When a fund is launched, the offering documents generally reflect the current practices of the fund at the time. However, as the fund continues to accept investor money and operates on an ongoing basis, it may run into various challenges, foreseeable or not.
Recessions, market volatility, and shifts in business opportunities may require a fund manager to update offering documents for a fund. One of the questions the fund sponsor must ask is whether there is a need for changes to the terms of the memorandum to reflect the current market. If so, what is required? Also, what form of communication with investors is required?
I. Regulation D Offering
Most fund sponsors in the private investment arena rely on Regulation D, Rule 506. If the sponsor is relying on registered or qualified securities, whether through intrastate offering or Regulation A, amendments require higher scrutiny, including seeking approval from regulators. However, under Regulation D, amendments are made per corporate formalities outlined in the charter documents (i.e., seeking investor consent, where applicable). For our purposes, we will focus on Regulation D offerings.
II. Amendments to the Offering Documents
The first question the fund sponsor should ask is – what terms within the offering documents should be amended?
The offering documents are the private placement memorandum, underlying governing document (i.e., limited partnership agreement or operating agreement), and the subscription agreement.
Material terms within the offering documents that may require an amendment:
- Changing investor distributions;
- Amending redemption provisions;
- Updating risk factors or other disclosures;
- Raising the maximum offering amount; or
- Adjusting the business or investment strategies.
III. Process and Method of Investor Communication
Once the fund sponsor identifies the terms it will need to amend the next question should be – what are the next steps to effectuate the amendment? Consent, notice, or oral communication?
In determining the next steps, the fund sponsor should look to the fund’s governing documents, such as the operating or limited partnership agreement. Observing the governing documents is important because some of the proposed changes are incorporated into these documents, which then require a vote or other consent from the investors. For example, if the preferred return decreases from 7% to 6%, the fund sponsors should seek a vote from investors.
On the other hand, the terms of the offering documents may not require an investor vote. If there is an update to the risk factors in the private placement memorandum to reflect a change in underwriting guidelines or increased default risks, then investor voting may not be required, as this would be an added disclosure to investors. Here, an update to the memorandum and notice to the members is best practice.
In some instances, a vote from the investors is required when a change to the agreement will adversely impact the investors. For example, if the distribution frequency adjusts from quarterly to monthly, which favors the investors, is a consent really required? Practically speaking, investors will likely not object to being paid more frequently. However, navigating these nuanced issues should be discussed with securities counsel when determining changes to the offering documents.
Best Practices for the Fund Sponsor
In all instances, amendments to the offering documents require discussion and analysis with your team members. Nevertheless, the fund sponsor should consider the following:
- All notices and/or consent should be in writing and proper format as evidence.
- Unless otherwise stated in the offering documents, the fund sponsor should not agree to an amendment with one investor over another, especially if the terms are unequal. Otherwise, the sponsor has created a “opens in a new windowside-letter” situation and possibly breached their fiduciary duties.
- Update the offering documents, at least annually, to keep investors informed.
- Simplify communication with investors to avoid confusion or overwhelming them.
- If the sponsor is not sure what to do – ask us!
