Setting up a Distressed Asset Investment Fund


I have been approached many times to explain how a Distressed Asset Investment Fund is set up.  Clearly, you need legal advice and consultation every step of the way in this process, and the laws, disclosure requirements, and particulars of each Fund will be different, but in general, below is a Legal Guide that I published on the website http://www.avvo.com, which is a site that gives consumers guidance, background information, including ratings in their selection of an attorney.  While this Legal Guide is meant to be educational and informative, it is posted for informational purposes only and discusses general legal principles, trends, and considerations; it is not intended as specific legal advice .  This post does not establish an attorney client relationship.  For legal advice, you should retain legal counsel in your state for advice regarding your specific circumstances:

That being said . . . Assets have become distressed due to above-average vacancy rates, inability to refinance existing debt, depletion of reserves, and disrepair. While these assets are now more affordable, the capital funding needed to acquire, rehabilitate and reposition these assets is more difficult to obtain.  The following are the basic steps and principles involved in the set-up of a Distressed Asset Investment Fund.

Step 1:   Know your purpose — The Fund Concept, i.e. a pooling of equity.

As traditional means of financing an acquisition of distressed assets have become difficult in the current credit market environment, consider a strategy that includes successfully completing a private equity offering into a fund-type entity that will utilize its assets to acquire, rehabilitate and reposition distressed assets for cash flow (rentals) and residual proceeds (sales). These ownership entities have a greater chance of obtaining financing on more favorable terms than individual or corporate borrowers, and such entities are also able to occupy a more preferable position as a buyer of distressed assets due to the fund’s capitalization.

Step 2:  Create a Set of Offering Documents.

What needs to be achieved is a private equity offering that meets the requirements of the 1993 Securities Act, and the applicable state securities statute (sometimes referred to as the Blue Sky laws). These are the “securities laws”, which are essentially disclosure statutes requiring you to prepare a set of offering documents that clearly lay out your plan, the risks involved, your financial assumptions, the projected returns that investors could achieve, as well as series of full and adequate precautions ensuring that the investors are appropriate for the particular investment, given their financial sophistication, net worth or earnings capacity, size of investment, and the relativity of the risk to their tolerance for such risk. This is where you separate investors as either “accredited” or “non-accredited” as that term in defined in Section 501 of the 1933 Securities Act. You should also create a corporate structure that will receive the funds, and hold the investments.

Step 3:  Raise Capital.

This is easier said than done, but please make sure that you have a full and legally adequate set of offering documents, and that you are presenting the investment to accredited investors that have a clear understanding of the investment, your business plan, the risks involved, and whether or not they will be able to have access to their capital. Your plan of action for the business, or business plan, needs to be well thought out and detailed. It is also helpful to have identified, or even secured the commitments of a group of people who are qualified experts in the field to act as your management team, particularly if there are pockets of inexperience in your current management team.

Step 4:  Identify appropriate investment opportunities.

Stick to the parameters that you identified in your business plan, and the asset investment requirements or stipulations that you committed to adhere to in your offering documents. Use industry sources, such as knowledgeable industry participants, brokers, subscriptions to publications, websites, bankers with knowledge of their distressed inventory, property listings, and other such information to source and identify appropriate investment opportunities for your fund.

Step 5:  Make sure that you are capable of rehabilitating the assets and repositioning them in the marketplace.

Many of the assets that you identify will have deteriorated and will need rehabilitation. You will need to have access to a general contractor and construction related expertise, such as someone to monitor or supervise the construction, and an attorney to draft contracts that define the process, the payments, and the job. Thereafter, you will either be holding the property for rental and will need a property manager, and a leasing staff, including your attorney to draft leasing documentation; or you will be looking to sell the property and reinvest the proceeds in another appropriate asset, which will require finding a buyer and closing the sale.

Step 6:  Keep your investors informed and create a compliance/administrative operation.

You will need to manage investor disbursements if this was promised in your offering documents, investor and property tax considerations, ensure you have adequate working capital for property repair, management, and additional capital investment, and ensure that you are in compliance with property management requirements, tax payments (for the properties and the fund entity), investor questions and reports. This will require adequate management and compliance skills, as well as professional accounting and legal assistance, for both purchases and sales of assets, as well as for leasing, eviction issues, disputes, insurance issues, injuries, and other daily property management concerns.

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7 responses to “Setting up a Distressed Asset Investment Fund

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  3. Warren, this is a great topic. Perhaps you would do a distressed assets podcast with me on this topic for distressedpro.com?

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