Private lending has become an increasingly popular investment option in recent years, as investors look to diversify their portfolios and take advantage of the potential for higher yields. One way that they have sought to scale their operations and offer a more structured investment option to their investors is by forming debt funds. Debt funds allow private lenders to pool capital from multiple investors and use it to fund a variety of debt instruments such as mortgages, business loans, and more.
However, while debt funds can be a useful tool for private lenders looking to grow their business, they are not always the most ideal solution. In this article we will take a closer look at some of the circumstances in which a debt fund model may not be the best fit.
One such circumstance is when the private lender is either new to the industry or is only dabbling in private lending as a hobby. Debt funds require a significant investment in both start-up capital and time and energy and are best suited for private lenders who are professionally committed to establishing, building, and scaling a private lending business. Many new private lenders may not yet be doing enough volume to justify such an investment, and those who are using private lending to diversify their investment portfolio may not be as well-suited to the debt fund model.
For these types of private lenders, it may be more practical to start small and focus on building a solid foundation for their business before considering a debt fund. This might include establishing a strong network of borrowers and investors, as well as developing a clear set of policies and procedures to ensure that their lending activities are conducted in a professional and transparent manner.
Institutionally Capitalized Private Lenders
Another group of private lenders that may not be well-suited to the debt fund model are those who are institutionally capitalized. While these lenders may have more advanced capital structures, they can still be subject to capital constraints. Some may have considered or even built debt funds to bolster support from their institutional investors. However, depending on the specific institutional investor involved, a debt fund strategy may be unnecessary or even create friction in the relationship between the private lender and the investor.
For instance, an institutional investor may have certain restrictions on the types of investments it is willing to make, and a debt fund may not align with these restrictions. Additionally, the investor may view the use of a debt fund as a conflict of interest, which could present non-legal PR risks. In these cases, it may be more appropriate for the private lender to consider alternative ways of raising capital, such as through traditional lending channels or through the use of other investment vehicles.
It is important to note that these are just a few examples of circumstances in which a debt fund model may not be the most ideal solution for a private lender. Each lender’s situation is unique, and you must carefully consider your goals, resources, and constraints before deciding whether a debt fund is the right fit. For private lenders who are ready to commit to building and scaling a professional private lending business, a debt fund can be a valuable tool. However, for those who are still in the early stages of building their business or who face constraints that make a debt fund less practical, other options may be more appropriate.
Curious if a debt fund is right for you? Contact Geraci LLP to set up a consultation today.