Adopting these approaches will help reduce your liabilities and foster success.
Managing a private lending fund is not easy. You need the help of accountants, compliance experts and, of course, reliable salespeople to ensure that your fund operates efficiently and continues to grow.
So, what are the key factors to operating a successful fund? First and foremost on your list should be reducing liability. Many tasks go into fund management, but most should be focused on running a compliant operation that reduces risk and promotes profitability. That is what every fund manager strives for. Accomplishing this feat takes a consistent and well-considered approach.
Let’s look at six key areas where you can improve your fund and reduce your liabilities.
1 Investor Communications
In the realm of fund management, the No. 1 reason for investor liability is poor investor communication. The No. 1 investor complaint is “I didn’t know that.” Why is that the case? Because the sponsor or fund manager did not properly communicate the ups and downs of the fund’s performance and did not adequately communicate their plan to resolve the downs, or how to continue the ups.
In today’s world, quickly communicating with clients is easy, but it has also become somewhat impersonal. Emailed statements, disclosures and updates on smartphones are all great, but the best fund managers incorporate a personal touch.
One practical solution is to improve the quality and frequency of investor reporting. The best fund managers will deliver institutional quality reports about the performance of the fund. This includes key metrics such as average interest rate, loan-to-value (LTV), property types by percentage, fund ROI, investor ROI and foreclosure/default rates. It will also include a very straightforward message (1) addressing the fund manager’s plans to continue success and resolve distressed assets and (2) outlining key initiatives for growth.
One more practical solution is to add a personal touch and be more intentional with your investors. Try a simple task: allocate one hour a week on your calendar to call three or four investors, just to talk and answer questions.
Improving the investor experience creates happier investors and increases the likelihood they will invest more.
2 Fiduciary Duty
There are several different types of funds and investment vehicles in the private lending space. Some may have complex business models or multiple business arms associated with the fund. This is a smart approach to increase diversification and provide hedging opportunities for a competitive marketplace. However, there are many situations where actual or perceived conflicts of interests can arise.
A properly constructed private placement memorandum (PPM) can reduce risk by disclosing potential conflicts and waiving certain conflicts that may arise. However, no matter how well drafted your PPM is, the No. 1 tenet is always to put the investors’ interests first. This is tantamount to executing the fiduciary duty imposed on a fund manager or sponsor by local corporate laws and federal securities laws.
When facing a potential conflict, the best question to ask is: “Is this in the best interests of the investors?” Taking back REO to the exclusion of the fund, lending outside of the fund, lending to an affiliate or doing deals in another fund managed by the fund manager all raise these issues.
Whether the fund manager’s action results in a loss to the fund or a profit, transparency will set you free. Clearly disclosing the conflicts that will arise is always a good idea, but also disclosing the plan of action when the conflict arises is an even better one. This transparency is expected and is part of the equation. However, not disclosing certain actions could lead to animosity or apprehension among the fund’s investors, and that is never a good thing.
How do fund managers ensure they are properly managing a conflict? First, is this conflict addressed in the PPM? If so, does it outline a plan of action? If not, it is important to present an action plan that is equitable to investors, puts their interests first and is committed to in the future.
Fund manager’s need to walk-in the shoes of the investor and evaluate things from their perspective. If you would not do something as an investor, you should not do it as a manager. Most managers are ambitious and want to grow their fund, to make it more efficient and profitable. However, crossing lines to chase quick returns does nothing for your bottom line except create acrimony and distrust among fund investors. Stepping back and questioning your decisions against your client’s best interest is key to reducing risk and earning trust.
3 Don’t Cut Corners
Fund managers are always thinking of the profitability of their fund and long-term growth. But sometimes eagerness gets in the way of prudence, and a manager will try to take a shortcut to save on costs and maximize income.
Today’s regulation-heavy environment for all things financial has made it increasingly difficult to know how to operate within the white lines without drowning in red tape. Compliance is not merely an afterthought, but a necessity. So, an ounce of prevention goes a long way.
You could do a hundred things right, but one wrong turn could spell disaster. Make it a priority to engage with a competent compliance attorney to ensure your lending business and your fund comply not just at formation, but on an ongoing basis. Investing in the right compliance team can help you avoid mistakes, reduce your risk exposure and prevent engaging in a business that places you and your investors at risk.
4 Don’t Test The PPM
Misrepresentation of facts is primarily a legal term used in securities circles, but it is a crucial reason funds use a private placement memorandum or offering circular and prospectus. A PPM is designed to disclose the nature of your business, assess risk and disclose potential returns and restrictions.
Often, fund managers choose to test the limits of their PPM. If there is an opportunity presented that is outside of the PPM or circular, fund managers often engage in “side deals” that may lead to omissions or misrepresentations. Side deals are often determined legally to be of “material fact,” and if these facts are not disclosed in offering documents, an investor may make accusations as to omission of facts.
Many side deals may be acceptable, if they are disclosed to the fund’s investors. If you wait for an investor to ask about a side deal, it could open the fund to scrutiny on all its dealings. Once one investor gets a side deal with better benefits than other investors, it will not be long before others are asking for the same deal. Pretty soon, you are changing terms to meet the demands of your investors for fear of losing them.
It is sometimes challenging for fund managers to stick to the original terms of their offering for all investors, but holding everyone to the same rules will, in the long run, reduce your risk of misrepresentation, earn the loyalty of current investors and attract new institutional investors.
Financial reporting is a critical aspect of any managed fund. Even if you do everything right, one mistake, misstatement or incorrect servicing report can put you at risk to lose all credibility with your clients. The most important thing to investors is their statement. If inaccuracies occur, no matter how insignificant, it opens your underwriting, loan management and servicing to investor scrutiny and questions.
First and foremost, it is prudent to look over your accounting statements. Numbers from previous months should be compared against the current account. Any numbers that stand out as new or excessive should be reviewed and evaluated to find out what caused the discrepancy. Discrepancies should be verified and corroborated and, if necessary, audited to ensure they are accurate.
Another way to ensure the integrity of your accounting is to use a third-party accounting firm. Many fund managers loathe paying a monthly fee to an outside firm when they could just as easily hire an in-house accounting manager. However, an outside accounting firm can lend credibility to your fund as a sort of independent reconciliation firm to validate your numbers.
There are experts who can help reduce investor liability by handling the day to day accounting tasks, along with reducing the time it takes to produce monthly accounting statements.
6 Making Your Compliance Count
Although most fund managers and private lenders make compliance a priority, the devil is in the details, as they say. With a new administration and a rapidly changing regulatory environment, it is impossible for a fund manager to stay up to date on new legislation and new rules.
Whether it is investor communications, accounting, reporting or servicing, there are areas where being out of compliance could spell disaster for your fund. It is not all about getting good people to work for you, although that is part of the equation. It’s about aligning yourself with service providers to assist with accounting, auditing, servicing, compliance and reporting functions.
These partnerships will not only help relieve the stress of day-to-day management but ensure that you reduce investor liability and increase the likelihood of continued success.