Good afternoon everybody!
Another day, another dawn rebels!
Today I’m here to outline yet another exemption commonly used with real estate funds.
Recently I showed the differences between 3(c)1 and 3(c)7 exemptions, and when you should file for what.
However, today I want to show you that if you don’t love either of those options, there is a third door.
Let’s recap a bit of the basics with 3(c) filings.
3(c)1 and 3(c)7 recap
There are basically three main distinctions amongst these filings. They are the following:
- Investor Type
- Number of Investors
- Investment Types
With a 3(c)1 you’re looking at no restrictions on the investor type, but there is a limit to how many investors you can have in your fund, 99 people to be exact.
With a 3(c)7 you have just the opposite. Now there are restrictions on what type of investors can contribute to your fund, but there is no limit to the number of investors that you want to receive. (Technically, that’s not entirely true. Under a 3(c)7 you can have up to 1999 investors, but we’ll count that as nearly unlimited.)
Under neither exemption do you have restriction on the type of investment you are making. This means under a 3(c)1 or 3(c)7 you can file for a fund that goes after real estate, venture capital, stock trading, etc.
Again, for a more in-depth analysis please refer to this article I put out a couple of months ago.
Now, following that same criteria let’s break down the 3(c)5 exemption.
This exemption is unique from the other two because there is no limit on the number of investors that you can have, nor is there a restriction on the investor type.
However, the asset class you are going into is regulated.
Under a 3(c)5 you have the following breakdown:
55% of the portfolio must go to qualified interests.
What does that mean? A qualified interest is basically just mortgages or leans on real estate.
Meaning that if you want to file a 3(c)5 you’re looking at allocating at least 55% of your portfolio directly to real estate.
The remaining 45% is broken down even further into two more tiers.
First, an additional 25% of the portfolio must be in real estate related interests.
Sadly, nobody really knows exactly what that means haha!
The SEC gets tons of complaints each year with people defining this space differently.
Therefore, in order to avoid any future headaches or mishaps I typically recommend just sticking with qualified interests with this chunk of your portfolio, unless a lawyer tells you otherwise.
Second, you’re looking at 20% that can be diverted to an asset of your choice.
This is what makes the 3(c)5 exemption awesome.
You get to almost have a side gig going with your fund.
I have a good friend who runs a real estate fund, and yet I knew that he also did a little bit of VC investing on the side.
For the longest time I didn’t understand how he was legally able to do that, unless he was running two separate funds.
Come to find out after all this time I sat him down and he told me he had filed under a 3(c)5, and that’s what had given him the extra flexibility.
Something to bear in mind is that you do NOT have to stick to these numbers exactly. Meaning, you’re welcome to do 100% of your investments in qualified interests if you so chose.
55% is just the minimum bar that you must hit.
Same goes for the 20% you’re diverting to a different asset class. That number can be anything under 20%, it’s just that is the maximum bar you can hit.
So what can you do with this knowledge?
You’ve now got at least a solid base for three different exemptions that are commonly used with funds, particularly in real estate.
You know you can effectively navigate the filing process based off of key indicators like;
How many investors do I foresee us securing?
What type of investor will be working with us?
Or, what asset class am I likely to invest in?
Using these baselines, I am confident that you’ll make the right call and be one step closer to launching your own fund.
Best of luck,
Want to get direct guidance for your fund? Schedule a time with my Fund Advisors!
DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.