The Difference Between a 3C1 vs 3C7 Fund Structure

Alright, boom, people! Welcome back to the show. Today, we're going to talk about the difference between a 3 fund and a 3 fund. This is going to be more of a technical episode and hopefully build on some of the stuff you've already learned in the podcast, What's Going On Now? Now, before we dive into this stuff, I want to bring up something wild that happened last week in the markets. If you guys watched, so Tesla, Elon Musk, our king of America that just is Just the maverick that's doing everything. I love Elon. I've made a few episodes about Elon. I love his mantra. I love what he does. He just sets a goal. He says, I'm going to do it no matter what. Screw the SEC. Screw everybody. He breaks every rule. I think it's awesome. So last week, there was around $14 billion, billion with a B, billions and billions, billion dollars of shorts on Tesla. Okay. From, I don't know who, hedge funds, other huge— trying— and they're— they— so how a short works, right? You borrow stock. So for instance, like the typical short would be, I think the simplest example, if the stock price is $100, you would borrow a stock in the morning and you would sell it in the morning for $100. And you're hoping the stock goes down throughout the day. And let's say at the end of the day, the stock price is $90. You have to replace your borrowed stock by 5:00 PM that night. So what you do is you have to buy the stock that night at 5:00 PM for, let's call it $90. And then you buy the stock for $90, you give it back, and you just made $10 because you sold in the morning for $100 and you bought back at $90. You just made $10 and you keep the $10. That's how shorts work. So shorting, you have to replace the stock. And so there is $14 billion of shorts pushing Tesla down, right? People hoping it's gonna go down. I don't know what Elon did, but he somehow got the stock to keep going up, and it's called a short squeeze. So for instance, instead of the stock going down to 90, it starts creeping up to 101, 102, 103, 105, 110, and those people are squeezed. Those people that borrowed stock like, shoot, it keeps going up. We got to buy back sometime. Their deadline is hitting and they have to buy back at 110. $14 billion of shorts all have to buy back at the same time. And so what happens is the stock jumps even higher. So last Friday, Tesla's jumped $150 because of all these short— these guys getting squeezed. They had to all buy back their stock. It's just wild. This year has been— if you guys have not been just glued to your TV, I don't know what else you're watching. There's nothing more exciting on the planet than to watch the news about what is happening every day and how they construe things, especially the election, how it's just screwed both sides. I mean, it's just wild, especially the financial markets. So anyways, that's what happened last week, a little side note. Huge squeeze. And then Tesla Just to get back, everybody, they made shorts. They're like, yeah, we're gonna start selling shorts and giving shorts to all the people that tried to short us. They're these red shorts, you can go buy them for people that were trying to short their stock. I think it's awesome. So I love those guys. We'll see what happens, man. The future, we'll see what the future holds. So okay, that was like a squirrel, like squirrel, like we're off topic. We're back, okay? We're back to 3C1s and 3C7s. Today's gonna be more of a technical episode getting into the weeds of funds, okay? So previously, set a little groundwork. We have talked about Regulation D, 506, and 506 funds, right? And now there's a lot of different types of funds. These are the most common funds out there. I'll write them on here, and I'll probably erase them in a second. Reg D, 506, and then you've got B, and you've got C. Okay, different exemptions under there and different rules. B is the most common. You can raise money from 35 non-accredited, and it says unlimited accredited, okay? Unlimited accredited, and you cannot advertise, and those accredited investors self-verify. So they will, they can check a box that says I'm accredited. Now on the other side, Reg D 506 funds, you can only raise from accredited investors or up, and you have to verify that they are accredited. So you have to have bank statements, a letter from their lawyer, a letter from a CPA to verify that they are accredited. Now, Bridget, what's an accredited investor? Really quick, just overview. I know in other videos talked about this, but I'll go quick. There's 4 different classifications of investors. Okay, there's non-accredited, there's accredited, there's a qualified client, and a qualified purchaser. And if you want more details on this, I have other videos to go on this. But non-accredited doesn't fit any other stuff. Accredited has a million-dollar net worth outside of their home, or two hundred—they make two hundred thousand dollars a year and expect to next year, or have three hundred k with their spouse. Okay, qualified client two point one million dollars net worth, or over two million dollars outside of their home, and then qualified purchaser five million dollar net worth. Now there's a few more nuances there, but that's the basics. Okay, so when I say five o's Reg D five o six B thirty five non-accredited here. But you have to over-disclose to them. I wouldn't recommend taking non-accredited investors. It's really hard. Accredited investor or above here, and then a 506, accredited or above, and you have to verify. Okay, making sense so far? A little recap on everything. Now, in the SEC, under the Investment Company Act of 1940, they wanted to start regulating investment companies. So any company that's trading securities in any way, shape, or form, and there's high regulations for those types of companies. However, they made a few different exemptions, and the 2 most famous are 3s and a 3 exemption to that scrutiny from the SEC. So when you file your fund, you can file under one of these filings, and you get exempt from all the regulations, the reports from the SEC, because you're doing a private offering. So on your Form D, when you're filing with the SEC, you're gonna see you can file for a 3, a A 3. There's 3s, there's other ones, but these 2 are by far the most common exemptions inside of there. Now, with each exemption, you're gonna have a few rules, okay? So inside of a 3 exemption, you can raise money from 99 investors, and they need to be accredited or above. Now, there's a nuance there. For accredited investors— remember the, the 4 classifications— accredited investors You can only charge a management fee. You cannot charge performance fees. So if you guys remember, this is, this is me tying a lot of our stuff together. I said this is gonna be technical. If this is going over your head, don't worry, go back to other videos. But so, man, a credit investor is only a management fee. If you want to charge performance fees or other fees, for instance, over like your carried interest or your catch-up above— remember your pref? I did an 8% pref. And then 20% catch-up to me as the general partner, then 80/20 split. So 80% the investor, 20% to myself. That's a performance fee. I only make that money if I perform. You cannot do that to accredited investors. If you want to charge 2 fees, they need to be a qualified client or above. And a qualified client, they have a net worth of about $2 million. Okay, so to review, 3s 99 investors. If you want to take accredited investor money, you can only charge a management fee. You can't charge 2 fees or more than that, any performance fees. You only can take qualified clients. So you'll see funds on CNBC or on the news, they'll say, we only take qualified investors' money. You think they mean accredited investor above. That's not what they mean. They mean qualified client or qualified purchaser. Okay, and that's under a 3. Now, over to a 3 exemption. Okay, a 3 exemption You can have 1,999 investors. Is this making sense so far? Are you guys with me? And if you're on the podcast, it's going over your head, that's fine. We have this video on YouTube as well if you want to see the whiteboard of me mapping this out. It might be a little bit clearer for you. Clear as mud, right? Okay, so 3, you can have 1,999 investors, almost 2,000 investors. However, all your investors must be a qualified purchaser Or above. It's like shoot, man. It's hard enough to find people with money, and now with these exemptions, we got to be a qualified purchaser or above. So typically, three C seven are usually bigger funds. These are massive, massive funds, right? Because a lot of funds, small funds like my fund, I haven't reached a hundred investors yet in my fund. You're really if you're going to be up to almost two thousand limited partners that are all qualified purchasers, you're going to have a very significant fund, probably in the billions range to do a three C seven. Now there also are a few other rules here with qualified purchaser clause. There's a few things that go into that. So you can— for to be a qualified purchaser, you have a net worth of $5 million or an entity that has a net worth or total assets of $25 million. So you can think, hey, if we all put money together into an entity and $5 million— no, the SEC knows what's going on. If you put money together, you have to have over $25 million in that entity, and the sole purpose of that entity can't be just to invest in the fund. That could be a workaround, right? If you had 1,998 investors, right, you're one short But you took 10 investors, put them into an entity, and they came in through one entity. The SEC knows what you're doing. They're smart people over there, right? Don't, don't think you're trying to trick the SEC. They understand the rules and loopholes of their— of what's going on. Okay, so qualified purchaser, $5 million net worth, $25 million for an entity. Or if you are a knowledgeable employee of the fund, you can also invest in both of these rules and get around what's going on there. So if you understand the inner workings of the portfolio, you can come in and invest in the fund. So a lot of fund managers that maybe they aren't a qualified purchaser yet can still invest in their own funds through this rule. And right now, actually, the SEC has proposed a few changes to the investor classifications. For instance, if you are an investment advisor, if you have a Series 7 or a Series 65, you have these different licenses. Well, you're pretty smart at making decisions on investing, right? So the SEC proposed is to— gonna change this to allow people that have licenses or giving investment advice already that they can invest in their own funds or in other people's funds. That makes kind of sense, right? I, I hope that change goes through there. It's on the proposal. We'll see if it gets passed. Okay, so to review, 3s, 99 investors, accredited investors, you can only charge a management fee. If you want to charge 2 fees or just a performance fee, you need to have qualified clients or above. In my funds, I only take qualified clients or above because I don't charge management fees. I only charge performance fees. Hence, I don't need a license to set up my funds. I don't have a 65 or a Series 63 or a 7, and my fund is a 3 filing. Now, bigger funds, 3 funds, they'll have 1,999 investors, and they'll have only qualified purchasers in that fund, or entities— $25 million entity— or key employees that understand the portfolio can invest in those funds. Now, a great question people ask is, Bridger, can I do both these funds at the same time as almost parallel funds? So I've seen some funds out there that they will have an investment thesis. They're gonna go do trade Bitcoin. Okay, that's their fund. They will set up a— and maybe Bitcoin's not the best example because it's not as well regulated, but we'll use Bitcoin just for fun, right? It's 2020, anything's possible, right? Bitcoin fund. Okay, 3. They'll set up a 3 fund and then almost copy and paste the LP, PPM, the legal docs, and set up a 3. fund right next to it, and they have the same investment thesis. And if they have an investor that comes in that is a qualified client but not yet a qualified purchaser, they will put them inside of the 3 fund, and they'll put some employees in there. They only have 99 spots to fill up. They will also have a parallel fund, a 3 fund, for qualified purchasers so they can raise a lot more money using both those parallel funds. Now, me saying all this, seek your own legal counsel, right? Everything's different for your fund, but these are the 2 most common exemptions under the Investment Company Act of 1940, 3s and 3s. So hopefully you took a few things in there. If that was fast for you, go back, watch the video again, watch this again, or go check out our other videos on 4 different types of investors, on the waterfall structure of how a management fee works, or pref, or catch-up, or carried interest. I kind of compiled all that together. I wanted to give it a more technical episode today. I thought you guys would enjoy it. I know some listeners here actually starting massive funds, and this is a good thing that I— it took me a while to learn this and figure this out, and I think this will help you win thinking through your fund when hiring lawyers to go in and file your Form D, you'll check a box. Do you want to be a 3 exemption or a 3 exemption? But I would say almost all funds that I've seen in America that file use one of these 2 exemptions when setting up their fund. So hopefully you didn't short Tesla this last week. Hopefully, and hopefully this helps you set up your fund in the future. Guys, there are so many funds getting set up right now. I can't even believe it. In our Actually, our community, we've had an incredible growth of people setting up funds, launching them in 2020 right now with a pandemic. It's hard to raise money. No, it's not. Like, my fund has doubled in size since coronavirus started the last, I don't know, 2 and a half months, 3 months. I've doubled my fund's investment size, AUM, from the last 3 months throughout coronavirus. And I actually have a big meeting this afternoon to maybe add another huge investor wants to come into our fund as well. So I'll keep you posted on that, but there are people doing stuff right now. Some of the biggest funds ever have launched out of crises. And right now the world is shifting and changing. There's a lot of opportunity out there. So hopefully that helped a little bit. Let me know on— if you're on Instagram, if you have any questions, um, hit me up, Bridger_Pennington. That's usually the best way to find me, and, and I'll answer some of your questions. We'll make some episodes based on what questions you guys have. Okay, thanks guys. See you on the next episode. Peace.