...By Warren Kirshenbaum
How is a Distressed Asset Investment Fund set up? First, you need legal advice and consultation throughout the entire process. The laws, disclosure requirements, and particulars of each Fund are different. However, here is a legal guide. This is only a guide and should not be considered legal counsel.
This Legal Guide is meant to be educational and informative and discusses general legal principles; however, it should be used for informational purposes only.
Many assets have become distressed due to high vacancy rates, inability to refinance existing debt, depletion of reserves, and disrepair. This, along with the decline in the real estate market, have made these assets more affordable. But the capital funding needed to acquire, rehabilitate and reposition these assets is more difficult to obtain. Here are the basic steps and principles involved in the set-up of a Distressed Asset Investment Fund.
Step 1: Know your purpose.
In the current credit market environment, the traditional means of financing an acquisition of distressed assets have become difficult. Consider a strategy that includes successfully completing a private equity offering into a fund-type entity that will utilize its assets to acquire, rehabilitate and reposition distressed assets for cash flow (rentals) and residual proceeds (sales). These ownership entities have a greater chance of obtaining financing than individual or corporate borrowers, and are also able to occupy a better position as a buyer of distressed assets due to the fund's capitalization.
Step 2: Create a Set of Offering Documents.
What needs to be achieved is a private equity offering that meets the requirements of the 1993 Securities Act, and the applicable state securities statutes, also referred to as the Blue Sky laws. These are the "securities laws", that require you to prepare a set of offering documents that clearly lay out your plan, the risks involved, your financial assumptions, and the projected returns investors could achieve. They should also included a series of full and adequate precautions ensuring that the investment is appropriate for the investors, and that the investors are appropriate for the particular investment, given their financial sophistication, net worth or earnings capacity, size of investment, and the relativity of the risk to their tolerance for such risk. This is where you separate investors as either "accredited" or "non-accredited" as that term is defined in the Statute. You should also create a corporate structure that will receive the funds, and hold the investments.
Step 3: Raise Capital.
This is easier said than done. You need a full and legally adequate set of offering documents that will present the investment to accredited investors so that have a clear understanding of the investment, your business plan, the risks involved, and whether or not they will be able to have access to their capital. Your business plan needs to be well thought out and detailed. It is also helpful to have identified, and secured the commitments of the people who are to act as your management team.
Step 4: Identify appropriate investment opportunities.
Stick to the parameters that you identified in your business plan and the asset investment requirements that you committed to in your offering documents. Use industry sources, and other such information to source and identify appropriate investment opportunities for your fund.
Step 5: Make sure that you are capable of rehabilitating the assets and repositioning them in the marketplace.
Most distressed assets are deteriorated and will need rehabilitation. You will need to have access to a general contractor and construction related expertise, and an attorney to draft contracts that define the process, the payments, and the job. Eventually, you will either be holding the property for rental and will need a property manager, and a leasing staff, including your business attorney to draft leasing documentation; or you will be looking to sell the property and reinvest the proceeds in another appropriate asset, which will require finding a buyer and closing the sale.
Step 6: Keep your investors informed and create a compliance/administrative operation.
You will need to manage investor disbursements if this was promised in your offering documents, investor and property tax considerations, ensure you have adequate working capital for property repair, management, and additional capital investment, and ensure that you are in compliance with property management requirements, tax payments, investor questions and reports. This will require adequate management and compliance skills, as well as professional accounting and legal assistance, for both purchases and sales of assets, as well as for leasing, eviction issues, disputes, insurance issues, injuries, and other daily property management concerns.