Last week, I introduced self storage Fundraising 101 and discussed three main types of raising capital for self storage investments.
I have organized this large and complicated world of fundraising into three main buckets, syndications, joint ventures, and funds (or private placements).
Some may question, like, why those categories? To some, it may seem too broad, given the vast differences between types of syndications, joint ventures, and private placements.
I am sure they are right, but that is how I have them organized in my head, so that is how they came out on paper.
Today, let’s look closer into the world of syndications.
Attorneys
Before I go any further, the most important team member for you in the world of syndications is your attorney.
I always recommend this before I start working with anyone doing their first syndication or any fundraising deal to get a competent attorney to guide them.
I am looking for someone who has experience in “syndications” and/or “private placements.” Those are the words I use.
If you have no idea where to start, start with your real estate attorney. Many of them have that experience, but if they don’t, ask them to refer you to someone who does.
Interview a few. I suggest your attorney relationship be designed as a long-term relationship whereby the lawyer knows your long-term goals and how any first or next deal you are considering fits into your long-range picture.
That way, they can best help you structure a deal, the documents, and what you present to potential investors in a way that complies with the law and helps achieve your current and long-term investment goals.
Syndications
So, when I say syndication, what do I mean?
It is the formation of a deal-specific group of people divided into two main groups, sponsors and investors.
There may be different classes of sponsors and different classes of investors, but in general, there are two main groups of people in syndication.
Sometimes they are called limited partners (LPs) (investors) and general partners (GPs) (sponsors).
In general, sponsors find deals, underwrite the deals, figure out the value-add play, if any, oversee the ongoing management of the asset, sometimes manage the operations of the asset (or oversee the management company managing the asset), and manage the LLC or company holding the asset.
Sponsors are usually on the loan, or if a non-recourse loan (one with no person or persons guaranteeing the loan), they secure the financing.
Investors usually put up the equity or cash needed in the deal.
Usually, syndications are deal specific. In other words, the sponsors get control of a specific facility or development opportunity, underwrite that deal, and cause the syndication to be put together, as well as present to potential investors.
Potential investors can say yes or no to that specific deal. If they say yes, their cash purchases a specific amount of ownership in the syndication entity, usually an LLC today.
In the last episode, I described what I am seeing today as a typical syndication today:
- Sponsors own 50% of LLC shares.
- Investors own 50% of LLC shares.
- Investors get a preferred return. Today 8% is not uncommon.
- Any unpaid preferred return year-by-year accrues and is paid to investors before sponsors receive any of the cash flow.
- If a liquidity event happens (i.e., let’s say, a refinance which generates cash), the investors usually get any unpaid preferred return first, then the balance of proceeds is split according to LLC ownership.
- On the sale and disposition of the asset, same as above, only the loan is paid first, then any unpaid preferred return, then excess cash proceeds are split according to the LLC ownership shares.
The above is a simple explanation of what a syndication could look like.
Yes, it may be too simple.
Let’s add some variations I have seen or been involved with.
I am currently involved in some syndications that have two classes of investors, Class A and B investors, or sometimes classified as Class A-1 & A-2 investors.
In the deals I am in, the Class B investors have ownership in the LLC and get a preferred return, let’s say, 8%, as above. If we are raising $1,000,000, this class may account for, let’s say, $700,000 of the funds raised.
The remaining $300,000 will come from the Class A investors. They get no ownership in the LLC and none of the upsides but will receive a 12% return on their investments. We pay it regardless of the performance of the asset.
It looks and feels like debt.
We can also pay them off at any point we want.
Some call this mezzanine debt or form a separate mezzanine fund for a portion of the equity raised.
This usually places more of a burden on the sponsors at the beginning of the deal but allows them to participate more in the profit created.
It works well with value-add plays.
We will also structure the deals so that once the investor’s IRR on the disposition of the asset reaches, let’s say, 15% (IRR is the cash flows and disposition sales proceeds combined to calculate an average annual yield on the cash they invested in the deal), the sponsors’ percentage of the remaining net sales proceeds will increase as a reward for exceeding the initial projections.
Flips or Conversions
I had a different twist on our syndications when we started.
I would structure the LLC as follows:
- Sponsors own 70% of LLC shares.
- Investors own 30% of LLC shares.
- Investors get a minimum preferred return. Today 8% is not uncommon.
- Investors also received most of the cash flow over the preferred return, if there was any, reducing the capital account we owed them back. They would receive up to 90% of the cash flow while their money was in the deal.
- In other words, if an investor put in $100,000 with an 8% preferred, and the project distributed $10,000 of cash flow to them in year three, when we paid them their initial capital back, it was reduced by the $2,000 extra they received in year three.
- The investors had preferred rights as long as their money was invested in the deal, such as unanimous consent being required to put more debt on the property or to sell it.
- Once we (the sponsors) executed our value-add play and were stabilized, we would refinance the deal and pay the investors their cash investment back (any unpaid preferred return).
- That was called the “conversion.” Some call this a “flip.”
- After the conversions (i.e., investors have their money back and preferred return), their preferred return and preferred rights go away. From then on, they get 30% of the cash flow and 30% of the sales proceeds when sold. The sponsors get 70% of each flowing the conversion.
It was a way we could get investors to feel safe. We told them we did not participate in the cash flow until they were whole and received their preferred return. They knew we were motivated to make the deal work so we could start getting money.
It allowed us to use other people’s money to build a portfolio that once the value add plays were done, we received the majority of the cash flow and sales proceeds.
It worked well for us, but many people I have coached say they have a hard time selling the 70% to the sponsors. For whatever reason, I was able to sell it, but many do not seem to be able to.
Again, I would say defer to what your attorney says and follow their lead.
I would also act like an investor or be one in other people’s deals to see what they are doing right and wrong.
Conclusion
For many of us, using other people’s money is the only way we can get into the self storage business.
Fundraising has evolved fast over the last ten years.
Crowdsourcing and using the internet to promote investment opportunities; all of these were not around when I started. If you advertised or promoted syndication, you had broken the law when I started.
Your team is very important, especially your attorney.
But just like the world of self storage had to be learned, so does the world of fundraising. Dive in if it is part of your business strategy.
This has been a brief look at some types of syndications.
The different structures are endless.
I will soon have an online training out that will go into more detail. The training will be designed for the small investor in self storage businesses specifically.
If you are interested in it, let me know, or keep an eye peeled for an email from me letting you know you can learn more about it.
Thanks, and I look forward to diving deeper into fundraising with you if you are interested.
