What Your Coach Didn't Tell You: Fund of Funds Regulations

Your coach called it the easiest way to get started raising capital. Raise money from investors, put that money into other operators' deals, collect a fee. You don't need a property under contract. You don't need to do your own underwriting. You just raise capital for other people's deals and get compensated for it. Sounds easy, right? I want to show you the layer of regulations that conversation skipped. My name is Kim Lisa Taylor. I'm a securities attorney and the founder of Syndication Attorneys. We have clients who use fund of funds structures, and we have clients who came to us after setting one up without understanding what they were dealing with. The difference in their situation is significant. Let me start with what a fund of funds is and why it sounds appealing. In a standard syndication, you have a property under contract, you raise money from investors to fund the acquisition, you do the due diligence, coordinate the financing and run the operations. The investors are passive. You, as the sponsor, are responsible for performance of the deal. In a fund of funds, you don't have a property. You raise money from investors by pooling it into your own entity, and then your entity invests that money into other operators' deals, all on behalf of your investors. You're a layer in the middle. You take a fee. Sometimes a percentage of capital invested, sometimes a percentage of the profits in exchange for sourcing and vetting the deals your investors' money goes into. That structure sounds cleaner. No need to source deals, no need to manage operations, just evaluate deals found by other operators and allocate capital. Here's what that structure actually creates. The first complication: investment advisor registration. The Investment Advisors Act of 1940 generally defines an investment advisor as someone who, for compensation, is in the business of advising others about investing in securities, including selecting, allocating capital to, or recommending investments in other funds or syndicates as part of a funds-of-funds strategy. When you raise money from investors and deploy it into other operators' securities offerings, your entity is purchasing securities. Not real estate. That distinction is critical. Investing in real estate that you own or control doesn't trigger investment advisor compliance. However, investing in securities such as LLC interest in other operators' deals does trigger investment advisor compliance. That's the core function of the funds-of-funds model. Whether that triggers investment advisor registration depends on specific factors: the number of funds you advise, where your fund management team maintains offices, the number of investors you have in specific states, the value of your assets under management, and whether you qualify for any exemptions from investment advisor registration. But this is a real question that needs a real analysis. Most coaches who teach the fund of funds model don't mention the Investment Advisors Act. They teach it as a variant of syndication structure, same Reg D filing, simpler operations, the investment advisor dimension gets left out entirely. If you're operating as an unregistered investment advisor when registration is required, that's a separate federal or state compliance issue on top of your securities offering compliance. The second complication, underwriting responsibility. Here's the question that matters. If you raise $2 million from your investors, And put $500,000 of it in another operator's deal, who's responsible to your investors for evaluating whether that deal was a sound investment? You are. Your investors gave money to you. They relied on your judgment to deploy it wisely. They didn't independently evaluate the deal you put them into. They trusted you to do that on their behalf. That means you need to be capable of underwriting that deal. Evaluating the sponsor's track record and experience, reviewing their offering documents, assessing their market assumptions, analyzing their capital structure, not just trusting the other operator's marketing materials. If you're using the fund of funds model to skip the property and operation side, and you don't know how to underwrite deals, that's exactly why this structure is dangerous early in your career. If one of the operators whose deal you funded fails, your investors are going to look at you first. You're the one they gave the money to. You're the one they trusted to evaluate the opportunities. And in securities disputes, that's the person who gets looked at first. Let me give you an analogy. Think about the fund manager that runs a mutual fund. They take your money and invest it across a portfolio of stocks. Their job is not to run the companies in their portfolio. Their job is to evaluate and select which company's securities to put your money into. They're compensated for that judgment, and they're held to a standard of care that matches that role. If their fund significantly underperforms because they made poor selections, investors have recourse. The fund-of-funds model puts you in that same role. You're not running the underlying deals, but you are selecting them and deploying your investors' capital into them. That selection responsibility doesn't disappear because you structured it as a fund of funds. What type of syndicator does the fund, fund of funds model actually work for? This structure can work well for someone who has significant track record as a deal sponsor themselves, who has personally underwritten hundreds of deals, who has strong relationships with multiple operators across different markets. who can genuinely evaluate the underlying investments and has a reputation of their own that attracts investor capital based on their own track record. For that person, the funds of funds structure offers real advantages: diversification for investors, reduced operational responsibility, scalable capital deployment, fewer operational headaches. But for someone early in their career who hasn't done their own deals and doesn't have deep underwriting experience, This structure is the opposite of simpler. It's the most complex and most liability-laden model of the available structures. The appeal is that it sounds easier. In reality, the complexity arises from the responsibility you assume and the additional liability you take on for a deal you don't control. You've put your investors' funds in the hands of others, and they don't know your investors. They don't feel a sense of allegiance to them. If the deal fails, oh well, it wasn't their investors that lost money, it was yours. What can you do if you're already set up this way? First, make sure you have your investment advisor question analyzed by a securities attorney, not skipped over, actually analyzed for your specific situation based on your investor count, your assets under management, your office locations, where your investors live, and what exemptions may be available. Second, make sure your offering documents specifically describe the fund-of-funds structure and the risks that come with it, including your underwriting role, your role in management if you have one, and the risks of the underlying investments. Third, make sure you have a genuine process for evaluating deals you're investing in that's more involved than just trusting the operator or their marketing materials. Make sure you're actually reviewing the documentation and making an informed judgment. If you're considering a fund-of-funds structure, or if you're already operating one and want to know whether your securities compliance side is set up correctly, schedule a call and discuss how you can get compliant. We'll review your structure and tell you what applies. The link is in the description, syndicationattorneys.com/schedule. Subscribe to hear about newly posted videos.