PPM vs. Operating Agreement: The Inconsistency That Kills Sophisticated LP Deals

You've been doing syndications for a few years. You have a PPM and an operating agreement. You've closed deals. Investors have been happy. Now you're about to bring in your first really sophisticated investor, someone who made their money in commercial real estate or private equity. They're interested. They want to wire. Before they do, their attorney is going to review your documents. I want to show you the first thing that attorney looks for. And then I want to ask whether your documents will survive that check. My name is Kim Lisa Taylor. I'm the founder of Syndication Attorneys. I've been the responsible attorney for close to 500 Reg D syndications or funds. Let me start with what the PPM and the Operating Agreement each do, because the distinction matters and it helps explain why inconsistencies create a problem. The PPM, the Private Placement Memorandum, that's your disclosure document. It tells investors what they're getting into, what the risks are, what the sponsor is allowed to do, what the fee structure looks like, what distributions will be based on. Investors read it before they decide to invest. The operating agreement is the governing document that dictates how you're going to run the company for the life of the deal. It lays out the actual legal rules of the entity. It defines how distributions are calculated, what manager authority looks like, what happens if an investor wants out, what decisions require a vote. Both create obligations and they have to agree with each other. Whatever you disclose in the PPM has to be backed up by what the operating agreement actually authorizes. If there's a conflict between them, the operating agreement controls because That's the contract. It's the governing document. But if an investor relied on the PPM and the operating agreement says something different, that gap is going to be a problem. Here's the 3 inconsistencies that come up most often. First, the waterfall. Your PPM describes how money flows. Maybe you offered investors a preferred return first, let's say 8%, then a split like 70/30 or 80/20 between the investors and sponsor. Maybe there's an additional promote above a certain threshold or sponsor catch-up. Your operating agreement is supposed to implement that exact structure, same threshold, same math. But if your operating agreement was drafted from a template, or if it was drafted separately from the PPM, it might have different numbers, different rules, a different preferred return, a different split, a different promote or carry calculation. The numbers might even be the same, but the end result, the way they're calculated, could be different. The investor's attorney reads both documents side by side. They find 2 different waterfalls. They flag it. At that point, you have one of 2 outcomes. You spend time and money fixing the documents before close, or the investor gets nervous and they walk. Neither is where you want to be when you're trying to close a deal. And you'll have to explain any changes to every investor and maybe get them to reaffirm their investment, giving them an opportunity to say, no thanks. Second, the fee structure. PPMs typically describe all the ways the sponsor gets compensated: acquisition fee, asset management fee, disposition fee, refinance fee, construction management fee. For each fee to be legitimate, It has to be authorized somewhere in the operating agreement. If the PPM discloses an asset management fee of 2% of gross collected income and the operating agreement doesn't mention asset management fees or list them as tied to a different number like assets under management, you've got a disclosure that isn't supported by your governing document. To an investor's attorney, that reads one of two ways. Either the sponsor was charging fees they weren't authorized to charge, Or the documents don't match and the sponsor doesn't know what's in their own files. Third, manager authority limits. Most PPMs describe what the manager can do without investor approval. Can they approve expenses up to a certain dollar amount, make certain operational decisions unilaterally, enter into contracts? If your PPM says the manager can approve expenses up to, say, $50,000 without a vote, your operating agreement needs to say the same thing. If the operating agreement has a different number or no limit at all, the operating agreement controls, and your PPM just told investors something that isn't actually true about how the entity is governed. Why does this happen? Because the documents may be drafted at different times or by different people. The operating agreement gets drafted when the deal is acquired often. And then the PPM gets drafted when the capital is needed, sometimes months later. If both documents aren't reviewed as a set before they go out to investors, the inconsistencies don't get noticed. Most syndicators read each document on its own. They look fine individually. The inconsistency only appears when someone reads them together, which is exactly what a sophisticated investor's attorney does. So here's what the review actually involves. They request all 3 documents: PPM, operating agreement, subscription agreement. They read them together. They run a cross-reference on the waterfall, the fee structure, the manager authority language, and the exit provisions. If they find something, they send back a list. Sometimes it's a request for clarification. Sometimes it's a request to amend the documents before they advise their client to wire. Either way, your deal is now delayed, and the investor who is ready to wire is now second-guessing whether your operation knows what it's doing. What to do before your next raise. Have your existing documents reviewed, or better yet, drafted as a set by a securities attorney. Don't create them individually. Make sure the documents are reviewed for consistency. between the PPM, operating agreement, and the subscription agreement. If you've been using templates from prior deals that got modified deal to deal, you should assume there are inconsistencies until you've confirmed otherwise. Knowing your documents are clean and consistent will give you confidence going forward. The cost of doing it right in the first place is significantly less been a delayed close, a renegotiated deal, or an investor who walks. Before your next raise or before you approach more sophisticated investors, make sure you hire an experienced securities attorney and avoid these kind of mistakes that can come to haunt you later on. If you'd like to understand our process, schedule a call. The link is in the description, syndicationattorneys.com. Schedule. Subscribe for more content like this.