Capital Calls & Distributions: The Flow of Money

[Music] all right welcome back today we've got actually a good lesson planned out here from lincoln talking about the flow of capital so when investors come in where does that money go when money goes out how does it all flow together that's what we're gonna talk about in this episode this is actually crucial this is one of the maybe the questions that you're scared to ask too you think it's obvious like oh and you're a little bit nervous to maybe bring it up on one of our live calls and i was actually nervous the first time i started a fun to ask my dad or other mentors just how does it actually work dumb it down for me let's get really simple here and that's what we're gonna do we're talking about capital calls distributions and how those can change within a fund that's right okay let's just start with the money right so let's call this investor a and he's gonna put in 10 million dollars okay and then investor b is gonna put in 40 million dollars okay what happens to that money now obviously there's soft commitments which we teach like go out and go raise this money just get see if there's proof of concept right you don't take the money into custody then and then you go sign you know your help you get your docs all set up your lpa your ppm you get sub docs they sign those side dots you still don't take the money into custody okay they keep the money there they have custody over the funds but you then have discretion okay meaning so you now have just a contract a piece of paper that says i can call 40 million dollars whenever i'd like from mrs investor b right here that's all your contract says and that helps on your liability as well you do not want to take the money before you need it there could be embezzling you could have an employee still you don't want to have that liability they keep the money in their account until you need it right and that also helps like with calculating your return right because you're only accountable to the funds that you have in custody right your irr clock starts ticking once you take that money so once you're ready to call that capital where does the money actually go okay we're gonna have two bank accounts here the gp bank and then you're gonna have the lp bank now your gp bank is just your regular bank account right it's usually in an llc okay you're gonna go apply it doesn't really matter like this is just for expenses right um what else do you pay for out of a fund depending on your fund structure you might pay for employees out of here it could be your ia or ra pays for that as well but office space and other stuff this is just general your business that you're running most banks should be just fine holding your general partner bank account no when you go and apply for this gp bank account you're going to need like an ein or a tin as well as just proof of entity right like an llc operating agreement articles of incorporation yeah something like that okay now the the limited partnership bank account is a little different right this is where the funds are actually held and banks get a little stingy sometimes so we just wanted to give quickly like recommendations on which banks are good to work with depending on what type of fund you're in when i started my first fund i was actually surprised i went to chase and i went to all these big banks wells fargo and they would turn me down they did not want to take my money they didn't want my business that was a little bit i didn't even realize that was an issue is that some banks do not even want to deal with funds so i actually called around to a bunch of different banks and asking them you know what's the best way to work with them and what you need essentially what i came to do with was this is that key bank's best to work with for real estate you know they have their methods all figured out and proof of funds concept whatever pac west is really good for venture capital or private equity funds and ubs is really good for hedge funds now this is solely bank accounts right pacques does do lending on those accounts if you're trying to get some leverage in a private equity or vc fund um but but mainly it's just for servicing you know these types of entities additionally one more i'll add is silicon valley bank they really like to work with funds and fund managers more primarily with a venture capital private equity and some hedge funds work there as well so you got your bank accounts set up and you've got your deal right we're going to call this abc code all right so you've got this company you want to invest in and let's say it's five million dollars all right the price of this so you're going to call your capital down pro rata we use that term a lot it seems like a lot of people don't understand it just means in proportion to so essentially from investor a you're going to take one million dollars and from investor b you're going to take 4 million dollars so that's 10 of the total capital that they committed and you know that gives you 5 million dollars right enough to invest into this entity so you're going to call the capital put it into your lp bank and then obviously there's a little bit of wait time but you then have the funds in your custody and then it's ready to you know buy you know whoever you're paying out this money to to acquire this company or property or investment whatever it is so typically i've seen with the timing of this sometimes it gets a little hard because abc corp wants to close on this friday but you need to notify investors i've typically seen you give investors 10 to 14 days to fulfill their capital calls meaning they need to send their 4 million or 1 million to your bank account you send them wire and routing instructions if they do not your lpa and ppm will have some type of penalty on their capital or capital commitment from them that'll be disclosed in your documents so 10 to 14 days that money comes in and now it's in your bank account you can go and close as you grow and get bigger some of these banks will give you and issue you lines of credit just for that waiting period their 10 14 maybe 21 day lines of credit just so that when capital calls are being fulfilled you can still close on abc corp this friday and you won't miss deals that's something you can negotiate with your banks as you get started obviously the more money you have the more leverage right now let's talk about timeline right so holding period of this and what that actually looks like so you know in year zero is when you're kind of doing all this stuff collecting raising the money getting everything set up it depends on what type of fund for hedge funds you kind of deploy capital right away doesn't have to be that way but within the first six months of operating but for most other funds like venture capital private equity and real estate it's usually two to three year investment period right where this is kind of like the deployment period where you're finding deals allocating the money and investing okay and then this other period anywhere between four to ten years right depending on the life of your fund this is more of the harvesting now bridger talk to us about how would you think about paying out this money do you want to pay it out on a lump sum in year 10 do you want to do it a little bit in year three through five and what does that all look like now again it packs what you're saying it depends right it depends on what you're doing but let's talk through a private equity or real estate fund that's going to be buying large assets and then selling them they typically well by year three they are hoping to be 100 deployed meaning we've got 50 million dollars here we're hoping in the first three years we can deploy all 50 million into deals by year four or five maybe we're upgrading those companies or we're value add to in our real estate we're letting those season by year maybe you can put down year maybe six or seven we're going to start looking at exiting those deals now what i've seen typically in funds is when they begin to exit let's say in this fund you've purchased 10 deals maybe on year 5 you exit your first deal what i've seen is most investors you let's say it's abc corp we bought we exit abc corp we sell it for a great profit or maybe we ipo we have this great exit right the money from the exit will flow back to the lp bank account here this is where it will flow and then from there you can do one of two things first thing you could do you could hold the money or maybe invest in other properties or other businesses whatever your funds doing or you distribute back to your investors typically i've seen the latter happen because as a fund manager some of these investors have waited four or five years to have a distribution yeah they are they're like they want to see money what's lincoln and bridger doing are they just sitting on their hands are they actually investing what's going on it's is one of the best days of your life and for me at least running a fun is when i send my investor a fat check i love to send them a check i read them out an email or whatever report we're gonna send them and i was like man i just got you a huge return and i know that investor is smiling on the other side of the world like man bridger did a great job with my money i would potentially like to maybe invest with him in the future and it just is a great feeling of what you're doing so typically i've seen the latter most fund managers will distribute most of the returns they get back now you gotta save some for taxes and other things like that but that money flows back to the investors there okay so you pay back your money and then of course you want to take a cut of that as well right you pay back after you pay back your investors so your performance fee is going to go to the general partnership right and your riaa is going to take the management fee and kind of a note on that as well it's typical for the management fee only to be charged in the years where you're deploying the capital especially for private equity and venture capital if there's a lot of maintenance and stuff that needs to happen then you know you can charge a management fee throughout the whole time but it's usually only collected in these first couple of years um that's something you guys can determine when you're putting together your fund docs yeah a note here on ria versus ia investment advisor is under 150 million dollars registered investment advisor now you're at the sec level is when you get over 150 million dollars aum those are the difference there we have other videos that talk about that so that split happens we also have other videos that talk about how to access exactly do that split we're not going to talk about that here but whether you do an american waterfall or european waterfall will also determine how that splits down again other videos we won't talk about that here but that split will happen here but that's when you are selling or exiting or disposing of these deals typically in this time of a timeline maybe year five six or seven you start exiting these types of deals now your irrs are calculated usually in a fund they back date for the entire time period that that money has been deployed so for abc co if you bought it on year two and you sold it on year seven you would have five years to calculate back your irrs on so if if that abc co got a hundred percent you doubled your money right in five years you doubled your money great your irr or yield in that case it's just simple math i'm not gonna the complexity of ir right now but would be a 20 per year split because it took five years to double your money so that's you'll have to back date the timing on when you purchased the original assets and just so you're informed like while the investor is waiting they're not usually keeping their money in just a bank account ready to go right they still want their money to make money so it's usually in some sort of money market account or even just very liquid uh public investments like a mutual fund or some sort of indicy that's you know has a high volume that they can get out of quickly if they need to so your capital calls and your distributions right when the money is paid back it's your distribution and you need to really reverse engineer your deal and your fund right and thinking about how often you make distributions venture capital like you're waiting for that money to ripen and season you're probably not going to have any distributions here right but if you're flipping real estate and you can buy and sell a property in six months or 18 months you don't want to have a distribution every couple years right you want to do that semi-annually or even quarterly or annually like whatever makes your investors happy it comes back to your ability to reinvest that capital and if you can't then just set expectations that you're going to give that money back to them yeah maybe we can erase this for a second and just share examples for other types of funds that would be for a long 10-year closing at funds inside of a hedge fund if you've got a one-year timeline here and your hedge fund is trading or whatever you're doing let's say this is one year right here you might do like lincoln was saying maybe every six months or at one year mark what you do let's say your fund started at x and it grew and grew and grew and now it's up here i've seen a lot of funds where they will sell off here and they will go back to their basis maybe it's every six months or every year and distribute those returns to their investors some hedge funds maybe they do it every two years or every three years they can have a longer it really comes down to your investment thesis and just being smart with how your capital is moving if you're a day trader this probably makes a lot of sense if you're a long term buy and hold type of trader this probably wouldn't make sense in a six months maybe it's a two year or a five year timeline it really depends on what you're doing like lincoln mentioned real estate example of flipping if you're flipping houses every 90 days well yeah send some distributions to your investors every maybe it's every six months maybe it's once a year my fund currently to give you an example i distribute every single month we do small micro loans they're fast they turn over about every three four five weeks so i make profits consistently every month and i make distributions i try to on them on a monthly basis again back to your fund and your concept you've got to make a distribution schedule that makes sense with how you're investing and again it doesn't matter i don't think investors will be mad one way or the other it really comes down to their expectations when they signed up for this fund if they if they signed up for the fund and they you know signed all stuff and they're expecting a distribution every six months that's what you told them but they only get one maybe a year and a half later and then two years they're like they're gonna be like what the heck i thought i was gonna have it every six months but if you tell them the expectation hey we expect to distribute in maybe year four five or six from now okay yeah i can sit i can wait that's my expectation it's all about meeting investors expectations when you're thinking about distributions and just design it so where it fits your deal right if you don't think you're going to have any money to distribute in the first three years then tell them that you know we're not going to pay out any distributions in the first three years but then once our deals start you know harvesting we're gonna pay out every six months after that or just whatever makes sense for your investments

Channel: Bridger Pennington

Views: 20,435

Keywords: raising money, raising capital, flow of capital, how to raise capital, how to raise money from investors, investment fund secrets, Bridger Pennington, how do investment funds work, how do hedge funds work, how does private equity work, how does venture capital work, how do hedge funds make money, how do investment funds make money, how do funds work, the flow of capital in a fund, capital calls, what are capital calls

Id: Tkj3jg27eAQ

Length: 14min 51sec (891 seconds)

Published: Tue Jan 26 2021