How to Start a Fund for FREE

Ever since discovering this information for myself, I’ve had a lot of people request to learn the process. Today, I’m excited to share how to setup a fund completely for free, because it could save you a significant amount of money—potentially around $40,000.

A lot of people think setting up a fund is a complex and expensive process. Complex? Maybe. Expensive? Not at all. You can actually set up a fund for free today. But there are absolutely some clear legal key points that you need to know and understand before doing so yourself.

Let’s break down the different fund structures so you can choose the right one for you and your business.

Disclaimer: I’m not an attorney, and this isn’t legal advice. You should understand the legal intricacies and ramifications of setting up a fund. What follows is simply what worked for me.

First, let’s go over the three main fund structures.

There’s Regulation A, Regulation CF (Crowdfunding), and Regulation D. Regulation D is likely the best fit for you. But I’ll cover Regulation A and Regulation CF first because they’re still useful to know. Who knows? They might fit into your business model.

Regulation CF

The first way to set up a fund is through Regulation CF, which stands for Crowdfunding.

This option comes with some restrictions that make it less ideal for our business, but it’s still good to know about. First, there’s a $5 million maximum in a rolling 12-month period. You can have more than $5 million in your fund, but if you’re looking to raise capital quickly, this might not be the best option since you’ll hit that cap.

Another downside is that you can only accept a maximum of around $1,000 to $2,000 per investor, based on my understanding from speaking with different attorneys. This makes it difficult to raise a large amount of money because you need to gather funds from many investors.

I’d rather receive a $50,000 check from one investor than fifty $1,000 checks. Not a great option.

“I’d rather receive a $50,000 check from one investor than fifty $1,000 checks. Not a great option.”

However, one great thing about Regulation CF is that you can have both non-accredited and accredited investors.

With some of the other regulations, which I’ll discuss later, you can only accept accredited investors. This can be both an advantage and a disadvantage. We’ll cover that later. But in Regulation CF, you can have both types of investors, which is really nice.

Another downside of Regulation CF is the requirement to use a “FINRA funding portal.” This is basically software that’s been vetted and approved by FINRA (Financial Industry Regulatory Authority). It’s the management tool that investors use to see your offering, review all documents related to the agreement, and use to send funds.

While this helps keep things organized, these tools can be expensive, with some costing as much as $2,500 per month.

If you’re just starting out, these costs can be prohibitive, and personally, it’s not something I really want to deal with.

Lastly, you should be aware that individual state filings are still required. For example, if you have investors from Idaho, Alabama, and Oklahoma, you need to file state filings with each state as soon as you have an actual investor committed to your fund.

You don’t have to pay investor/filing fees to all 50 states; you only need to file with the states in which you have investors.

Filing fees range from $0 to $600. For example, Florida has no filing fee, while Vermont has a $600 fee. This fee is per state, not per investor. If you have 100 investors from Vermont, you only pay the $600 fee once, which is really great. This is not an annual fee, it’s one-time. If you want to see the particular filing fee for your state, you can see those here.

That’s Regulation CF. While it’s not my favorite option, it’s still good to know about because it might be valuable for you or something you’re working on.

Regulation A

Another popular fund structure is Regulation A. This option is similar to Regulation CF but more flexible and also more expensive.

Tier 1

Regulation A has two different tiers, and I’ll start with Tier 1. In Tier 1, you can raise up to $20 million in a 12-month period, which is significantly more than Regulation CF.

This is a great option for setting up a fund. I don’t know too many people who will hit that $20 million limit in a 12-month period, but if you can do that, that’s great!

The nice thing is that you can publicly solicit with this regulation.

With some of the other structures, you’re not allowed to advertise publicly. You can’t run radio ads, paid ads, post on Facebook, etc.—nothing. But with Regulation A, you can publicly solicit.

Another benefit is that this option is open to both non-accredited and accredited investors. Again, this regulation is very flexible. People often refer to it as a “mini IPO.” It’s not as extensive as a full IPO where you have to do tons of financials, but it’s still in-depth. It can take anywhere from six to nine months because the SEC has to approve you. Also, with Regulation A, you still need to use that FINRA-approved funding portal like in Regulation CF.

Another requirement in Regulation A is that your financial statements must be reviewed, though they don’t necessarily have to be audited.

There are also no reporting requirements. Similar to Regulation CF, you still need to do individual state filings, which can range from $0 to $600 per state.

At one point, I did the math. If I got at least one investor in every state, the total cost would be somewhere around $18,000. Is that expensive? Yes. But the likelihood of having an investor in all 50 states is low. You probably don’t need to worry about that cost until you scale to the point where $18,000 is just a rounding error.

Finally, in Tier 1 under Regulation A, you still have to adhere to blue sky laws.

Although I don’t fully understand all the intricacies, blue sky laws are essentially anti-fraud regulations that require you to notify your investors about what you’re doing. It’s important to disclose certain things about your fund and the securities you have, including the risks involved and financial statements. These laws are in place to ensure your investors aren’t in the dark, which is honestly a good practice anyway.

Tier 2

Tier 2 is very similar to Tier 1, except instead of a $20 million limit, you have a $75 million limit in a 12-month period—a huge difference.

While some well-connected individuals might raise that much, it’s a significant amount to gather in just 12 months. Tier 2 exempts you from blue sky laws, but you have to have your financial statements not only reviewed but also audited and submitted annually and semi-annually. It’s quite extensive.

Most people outsource this to a CPA or fund manager because it’s so detailed and can be a pain. Depending on how many investors you have, it can be rather involved. Remember, this is an actual filing with the SEC, so it can take up to nine months or even a year to complete. Be aware of what you’re getting into.

Regulation D

Now that we’ve covered Regulation A and Regulation CF, let’s talk about Regulation D. This is what we used to set up our fund, and it’s probably the most common for private and hard money lenders. It’s likely what you’ll be using too.

As a side note, I’d say 98% of lenders who create a fund would actually be fine using a Regulation D 504 filing instead of a Regulation D 506. The 504 allows you to have up to $10 million, while the 506 has no limit on investor capital. I don’t think many people cross that $10 million threshold, but it’s funny that a lot of people could reduce hassle by choosing the 504, yet everyone goes with the 506.

Within Regulation D, there are two main distinctions (there are more than just these, but these are the most popular): 506(b) and 506(c).

The differences between the two are subtle but crucial.

506(b)

With 506(b), there’s no limit on the amount of funds you can raise! Unlike Regulation A and CF, where there are caps, there’s no cap here. The only catch is that there’s no public solicitation. This means you cannot advertise on Facebook, post paid ads, run radio or TV ads, etc. There is no general advertising allowed.

“Using a 506(b) means you cannot advertise on Facebook, post paid ads, run radio or TV ads, etc. There is no general advertising allowed.”

All fundraising efforts must be done through existing relationships or word of mouth—friends, family, friends of friends, etc. The key distinction is that there must be a substantive, pre-existing relationship.

You can’t take just anyone. For example, someone you went to high school with or a couple you met on an Anniversary trip to Aruba. You need to have a substantial relationship with these people. If you were to get audited, you’d need to prove these relationships. The good thing about 506(b) is that you can have both accredited and non-accredited investors. However, you can only have 35 non-accredited investors. You can have an unlimited number of accredited investors.

If you have a warm network of non-accredited investors, this can work in your favor for those individuals who haven’t yet reached accreditation status (which is far more common than accredited).

With 506(b), you still need to do individual state filings. You only need to do this once an investor subscribes, not before. After an investor subscribes to the fund, you have 15 days to submit the filing with the state.

506(c)

Personally, I think 506(c) caters most to hard and private money lenders. It’s very similar to 506(b), but the main difference is that public solicitation is allowed solicit. You can openly advertise, run Google ads, Facebook ads, etc., to attract investors. The only downside is that each investor must be accredited. In no way, shape, or form can you have non-accredited investors inside of a 506(c) structure.

An accredited investor (as defined by the SEC) is someone:

• With a net worth of one million dollars or more, excluding their primary residence

OR

• They must have earned at least $200,000 in the past two years and reasonably expect to earn the same in the coming year. If they’re married and filing jointly, that amount increases to $300,000/year.

While most people with a net worth of over $1M probably have a high income as well to match, it’s nice to know that investors have to match one of the criteria, but not both. It’s crucial to understand this distinction because while you can publicly solicit, you still can’t accept just anyone as an investor.

Similar to the other regulations, you still need to file individually with each state where you have investors.

What We Use for Our Fund

We opted for the 506(c) structure to ensure we bring on accredited investors. While it’s been more challenging than expected to raise capital, I believe it will be easier to get $100,000 or $250,000 checks rather than $10,000 or $20,000 checks from non-accredited investors.

It’s not that non-accredited investors don’t have money, but accredited investors do have money. It’s probably not that cut and dry, but in my mind, if you’re accredited you likely have more funds available to invest than someone who isn’t. That’s why we chose 506(c).

State Filings/Blue Sky Laws

Except for Florida each State requires a “Blue Sky” filing. All states now use the NASAA Electronic Filing Depository (EFD) system except for Arizona. Arizona has its online filing system where you can upload your Form D and pay the state filing fee.

Can I Have Both a 506(b) AND a 506(c)?

The answer is yes, but you probably shouldn’t.

If you have both a 506(b) and a 506(c), the offerings must be entirely separate. You can’t set up a 506(b) fund for non-accredited investors and a 506(c) fund for accredited ones and expect to cater to everyone. You’d likely run into trouble if you did that.

If you want both, the offerings must be distinct with no overlap. For example, your 506(b) might accept investors for mineral rights and drilling, while your 506(c) could be for hard and private money lending. Those offerings are different. Again, I’m not an attorney, but you should keep the offerings as separate as possible to avoid legal issues.

I would recommend choosing the structure that works best for you and deciding whether you want accredited or non-accredited investors. Also, consider whether you want to be able to solicit publicly or not. These are key details in setting up your fund.

Fund Setup

When it comes to physically setting up the fund, you might be asking yourself, “What is required to get started?” Honestly, it’s very simple to set up.

1. EDGAR Access

First, go to the EDGAR (Electronic Data Gathering, Analysis, and Retrieval) website. You need to register with EDGAR to obtain certain passcodes. Once you have them, you can access the SEC’s filing website.

I’ll be honest, the EDGAR website, as well as the SEC website, is a pain. The government is not known for being super tech-savvy. It’s very much a government website—difficult to navigate and antiquated.

2. Notarize Documents

Inside of EDGAR, you’ll need to print some documents, get them notarized, and then re-upload them to the portal. When I did this, I had to repeat the process three or four times because I kept filling things out incorrectly. Be patient during this process. It takes some back and forth, but once it’s completed, you’ll receive your EDGAR access codes. With those codes, you can go to the SEC’s website and file a Form D. It’s completely free.

3. Submit Form D

In my opinion, attorneys are worth the money. Do I think they’re worth $40,000? In some situations, absolutely. But not for filing a simple Form D.

If you feel in the dark about the various fund structures, it might be worth consulting someone to guide you through it. There are some nuances to this process, but a helpful trick is to look up other filings once you’re on the SEC’s website.

You can theoretically look up my filing and use it as a template. The SEC’s website hosts hundreds of thousands, if not millions, of filings. They’re all publicly accessible, so you can pull them up to see how others have done theirs. You might find filings similar to what you’re planning to do—similar size offerings, number of investors, investment type (raw land, agriculture, mineral rights, general real estate, etc.). Find someone who has already filed something similar to what you’re doing, and you’ll get an idea of how yours should look.

4. Investor Documents

After that’s all done, what exactly do you need to give your investors? There are a few important documents.

Private Placement Memorandum

The first and most important document is the Private Placement Memorandum (PPM). It’s a massive, 60-page document filled with legal jargon. It covers every detail of your fund—who the board members are, who is facilitating the fund, how those members are compensated, the different structures, the fees drawn from investors, investment strategies, risk tolerance, etc.

It’s crucial to include all this information in the PPM to ensure transparency with your investors. At the end of the day, you want them to be well-informed.

Subscription Agreement

The Subscription Agreement is what an investor fills out to subscribe to the fund. In this agreement, they verify that they have read the PPM and agree with what it states. After signing the subscription agreement, they send it to you along with their funds, officially becoming a member of the fund.

Investor Questionnaire

I highly recommend including an investor questionnaire. This verifies whether they are accredited or non-accredited. Our questionnaire goes pretty in-depth. It asks:

• What is your profession?
• Why do you feel your risk tolerance is sufficient to invest in the fund?
• Does this align with your overall investment strategy?
• Is the amount of money you’re allocating to the fund a substantial portion of your overall net worth?
• Will investing in this fund put you in any sort of financial bind?

The last thing I want is for someone who isn’t qualified to join the fund. I don’t want to put anyone in a bind.

Dial in that investor questionnaire to really qualify your investors and ensure they should be a member of the fund in the first place.

Operating Agreement

Lastly, provide your investors with a copy of your Operating Agreement. An Operating Agreement is a basic overview of what your fund entails. It outlines who the members of the LLC are, what the voting rights are, etc. As a member of the fund, the investor should have access to all that information.

They need to see who the managing members are, what the percentages are, what the compensation structure is, and other relevant details.

Those are the four main documents your investors should find or fill out to subscribe to the fund.

Conclusion

Phew! That’s a lot of information. Are you bored to tears yet?

In my opinion, the fund structure is probably one of the best ways to run a hard or private lending business. With a fund, you set up a bank account and control the funds, which makes things a bit easier compared to something like the Direct Placement method. Not to mention, it’s completely free!

I focused on this topic of setting up a fund for free because I used to be confused about what to choose as well. I was about to spend almost $40,000 to have someone else set up my fund.

After deciding against that, I’m glad I saved the money.