February 2018

In the February Issue

  • Public vs Private Funds
  • Tempo Opportunity Fund LLC Structure
  • Our Waterfall Model and Splits

Intro to Funds

Here at TF Management Group LLC, funds are at the core of what we do because they put our investors in successful financial situations. We pool your money together with that of others to create a mutually beneficial investment; however, in order to fully maximize your returns, it’s essential to understand a fund’s structure, their qualifications and how they benefit you.

In this newsletter, we’ll discuss various kinds of funds and how we structure our own Tempo Opportunity Fund LLC to maximize returns for everyone. We’ll even discuss in detail how we pay our investors through what we call our ‘waterfall method’.

To get started, let’s take it back to the beginning by discussing the main differences between public funds and private funds.

Public Funds

Public funds are a type of fund listed on various exchanges like Wall Street that have a fluctuating daily price, dictating how they are bought and sold.

There are two common types of public funds:

  1. Publicly Traded Funds

    Publicly traded funds include both mutual funds and exchange traded funds, but let’s focus on the latter. Exchange traded funds are like trading stock; they have a ticker and symbol, so in essence you’re buying a stock when you invest in one.

    One of the most well known exchange funds is the QQQ fund. It’s an exchange traded fund that tracks technology, but it works the same way as a stock. You buy into the fund, and the fund buys a portfolio of shares of other companies.

  2. Traditional Public Funds

    Traditional funds, in contrast, don’t trade in exchanges. You can only buy and sell them at the end of the day. To redeem shares from a traditional fund, an investor sells them at the end of the day at whatever the price is determined by the fund. The fund company self-computes the share price.

    Similarly, on the buy side, if you as an investor want to buy, you can put in a buy order. Then at the end of the day, you can buy the shares at the net price-per-share determined by the fund.

Private Funds (for Accredited Investors)

Private funds are non-registered securities offered through a private placement memorandum (PPM).

An example of a real estate fund in the private fund sector is the Tempo Opportunity Fund LLC. As Fund Manager, we, TF Management Group LLC, file with the SEC (U.S. Securities and Exchange Commission) form D, but it’s still a non-registered security.

There are many small funds that operate the same way (i.e. as non-registered securities), but often the catch is that some funds are offered to all investors, regardless of level of sophistication, income, or net worth.

The Tempo Opportunity Fund LLC, by contrast, only accepts accredited investors since we deem that to be a safer approach.

Who is Accredited?

The SEC defines an accredited investor in two ways:

  1. An individual who has earned $200,000 ($300,000 if they’re married) for the last two years and can prove their income through tax returns, W2 forms, or other acceptable documentation.
  2. OR

  3. An individual with net worth (not counting his/her primary residence) of $1M or more. Put differently, it’s based on net worth apart from your personal home.

It’s important to recognize that these specifications go across the board (as defined by the SEC) and not just for our fund. To elaborate, the Tempo Opportunity Fund LLC is a 506D election C fund, so it can be freely advertised to the public, but every investor coming in must be accredited.

*Note: You can buy $2,000 shares or $3,000 shares in stock and be a non-accredited investor because those shares are publicly registered securities on Wall Street.

Here’s the takeaway: explore your options when it comes to various types of funds and know their qualifications so you can determine which fund (private or public) meets your investment goals.

With that in mind, let’s take a look at The Tempo Opportunity Fund LLC’s structure and how you, as an investor, get paid.

Tempo Opportunity Fund LLC Structure

As previously mentioned, Tempo Opportunity Fund LLC operates as a pooled investment vehicle. Investors buy units in the fund and then the fund buys assets, which are held by the fund.

Specifically, Tempo Opportunity Fund LLC buys a mix of real estate assets:

  • Equity deals backed by real estate
  • Individual properties
  • Syndicated (multi-owner) projects
  • Promissory notes (debt secured by real estate)

In terms of timing, investors in the Fund agree to a subscription that occurs once a quarter. It’s important to note that we do not allow people to subscribe in the middle of the quarter because the fund needs time to value assets properly.

Once investors subscribe, they become unit holders attached to investments in the fund. Because the fund is structured as a LLC, the members, those who have invested in the fund, will get a K1 statement at the end of each year.

Why an LLC as Entity Type?

The advantages of structuring the fund as a LLC are two fold:

  1. Money passes through without corporate taxes.
  2. Investors benefit from depreciation as if they directly owned the assets.

When you own real estate, you get to depreciate that asset. There are various depreciation schedules, but when you invest in the fund, your share of depreciation is passed down through the K1 you receive at the end of the tax year. It’s as if you owned a bunch of little real estate investments, each with its own depreciation schedule.

In short, the advantages of an LLC are far greater than any other entity when it comes to a fund. It’s why we structured the Tempo Opportunity Fund LLC accordingly.

Now that we have an understanding of the fund’s outer structure, let’s look inward at the simple, yet effective payment structure that brings you, our investors, great returns.

It all starts with a waterfall…

How Money Flows in a Fund

Tempo Opportunity Fund LLC's Model
Tempo Opportunity Fund LLC’s Model

Fund investors are compensated through what we call a “waterfall model.” These models can vary, but generally speaking, they follow a similar pattern in establishing priorities for how expenses are paid.

Imagine the money flowing through the fund like water. There are different “pools” (people involved with the fund) that need to get “filled” (paid) before the money flows on into the next pool.

When Do Investors Get Paid?

Typically, management fees and operating expenses of the fund are paid first. In the case of the Tempo Opportunity Fund LLC, the fund manager is TF Management Group LLC, which is responsible for “keeping the lights on” for the fund. These fees usually add up to around 2.5% in total.

The next payment in the waterfall, the second “pool,” is the Preferred Return (often called the “pref”) to investors. Tempo Opportunity Fund LLC currently has a preferred return of 7% per year.

The last “pool” in the model involves performance splits, or in essence, profit sharing. Let’s look at the splits for the Tempo Opportunity Fund LLC.

Tempo Opportunity Fund LLC Splits

How exactly do funds calculate payouts on the upside or performance splits in investments? The Tempo Opportunity Fund LLC, like many others, uses splits on established tiers of investors.

In our case, we have three types of units in the Tempo Opportunity Fund LLC: A unit, B unit, and C unit.

*Splits following the 7% preferred return

For example, if the fund generates a 19.5% return on its investments, then after taking out the management fee (2%), operating expenses (0.5%), and preferred returns (7%), the last 10% is split on a performance split basis.

The A units would get an additional 8% on top of their 7%. B units would get an additional 7% and C unit would get an additional 6%.

Net Income Considerations

While the waterfall model of a fund is very important, it must be paired with an excellent fund strategy. Investors want to know where the net income is coming from and how much it is.

When you invest in real estate, income can come in two forms: cash flow and appreciation. The Tempo Opportunity Fund LLC invests in debt instruments and promissory notes that generate income in the form of cash flow. However, we also invest in equity deals that bring in appreciation (realized in the future when the asset is sold) to the fund.

Our strategic approach is to pay the preferred return first from cash flow but then to also allow room for appreciation in the fund, so we set our rates with that in mind.

Final Thoughts

There is no right or wrong fund structure per se, but in our experience, it’s much better for investors to have a preferred return. Though not guaranteed, it creates a structured priority for paying distributions to fund investors first.

As an example, a colleague of ours is a fund manager for a hard money fund that doesn’t have management fees and instead pays an 8% preferred return. There is no upside (performance split), but the investors have been happy with that level of preferred return.

We’ve tweaked and tested the Tempo Opportunity Fund LLC to optimize the financial experience for our investors. In doing so, we focus a little more on income, delivering between half and two-thirds of the total return in the form of income and the rest in the form of appreciation.

If you’d like to learn more about our structure or waterfall model, please contact us and we’ll be happy to talk with you and answer any questions you may have.

Thanks for reading,

Mike Zlotnik
CEO, TF Management Group LLC

This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.

TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.