When new clients who are seeking private capital for a multi-million dollar acquisition or for a $65 million dollar development project ask about up front fees, due diligence fees, and structuring fees, we often know we are beginning a potential relationship with someone who is used to simple conventional financing. They have been conditioned to walk into a bank and with as little as a signature and a history of good personal credit, obtain 100% financing for an auto-loan, a small business loan, or a home loan which can require relatively little out-of-pocket expense.
At other times, they may be a “green” entrepreneur who claims to have invested $50 to $100K (or more) with a broker or private lending source that was not properly vetted and they wasted their valuable time and money with a source that could not perform, or took their money and disappeared.
Regardless of their situation and experience or lack thereof, there is an educational curve and a process of trust development for clients to be equipped financially, mentally and emotionally to engage in the world of private funding.
Investment bankers who work closely with investors and especially hedge funds must package and structure all funding requests in a way that considers the fund and the tax considerations of investing funds for the shareholders, so that the money is issued properly, legally and wisely.
Every time a client engages a private investor or fund for close to 100% financing on any project or acquisition, the majority risk (99.9%) is on the funding source (not the client), whether it is a hedge fund or private investor or JV / syndicate.
In order to make the funding process work for a new client (or any client who has not previously funded through a particular hedge fund or investment banker) while mitigating risk and tax burdens for the funding source, a pod (team) of analysts, MBAs, forensic accountants and an SEC attorney must be hired to “structure” the funding process and mechanism to be sure it has the least tax burden and that everything is clean and legal for all parties.
Since the funding sources are taking the majority risk, they require the client to pay for the costs of structuring and this ensures that the project will meet the strict requirements of the hedge fund and will ultimately be funded.
If there were no up-front costs for due diligence and structuring, anyone could come off the street and request millions in funding.
Therefore, by requiring the client to pay these fees, this requirement (although very low) weeds out the clients who are not capable of engaging and this also protects the investment banker from spending valuable time and resources out-of-pocket for clients who will not cross the finish line (some investors will not mention structuring, but will sometimes call it all “due diligence fees” or “diligence”).
Regardless of the financial jargon that is tossed around, obtaining private capital is an expensive process for those who are working on behalf of the client, those who must structure or “engineer” the financing in a way that will work for all parties involved. Also, while there are never guarantees in private funding, this fee is paying for the Investment Banker’s time and expertise and his analyst team’s time to package and structure the funding mechanism or mechanisms so that everyone wins and to meet the requirements of the specific hedge fund, investor, JV or syndicate.
They know how to structure it so that the entire package is accepted by the hedge fund or other private source of funds (as they often also sit on the board of the fund or funds as a shareholder and are very familiar with the requirements and work involved up front). With proper structuring, the project will get accepted and will be funded. Without the proper structuring, the hedge fund or private funding source will not accept the project.
For these reasons, it is not as simple as reviewing a business plan and proforma and cutting a check. That kind of simple process often occurs with private angel investors who are usually injecting cash into a start-up with limits that usually have a ceiling of $1M (and they usually take majority equity on those deals as well).
Their concern (the hedge fund manager, investment banker and shareholders) is that the client’s business also receives the funds in a way in which the debt is serviceable and will not consume the profits of the business being funded, and will make the client successful so that the business being acquired is not overly-burdened from the acquisition debt.
For this, due diligence and structuring is a very small cost for the client to have access to the multiples of millions in funds needed for acquisition (or in other cases the project development).
In some cases, where the investment banker or firm has access to legitimate 100% private funding sources, it costs the client much less than 1% to acquire the funds, but market trends are showing that it may become more expensive for clients to access private capital / equity in the near future.
Also, after the client’s project is successfully funded, the hedge fund will often invite the client to be a share-holder, giving them direct access to future funding as a shareholder versus being an outsider. After success as a shareholder, the client will then be an active part of the fund, helping other fledgling businesses get off the ground, offering qualifying new entrepreneurs a “hand up” and not a “handout”.
The biggest leap, sometimes, is to help the inexperienced client step into the shoes of the shareholders of the hedge fund or the shoes of the private investor and realize that they want the client’s business (the business that will be funded) to be successful, as the returns will help the hedge fund grow which is good for the shareholders, good for the hedge fund, and great for the business owner / client. This process also enriches the economy, helping the overall access to private capital get richer and less expensive, not leaner and more costly.
If the funds are not structured properly from the beginning, it is not in the best interests of all parties and for this there is a fee required of the client for engagement, due diligence and structuring.
This will ensure that the project will get funded properly, and also ensure that the investment banker, investor or hedge fund manager will not ultimately come to the “closing table” with a client who has no commitment to the process and will not get cold-feet when it is time to receive the funds for the project or acquisition.
When the client pays these fees to a legitimate funding source or investment banker, they are ensuring the investment banker, fund and team that they are committed to the process and will not back out, otherwise wasting valuable time and many expenses for the investment banker and his team.
Structuring ensures that everyone involved (lender, client, investment banker, shareholders) has the very best chance at funding and growing a successful business for the client so that everyone wins.
Structuring fees and/ or due diligence fees paid by the client allows for both parties to be fully committed to the process until the project is successfully funded.
Another simple analogy would be that the investment banker and analyst team are the “financial architects” and “engineers” (much like architects and engineers are paid to create blueprints before a building or home is built) to make sure that the funding is structured / engineered properly so that both sides of the transaction are successful and satisfied.
The client must pay the architect and his team of engineers and analysts to ensure:
1- That the client’s business is successful from a financial underwriting perspective
2- That the source of funds (hedge fund, investor or JV / syndicate) is issuing funds in a way that is best for the client’s business, tax implications for the fund and shareholders, and that all legal compliance is covered.
For further information on due diligence and structuring fees, consider reading our 2-part article on Structuring:
https://5thaavc.com/blog/project-funding-and-costs-proper-structuring
https://5thaavc.com/blog/project-funding-and-costs-proper-structuring
https://5thaavc.com/blog/why-private-project-funding-requires-structuring-c…
And one of our articles on Due Diligence-
https://5thaavc.com/blog/due-diligence-and-private-funding
These article review generalizations on structuring and due diligence, but every funding opportunity is different and different scenarios apply.
5th Avenue Capital’s private investor partners and investment banking sources can help properly structure your project funding for optimal success. To begin the process of structuring your private project funding, contact us.
