Bridger Payson breaks down how equity and debt investors fund real estate deals differently. Equity investors get a 2% management fee, 8% preferred return, and 80/20 split on profits above that, so a 35% fund return nets them roughly 26%. Debt investors receive a fixed interest rate regardless of performance but get paid first, protecting them from downside while the fund must cover debt payments even in weak years.
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Hey, welcome back to the show. My name is Bridger Payson. Today we're going to talk about debt versus equity investors inside of your fund. Now, if you're new to this channel, I've launched two funds in my twenties. We're launching a third fund right now. We've helped over four thousand people get started in the fund game. That's what we do. We eat, sleep, and drink funds. That's what we do on this channel. So welcome in. Good to see you guys. So if you've seen some of our other videos, you guys understand basic fund structure. Actually, but this as well. This is also true for syndications, for other type of fundraising vehicles. You can determine if again you want debt or equity. Now, another note too, you don't have to choose one or the other. You can have both. So let me explain this to you guys real quick. So a lot of you have seen this outline in our other videos. We have a general partner and we have a limited partnership or fund. I'm just going to put fund right here in small. This is our fund or our limited partnership. And then we will have investors or limited partners over here put money into the fund. And if that doesn't make sense for you, go check out other videos. We've got awesome stuff that teaches you all about how this is structured. So today though, we're talking about this little piece right here. You have limited partners. That want to come in. Now typically, what we talk about is the equity side of things. Investor would come in, a limited partner, they pay a lot of times a 2% management fee, and then you'll do some kind of carried interest split. So a lot of times we talk about doing an 8% pref, so first 8% would go to the investor, and then above that you'd split like 80/20. 80% to the investor, 20% to the general partner. Now with equity investors, this allows for them to make a lot of money and a little money depending on how well your fund does. So if this year your fund does really well and you guys made a, you know, 35% return, you'd pay a 2% management fee, first 8% would go to investors and then you'd split 80/20. And investors could take home in this scenario, I don't know if they have the exact math, would be around 26%. On the other side of the coin, if you guys did bad this year, maybe this year you only made 4%, you know, you had a pretty sad year, you know, it just didn't work out for you on the investing side of things, investors Depending on how you're set up, you charge a 2% management fee and they would take the remainder. You would not make anything else. No performance fees in this fund. Again, these are for equity investors. They are taking the risk with you. They're risking their dollars putting that forward. Now, debt investors are a little different. Debt investors come in and essentially what it looks like is they are giving a loan to the fund. They're going to give a loan of $1 million to the fund and the fund is going to promise to pay them back, let's call it 8% a year no matter what. So if this year we did 35%, they would still only make 8%. If this year we only— we did 4%, they would still make 8%. So you'd be bleeding even further if you didn't hit that hurdle mark. It doesn't matter how good or bad the fund is doing, they're going to collect their check every single quarter. So a lot of times when I sit down with people, we've helped a lot of people launch funds, I ask them, do you want to raise from debt or equity or both? A debt investor will be cheaper money if you perform well. See, instead of giving 26% to your investors, if the fund made 35%, you would only give 8% to your investor and you would keep the rest. So you'd make way more money in this type of scenario. Now let me tell you what I typically see in funds. Number 1, I typically see just straight equity. A lot of funds just do equity investors. Now some funds as they grow, they'll also raise from debt and typically the debt is smaller. So in their fund, we got their fund right here. Well, What they'll do is say, hey, we're going to raise 20% of the capital we raise is going to be from debt. 80% is going to be from equity. These equity players get the same thing we have here. They get all the performance fees. The debt players only get, let's say, 8% in this example. And this is the way the capital stack would work. The debt investors are paid first, no matter what. Now, if the fund makes money, everybody's happy. Everyone's getting paid. No worries. It's only when the fund starts to lose money that this comes into order. If the fund starts to lose money, let's say we had a 4% year, it was bad. These investors are still promised 8% and they're going to get 8%. We don't want to default on our debt. So it would actually come out of the equity over on these equity investors. This is your debt obligation that you're paying and you're paying that to your debt investors. And then if you lost money the next year, you'd pay more of that to make sure you're not going to default on this debt. And these investors would even be down further. It's leverage. You're applying leverage to your fund and it's a 2-edged sword. Leverage can make you a lot of money. And it can lose you a lot of money. Now, let me erase this real quick, clean this up for a second. Most funds in addition or separate from this will also use leverage when they buy their property. Now, in addition to this, most funds will use leverage when they buy whatever asset they're investing into. A stock fund will oftentimes borrow money from a bank to buy more stock or a private equity firm will do a leveraged buyout, an LBO, Borrow money from the bank to buy their businesses. Real estate funds borrow from banks to buy things. So you're adding more leverage here, and that's why a lot of funds actually don't raise from debt because they're going to add leverage anyways. Just like a mortgage, when you buy a house, you put 20% down, you borrow 80% from the bank. Funds do this at the massive scale. The best part about funds is you get to write the rules. People always ask me, Bridger, what should I do? You can do whatever you want. Run the Excel spreadsheet, see what it looks like if you raised from 20% Debt investors or 30% or 50% debt investors and 50% equity investors. What does that look like? What are the payments you're making? Do you want to add that amount of leverage? Do you want to take that kind of risk? If you want to, we can do it. There's a plethora of money right now in the world. You can definitely find debt and equity investors to invest in your fund. They have different reasons for doing both. The debt investors are backed up by the equity investment, so they have a safer investment. Their risk-adjusted rate of return is different than the equity investors who have a more risky investment, but they can hit a higher return if you guys hit a moonshot. Hopefully that helps. Let me know what you guys think below in the comments. Thank you guys so much and I'll see you in the next video. Bye.
