Raising Capital for SBRE Entrepreneurs
The Small Balance Real Estate (“SBRE”) entrepreneur, you may remember, I define as any person running a full time business that does some type of real estate asset based deal (e.g., real estate loans, direct property ownership, buying existing notes, fixing and flipping homes, etc.) on a regular, ongoing basis and who requires significant and repeated procurement of capital from investors in order to execute on this business model. There are literally tens of thousands of such people across the U.S. pursuing some asset model that suits their skills, abilities, and proclivities and for which their background, experience, and situation qualifies them in such an endeavor. What all of these people have in common (and what I believe is their biggest challenge, frustration, and constraint) is the necessity of raising capital to fund and grow their businesses. To do this really well is very hard.
It is hard for many reasons, many of which most SBRE entrepreneurs do not understand very well. Having been an SBRE entrepreneur for over 20 years now, I know firsthand the myths, the misconceptions, and the dead ends that cause much wasted time and effort, having gone down many a rabbit hole myself. I do not pretend to have all of the answers or to say that there is a single right way to do it. But I do know that there are some basic laws and truths that drive outcomes, and produce averages and statistics that one would be very wise to try to understand in order to maximize time and avoid dead ends and rabbit holes as frequently as possible. Trying to help people understand these ideas, and the reasons raising capital proves to be difficult for many of them, is at the heart of our objective as a business at Fairway America.
As a starting point to effective capital raising, one must first consider his asset model and then and only then, consider his capital structure(s) to fund that asset model. A mismatch between asset model and capital structure often exists and can greatly contribute to the difficulty in getting investors to say yes consistently, especially once our SBRE entrepreneur has reached the point where he is required to go beyond his circle of influence and find investors who do not know him well and are investing based purely on personal trust. There are a few basic capital structures that can be deployed and they each have their strengths and weaknesses, pluses and minuses. I find that many SBRE entrepreneurs do not grasp the differences between these capital structures and when one vs. another makes sense or does not, or what the real world, downstream implications are for each. Let me walk through the various capital structures starting from the most basic and working toward the more sophisticated and complex.
There are multiple ways an SBRE entrepreneur, again depending on his asset model, can capitalize deals. He can borrow money – from a bank, from a hard money lender, from a relative or friend – or he can take on equity for his project(s). At the most basic level, our SBRE entrepreneur gets capital – either debt or equity, or sometimes both – from a single source. This is often the case with small deal sizes and in the early days of our entrepreneur’s business life. People new to any given SBRE asset model often start here when they are only doing a deal here and there. This capital model is not particularly hard to structure or to understand, but it does tend to be very limiting in terms of being able to grow a business. The next rung up is to take in multiple investors in a single deal. When buying property this is called syndication. When making loans using multiple people in one trust deed, it is called “fractionalizing.” The SBRE entrepreneur may still use both debt and equity for such a deal, especially in the case of direct property ownership (and sometimes when making loans, as in the case of a warehouse or collateral pledge line), create a single purpose LLC, and get the rest of the capital in the form of equity from several investors who become the owners of that LLC with the SBRE entrepreneur as the LLC’s manager. This is more complex, requires additional documentation, and is perfectly appropriate for certain types of deals. As SBRE entrepreneurs move from being newbies in the business to doing more deals more often, this is frequently, and appropriately, the direction they go.
As their infrastructure and capacity to originate product continues to grow, this model can become quite unwieldy and SBRE entrepreneurs often seek other ways to do it. At that point there are two basic ways to go – a pooled investment fund where the SBRE entrepreneur (who I may also refer to as the “Manager” or the “Sponsor”) gets to make the asset decisions autonomously (often called a blind pool), or a “managed account,” where a single large investor (such as a family office, a hedge fund, or other quite sophisticated investor) provides 100% (or close to that figure) of the capital and the SBRE entrepreneur “manages” that capital. These are the two most common models for what I would call the seasoned SBRE entrepreneur (someone who has been doing deals for a significant period of time and who has strong origination capacity) and they are very, very different. In a managed account scenario, the Manager/Sponsor finds the deals, makes recommendations, maybe has the latitude to pull the trigger on deals within some guidelines or boundaries, and then manages the asset after origination or acquisition. He typically gets a management fee and some back-end profit split after the investor has made some preferred return and recovered his capital. In a blind pool, the Manager/Sponsor has the autonomy to make decisions independently and the investors are just buying shares of the pooled investment fund (or lending to that pooled investment fund). In either scenario, the Manager/Sponsor may choose to use debt, either at the asset level or at the fund level as the case may be, to help reduce the amount of equity necessary to close a deal (or deals). Each of these options has their own pluses and minuses and neither is inherently “good” or “bad,” they are simply different and in fact they are very, very different. (Search "Capital Raising" on this website to read additional blogs focused on capitalizing an SBRE business including the use of debt, leverage, warehouse lines, and credit facilities.)
Depending on what stage of your life as an SBRE entrepreneur you are, as well as your personality and natural style, one or more of these options may be better or worse for you at any given point in your development. How do you know when the one investor model is best? When does it make sense to syndicate or fractionalize? Should you pursue a managed account? Should you set up a blind pool fund? If you do, what issues do you need to know about? Should you use debt? If so, what type? Can you even get it? On what terms? Depending on which route you are going, what are the ways to attract investors (especially those beyond your personal circle or network)? Can you take in foreign money? Self-directed IRA money? When is the best time to move from one capital structure to the next? If you do move, what issues and challenges await you? How do you avoid landmines and proceed as quickly as possible? The answers to these questions are not easy to find and they are different for each person (although the same principles apply to different situations so this makes it easier to predict what will and will not be likely to work if one knows what to look for). Shedding light on these issues, providing answers to these questions (and more), and helping take SBRE entrepreneurs to higher levels of success is our mission.
To navigate the world of raising capital effectively for an SBRE entrepreneur is often the supreme test of his abilities as a business person, much more so than the other side of the equation which tends to be far more focused upon and better understood. Think of running your SBRE business like using a giant apothecary scale, with “deals” in the one bowl of the scale and “capital” in the other. In order to balance the scale at any given time, care and attention needs to be given equally to both bowls of the delicate mechanism, lest one side weigh down the other. For many SBRE entrepreneurs, the deal bowl of the scale is most often the one that weighs down the capital bowl. Yet there are huge amounts of capital out there looking for attractive, well-secured returns. How to best keep the capital bowl in balance with the deal bowl is a conundrum which can be analyzed, pursued, and studied for a lifetime and still requires more analysis, pursuit, and study to keep the bowls in balance as your business, life, and objectives evolve over time. Our business is to help you understand and manage the more difficult and arcane of the bowls in order to achieve the balance, and ultimately the success, you seek.
Matt Burk is founder and CEO of Fairway America, LLC, and SBREfunds.com, and Chief Investment Officer of Fairway’s two proprietary nationwide small balance real estate (SBRE) asset based pooled investment funds, Fairway America Fund VI, LLC, and Fairway America Fund VII LP. Fairway is the nation’s premier consulting, advisory, and investment firm in the SBRE private pooled investment fund space, providing a full spectrum of practical, real world products and services (including capital) needed for true success for SBRE entrepreneurs all over the U.S. Matt is a highly regarded adviser, consultant, and mentor to dozens of SBRE fund managers and author of a widely read blog followed by serious SBRE entrepreneurs and investors. For over 20 years, Matt has led Fairway’s deal underwriting as well as capital raising efforts in Fairway’s seven proprietary funds and individual trust deed investments, resulting in more than $250,000,000 in capital raised from accredited investors through more than 1,000 SBRE deals. He is currently working on multiple SBRE fund consulting engagements nationwide, authoring a book on how to raise capital for and effectively manage pooled investment funds, and dedicating his efforts to create greater awareness and drive more capital to the many high caliber and deserving SBRE entrepreneurs around the U.S.