For a debt fund to be a successful business strategy for a lender, an understanding of state-specific licensing requirements is crucial. The proper licensing approach must align with both state-specific regulatory requirements and the fund’s operational model, with respect to balance sheet lending, capital raising, loan origination, and servicing.
Below, we’ll cover what factors a lender must consider when utilizing a debt fund for their business and provide examples of state-specific regulatory requirements.
Debt Fund vs. Affiliate Licensing: Key Considerations
Lending licenses can be held at the debt fund entity level or at a manager-affiliated operating company. The correct placement depends largely on how the fund conducts its lending activities and the specific requirements of each jurisdiction.
When the Fund Should Be Licensed
In many cases, the debt fund serves as the capital-raising entity, the originator, and the servicer of loans. Some states require that the licensed entity originate and fund loans directly from its balance sheet. In such cases, the fund entity must hold the license to comply with regulatory requirements.
- Example – California: Under the California Finance Lender license (CFL), entities engaging in consumer or commercial lending must be licensed, and loans must be funded directly by the licensed entity. If the debt fund is the entity originating and funding loans, the debt fund must hold the CFL license. Because the debt fund entity holds the capital used to fund loans, the CFL requirement for direct balance sheet lending mandates that the CFL license be held at the debt fund entity level. Structuring the license at an affiliate level would not satisfy this requirement.
When Licensing at the Affiliate Level Works
Some states provide licensing exemptions or permit brokered transactions, allowing a licensed manager or affiliate to originate or broker loans, which are then funded by the unlicensed debt fund. This structure enables the fund to deploy capital efficiently without directly holding a license, provided that state-specific licensing exemption conditions are met.
- Example – Arizona: Arizona may allow unlicensed entities to fund loans under certain conditions when a licensed entity brokers loans to the fund. This allows for flexibility in structuring and may eliminate the need for the fund itself to hold a license.
Operational and Legal Implications
- Regulatory Compliance: States differ widely in their approach to licensing. Some mandate direct balance sheet lending by the licensee, while others allow loan brokering or offer exemptions. Depending on the fund’s business strategy, some states may also require licenses to buy or sell loans, which may impact fund operations.  Navigating these differences is essential for avoiding regulatory risk.
- Operational Efficiency: When the fund is licensed, it can originate, fund, and service loans directly, maintaining full control over the process. Alternatively, licensing at the affiliate level allows for segregation of duties, where the affiliate originates and services, and the fund focuses on capital deployment.
- Liability Containment: Placing the license at the manager or affiliate level can help isolate operational liabilities from the fund, offering additional risk management protections for investors and the fund’s balance sheet.
The Importance of Expert Guidance When Implementing a Debt Fund
The placement of lending licenses is not a one-size-fits-all decision. It must reflect:
- The funds and organization’s operational model.
- The types of lending activity conducted at each entity level.
- The jurisdictions in which the fund operates.
Failing to correctly align licensing with both regulatory requirements and operational reality can result in regulatory violations, penalties, and reputational damage. By strategically planning license placement—and staying attuned to state-specific licensing rules—debt funds can ensure compliance and operate with confidence.
Working with professionals who understand the licensing requirements across multiple states, and who understand the fund’s unique organizational structure and business strategy is essential for ensuring compliant, efficient operations. Our Corporate & Securities team can assist you throughout the complex fund formation process, and ensure your business remains compliant. Click here to contact us today.
