Related-Party Transactions: Affiliates Paid by Your Deal
The sponsor's fee is one line. The sponsor's affiliates can be five more, disclosed accurately and in a section most readers skip. This is how to find them and put them in one place.
The compensation table in a private placement memorandum lists what the sponsor is paid: an acquisition fee, an asset management fee, perhaps a disposition fee, and the promote. It is usually accurate, and it is usually incomplete. Payments to businesses the sponsor owns tend to appear somewhere else.
Those payments are related-party transactions. They are legal, common and disclosed. They are also the part of a sponsor's economics that investors are least likely to add up, because nobody puts them in one table.
Where they come from¶
A sponsor that has grown beyond a single deal often owns more than one kind of business. Each of them can be paid by the partnership.
| Affiliate | What it is paid for | How the fee is usually based |
|---|---|---|
| Property manager | Day-to-day operations, leasing, collections | A percentage of collected revenue |
| Construction manager or general contractor | Supervising or carrying out the renovation | A percentage of project cost, or a contractor's margin |
| Brokerage | Buying, selling or refinancing the property | A commission on the transaction |
| Lender or capital provider | Bridge, preferred equity or rescue capital from a sponsor fund | Interest, a preferred rate, or fees |
| Guarantor | Signing the non-recourse carve-out guaranty on the loan | A one-time or annual guaranty fee |
| Insurance or services company | Insurance brokerage, utility billing, technology | Commissions or service fees |
The list has a pattern. Most of these fees are earned whether or not the deal succeeds, and several of them grow with activity. A renovation that runs over budget pays the affiliated contractor more, and a refinance pays the affiliated broker again.
Where they are disclosed¶
Three places, and they rarely match exactly.
The conflicts of interest section of the memorandum. It is the most comprehensive and the least specific. It will list the affiliates and say that their compensation was not negotiated at arm's length. It often gives a percentage or a range but no dollar total. Reading a memorandum in the right order puts this section first for that reason.
The compensation table. Sometimes it includes the affiliates, and often it covers only fees paid to the sponsor entity itself.
The operating agreement. Usually a clause authorizing the manager to hire affiliates, subject to a standard such as "on terms no less favorable to the Company than would be obtained from an unaffiliated third party." That clause is the binding one.
Why private placements disclose less than you might expect¶
A company registered with the SEC has to disclose related-party dealings under Item 404 of Regulation S-K. It must describe any transaction above $120,000 in which a related person has a material interest, naming the person and the amount.
A private placement has no equivalent line-item rule. The disclosure is whatever the issuer's counsel decides is needed to avoid a misleading omission. Rule 502(b) is the one exception with a structure: in a Rule 506(b) offering that includes non-accredited investors, the issuer has to furnish those investors specified information, modeled on registered-offering disclosure, a reasonable time before sale. Most syndications sell only to accredited investors, so the rule does not apply to them.
The practical result is that the dollar figures you need are sometimes in the documents and sometimes only in an answer to a direct question.
The arm's-length clause, read closely¶
The standard sounds protective. Look at who applies it.
Unless the agreement adds something, the manager decides whether its own affiliate's terms are no less favorable than a third party's. No independent reviewer is involved, no comparison bids are required, and no investor approves. Some agreements go further and require an advisory committee of limited partners to consent to affiliate contracts, or require competitive bids above a threshold. Those provisions exist, and whether yours has one is a fact you can check.
The second question is whether the affiliate can be replaced. If the property manager is an affiliate, the right to terminate the management agreement sits with the same manager. The control rights in the operating agreement decide whether investors can act if performance is poor, and a GP removal provision that does not also reach the affiliated contracts does less than it appears to.
Putting the numbers in one place¶
The affiliate fees may all be reasonable. The point of the exercise is that you cannot judge reasonableness on a figure you have not totaled. The method for the full total, and what to compare it with, is in the fee stack.
A related-party checklist¶
None of these questions accuses anyone. A sponsor that has priced its affiliates fairly can usually answer all of them from the budget it already has.
Primary sources
Every factual claim above is traceable to a filing, a rule or an agency publication. These are the ones this article relies on.
Questions readers ask
What is a related-party transaction in a syndication?
Any arrangement under which the partnership pays, borrows from, buys from or sells to the sponsor, its principals, or a business they own or control. Common examples are an affiliated property manager, construction manager, broker or lender.
Are affiliate arrangements disclosed?
They are usually described in the conflicts of interest section of the memorandum, and the operating agreement usually authorizes them. Private placements have no line-item rule requiring a particular format, so the description can be general rather than a dollar figure.
What does "on terms no less favorable than arm's length" mean in practice?
It is a standard the manager applies to its own contracts with affiliates. Unless the agreement requires an independent review or an investor vote, the party deciding whether the standard is met is the party that benefits.
Is an affiliated property manager a problem in itself?
Not by itself. Many sponsors manage their own properties. The questions are what it is paid, whether the fee appears in the fee totals you were shown, and whether it can be replaced if performance is poor.
Which document governs if the memorandum and the agreement differ?
The operating or limited partnership agreement is the binding contract. The memorandum describes it and generally says that the agreement controls.
Read next
- DocumentsHow to Read a Private Placement MemorandumThe memorandum is written to protect the issuer by disclosing what could go wrong, which makes it the most informative document in the package.
- SponsorsSyndication Fees: What a Sponsor Earns Before You Earn AnythingSyndication fees one by one, the total a sponsor earns from a deal that only returns your capital, and how IRC 709 treats syndication costs for tax.
- DocumentsThe Operating Agreement: Control, Voting and Removal RightsThe binding document. It holds the real waterfall, the short list of things you vote on, and the conditions under which a sponsor can be replaced.
This article sits in section IV, Offering Documents, which runs to 9 articles in reading order.