Decisions to be Made in Forming Investment Syndicates

Loon Creek helps investors form and administer investment syndicates. This is one in a series of blog posts based upon our experiences in doing so. An investment syndicate (also known as a “single purpose vehicle” or a “single investment entity”) is a group of investors who combine together into some type of organizational vehicle in order to make an investment in a specific company. Usually the vehicle is a limited liability company (LLC).

In an another post, I wrote about some of the reasons investors may want to form syndicates to make their angel investments. This post discusses some of the decisions the investors need to make in setting up their syndicate.

Decisions

A syndicate is a legal entity under the laws of some state. To form such an entity and operate it throughout its life requires a number of decisions and actions, some of which are:

• The state must be selected.

• The LLC must be registered with the state.

• The investors must decide whether the syndicate will be governed by vote of the members (member-managed) or by a manager (manager-managed) or some combination of the two.

• An operating agreement reflecting this decision must be drafted and signed by all members. This agreement needs to adhere to the laws of the state in which the LLC is registered.

• A taxpayer ID number (EIN) must be obtained from the IRS.

• Assuming the syndicate intends to invest under the accredited investor exemption (Rule 501, Regulation D of the SEC), each individual investor must attest to his/her/their accredited investor status.

• Records must be kept to document each investor’s accredited investor certification.

• A financial vehicle (e.g. a bank account or an attorney’s trust account) must be set up to receive, disburse, and hold the syndicate’s funds.

• Funds must be collected.

• Funds must be disbursed to purchase the investment and pay the set up and operating expenses of the syndicate.

• Financial and investment records must be maintained for the life of the syndicate, often five to ten years.

• Often a tax return must be filed and an accountant paid to file the return; in some states an annual fee must be paid to the state. • When tax returns are filed, individual K-1s must be prepared and sent to all members who must then report the effect of the K-1s on their own individual tax returns.

• Someone must be prepared to receive communications from the company, and when appropriate, act on requests from the company such as shareholder votes.

• Someone must keep records of the members who may get married, divorced, die, transfer their interests in or out of trusts, and otherwise modify their membership accounts.

• Someone must agree to be the agent for the entity, provide a physical address in the state of formation and agree to accept service on behalf of the entity.

Implications

Each decision will impact the operation of the syndicate for its life, and naturally the cost of setting up and managing the syndicate. Here are two examples:

• State costs. Each state charges a fee to register an LLC and some states charge annual fees to keep the LLC active. For example, Idaho charges a one- time fee of $100 to register an LLC, and does not charge an annual renewal fee. Delaware charges $90 to register an LLC and charges an annual franchise tax of $300 each year thereafter. LLC University posts a table of the set up and annual fees in each state.

• Manager. Often, someone “volunteers” to be the syndicate manager and perform the above tasks, frequently without compensation. I’ve made that mistake three times myself. Each of my syndicates, by the way, is still alive; one for more than twelve years. If you agree to be the manager, you are potentially signing up for years of service. You may want to charge the members for your time, and/or outsource much of the administrative work to a firm like Loon Creek.

Conclusion

There are a lot of decisions to be made when setting up a new investment syndicate, with potentially years of ramifications. Loon Creek has developed a number of best practices with regard to the setup decisions in order to minimize the work and operating costs of setting up and administering investment syndicates. In my other posts I address some of these practices.

Loon Creek specializes in syndication services for angel investors. You can learn more about our services on our web site.