “investor” designations, liquity events that alter cashflow disbursements or LLC ownerships, and on and on.
I will mention a few and give details in later episodes and much more detail in the upcoming training.
However, today for most small investors starting out in this world of fundraising, usually see something like a 50% LLC ownership to the sponsors and 50% to the investors.
After the first 8% of preferred return is distributed to the investors in the case of an ‘8% preferred return,” the remaining cash flow is usually distributed according to the LLC percentage ownership. Sometimes I see sponsors getting the next 8% in cash flow, then anything over that is split according to LLC ownership.
Syndications are deal specific. The investors say yes, I want to invest in that deal as opposed to giving money to a sponsor to invest in deals they will find later, as is the case in most funds.
Joint Ventures
I have helped a few people get into joint ventures instead of syndicating a deal.
I have also been, and am currently, a joint venture partner of the sponsor side of some deals, both in and outside of the storage industry.
Typically, with the few people I have worked with and helped find a joint venture partner, there is one joint venture partner in the deal.
The deals I have done look something like this:
- Joint venture partners put up 90% of the equity.
- The sponsor puts 10% of the equity in the deal.
- The sponsor is on the loan. Sometimes the joint venture partner also goes on loan during the construction phase or value add phase of a deal.
- The joint venture partner owns 50%, sponsor owns 50%.
The advantage of this structure for a person getting into the self storage business is that the joint venture partner usually has more experience. A new person can learn a lot and piggyback off the joint venture partner.
The downside is sponsors lose a lot of control.
In the few I have helped in, the joint venture partner decides who the management company will be, who manages the money, who does the asset management, etc.
The joint venture partner usually wants to see the sponsor be strong enough to guarantee a loan, and put in some of the equity, and they have very tight perimeters in the type of deal they will joint venture in.
The ones I have been involved in were all new construction and multi-story 100% climate control deals in major markets.
Extra Space, to my understanding, has joint ventured before, but they want the sponsor to be in the storage business and they say they won’t joint venture on someone’s first deal.
This a good way for someone who has little experience in storage and is constructing an institutional-grade project, and is willing to give up a lot of control and ownership to learn.
Of course, there are also an endless variety of ways joint ventures can be structured. You could have a joint venture sponsor partner, then syndicate the deal.
Private Placements and/or Fund Structures
This is a big world inside the storage and real estate business.
Open any industry website or magazine, and you will see something like this:
We have sold a number of our projects to Prime Group.
These people raise money, usually in “blind pools.” This just means you invest with a fund, not in a specific deal.
Sometimes smaller funds will have deals to look at. Still, usually, investors just put their cash into the fund, and the fund manager or directors buys, sell, and manage the assets and pay a minimum specific return to the investors.
I have also been an investor in a fund before.
This is usually done by people who have started off syndicating deals, got some traction, then use this structure to really grow.
Although there is, again, an endless variety o= deal structures, here is a typical one. The fund purchases a project, then:
- Sponsors own 20% of the fund or asset.
- Investors own 80%.
- Sponsors are on loan if needed. Often, they are big enough to have financial instruments that allow them to purchase, then refinance and put a non-recourse loan on when the project is stabilized if new construction or value-add-play.
- Investors get a preferred return.
- After the preferred return, cash flow is distributed according to LLC ownership percentages.
However, in funds, the sponsor usually makes more ‘fees” than in typical syndications or joint ventures.
Fees can include some, usually not all, of the following fees:
- Acquisition fee.
- Ongoing asset management fee.
- Financing fees.
- Construction management fees if construction is involved.
- Disposition fee.
This is a partial list, but these fees can be significant to sponsors due to the cost of running a fund.
I have seen a few people try to get into the self storage business using a fund structure but have never seen it succeed.
Some funds take money from institutional money managers (people who manage other people’s money). Some only deal with retail investors, like sponsors who do syndications.
When people say, “a lot of cash has flowed into the self storage space over the past decade,” this is where the majority of it has flowed.
This is a heavily regulated corner of the fundraising industry, so venture into it if you want to only with top-notch CPAs, Attorneys, and other team members.
Again, I would not go here until you have some experience doing deals, a track record you can point to, and a first-class team behind you.
Conclusion
This is a very broad-brush attempt to peer into the world of fundraising from a small investor’s perspective.
I will go into more detail in the next episodes and do a deep dive into my course, but I get a lot of questions in the boot camps and coaching about raising money.
This is how I explain it, and though it may be of interest to the followers of these episodes.
For many of us, fundraising is critical to our success, so the more we learn, the better.
