Scroll to top

The Cost of Raising Private Capital


By Matt Scott

He sat there in the front row with his arms crossed for 3 hours staring at me.

With a scowl on his face, he wasn’t enjoying my presentation.

At the end of my session for this national franchise, they opened up the floor to questions from the franchisees. Note, I was not promoting anything and I was training their franchisees on how to raise private capital at their annual convention.

The guy in the front was the first to raise his hand.

With the mic, he asked, “This all sounds interesting, but how do I outsource this?”

Obviously, the “outsource your entire life” trend had made it to this guy.

Without missing a second, I responded… “So you want to outsource this?”

“Yes… I do”

“Great, grab your pen… here’s how to outsource raising capital. Go to the bank, private lenders, hard money lender, or find a willing broker. They’ve already completed the hard work of raising capital. Next question?”

We all want the easy way out when raising capital.

Some real estate syndications want to just deal with lenders if they can scrounge up enough money for a down payment. That’s great on smaller deals, but to raise capital at the levels our private clientele are used to, the down payment can be as much as $1MM to $3MM, or more.

I get it.

Loans are convenient, even if the price to play may be a little high. That’s why real estate syndicators who want convenience will also consider going through Broker/Dealers, Registered Investment Advisors or Family Office Brokers who charge as much as 10% commissions for bringing capital to the table. Let’s call this group “Brokers” collectively for convenience since they all serve the same purpose and charge roughly the same commissions.

In the real world, we’ve had prospective clients inform us on the initial call of their willingness to pay 10% Broker commissions on any capital raised. They want the convenience and the speed of going through Brokers without realizing the real cost of that capital. They don’t recognize that convenience comes at a hefty price. 

That’s because a 10% commission results in dead capital – non-performing (non-productive) capital that goes into the pockets of these Brokers (money-finders) and doesn’t get used for actual investments. The kicker is, on top of being non-productive, you’ll still be on the hook for returns and distributions on the pre-commission amount of this capital owed to the source of these funds, be it an individual, institutional investor, or a family office.

Take a look at the following two examples to get an idea of what I’m talking about. Let’s assume an expected Net Cash Flow of 15% annually.

REAL ESTATE SYNDICATION EXAMPLE

EXAMPLE 1 – With Brokers

Total Raise: $10,000,000
Commission: $1,000,000
Investable Proceeds: $9,000,000
Annual Net Cash Flow %: 15%
Annual Net Cash Flow: $1,350,000
Investor Return: Preferred 10%
Annual Distribution to Investors: $1,000,000
Net Profit to Founders: $350,000

EXAMPLE 2 – Without Brokers

Total Raise: $10,000,000
Commission: $0
Investable Proceeds: $10,000,000
Annual Net Cash Flow %: 15%
Annual Net Cash Flow: $1,500,000
Investor Return: Preferred 10%
Annual Distribution to Investors: $1,000,000
Net Profit to Founders: $500,000

Under the two scenarios, using Brokers results in an annual net loss of $150,000 in Net Profits to the Founders compared to when not using Brokers.

Assuming a typical seven-year exit strategy, this results in a difference of $1,050,000 in Net Profits to the Founders between using Brokers and not using Brokers.

Yes, there’s a cost of raising capital, but 10% of the amount raised is well beyond what smart founders or syndicators allocate for the cost of capital. That handicap, to the tune of a 10% commission, can be the difference between taking profits home as a Founder and leaving empty-handed.

There are many more ways to run the scenario depending on the business, use of proceeds, return structure, and more. This should make it clear that if your business is investor-focused, you have to make 90% perform like 100%. Be aware, there many hidden costs when you’re paying out commissions on capital. 

That’s why successful syndications insist on having their own private pool of investors to leverage and not pay commissions each raise.

Your private list of investors is not one you purchased. It’s not a list of RIAs or family offices you rented or have accessed.

Our clients in our PCG program are solely focused on building their own lists, building credibility and trust with the lists, and then pre-selling their investment to them when the time arrives.

The cost of raising capital from qualified investors this way is a fraction, and I mean very small fraction, of the total cost of paying 10% commissions. Raising capital without the use of Brokers and their high commissions can also benefit a strategy mixed with traditional lending.

Raising capital from qualified investors can magnify your investment strategy when combined with lending.

Take a look at the following two examples. Let’s assume an expected Net Cash Flow of 15% annually. Also, assume straight-line amortization of principal and interest for simplicity’s sake.

REAL ESTATE SYNDICATION 2

EXAMPLE 1 – Straight Commercial Loan (No Capital Raise)

Down Payment: $2,000,000
Commercial Loan (based on 20% down): $10,000,000
Interest Rate: 7%
Annual Interest Payment: $700,000
Annual Net Cash Flow %: 15%
Annual Net Cash Flow: $1,500,000
Annual Net Profit to Founders: $800,000

EXAMPLE 2 – Commercial Loan plus Capital Raise

Capital Raise: $8,000,000
Founder Contribution: $2,000,000
Commercial Loan (based on 20% down): $50,000,000
Loan Interest Rate: 7%
Annual Interest Payment: $3,500,000
Investor Return: Preferred 10%
Annual Distribution to Investors
(based on $8,,000,000 raise):: $800,000
Annual Net Cash Flow %: 11%
Annual Net Cash Flow: $7,500,000
Total Interest + Investor Payments: $4,300,000
Net Profit to Founders: $3,200,000

As with using Brokers to raise capital, traditional commercial loans come with a hidden cost as well. The hidden cost is the profits you could be foregoing if you’re not incorporating a hybrid strategy combining a commercial loan with private capital.

Under the two scenarios above, with $2,000,000 in hand, you can either obtain a straight-forward loan of $10,000,000 and make an annual net profit of $800,000 or you can leverage that $2,000,000 with a capital raise of $8,000,000 to magnify your loan amount to $50,000,000 and enjoy annual net profits of $3,200,000 instead of $800,000. In reality, the gap could be higher in the hybrid scenario because economies of scale could result in lower expenses on a prorated basis.

There’s a price you will pay if you choose the easy route.

Going with broker/dealers (B&Ds), banks, money-finders (stay compliant), private lenders, or HMLs is the road of less resistance.

Raising capital from qualified investors as an alternative to using Brokers or as a supplement to commercial loans can increase the bottom line for real estate syndicators, allowing them to hit your projections easier, and much more.

Stop paying such a high price for capital every time you need funding and build your list of investors. 

Besides the direct costs, the long-term costs of commissions are often overlooked.

  • If you raise capital by paying commissions, that’s a large expense you will pay for each and every raise.
  • If you build your own list of investors, it’s a small one-time investment because once you have the investor in your database, it’s yours and you can go back time and time again at no additional cost.

Imagine having your own list of eager investors waiting to invest in your company, syndication, or fund. You’ll find your focus moves from “where will we get the capital” to “how can I find more companies to buy or assets to acquire or….”

Are you ready to get started?

Call Now