In real estate syndication and funds, syndicators must navigate a regulatory landscape governed by the Securities and Exchange Commission (SEC) and various state laws. However, internally, the operational and subscription agreements are two equally important components of its legal framework.

These documents define the internal workings of a limited liability company (LLC) and dictate the rights and responsibilities of its members. They are foundational to setting the stage for the syndication’s functions and the investments’ management.

Many new syndicators tend to use templates found online, which often result in conflicts between the agreements and the Private Placement Memorandum (PPM). Such inconsistencies can undermine the legal protection the LLC structure is supposed to provide.

Ensuring that both agreements are meticulously tailored to fit the unique needs of each real estate syndication is essential to maintaining stability and trust among all parties involved. This article aims to guide syndicators through their key elements and to be well-equipped to draft these crucial documents. 

The Roles of Operational and Subscription Agreements in Real Estate Syndications and Funds

Operational agreements define the rules and structure of the LLC managing the syndication, covering critical aspects such as management system, voting rights, and profit distribution. This clarity helps prevent misunderstandings and conflicts, providing a roadmap for decision-making and day-to-day operations. Knowing exactly who is responsible for what and how profits will be shared builds a solid foundation for the syndication.

Subscription agreements, on the other hand, formalize the relationship between the syndicator and the investors. They spell out the terms of the investment, including any risks involved, as well as the restrictions on transferring the investment. Such transparency ensures all parties are on the same page from the outset, fostering trust and confidence. By clearly outlining representations, warranties, and transfer restrictions, subscription agreements help protect both the syndicator and the investors.

Understanding these two agreements can seem daunting for syndicators but breaking them down into manageable parts can make the process more accessible.

Elements of an Operating Agreement

Initially, only the founders of the LLC (you and your partners) sign the operational agreement, which serves as its rulebook. It outlines the procedures for virtually every situation, ensuring all parties have a reference document with clear guidelines.

Here are the key parts:

LLC Formation

This part details the creation of the LLC, including its name, address, purpose (as specified in previously filed articles), notification protocols, and storage of books and records. As the syndicator, you are also expected to file the necessary documents with the state to make the LLC a separate legal entity from its members.

Management Classification

Determine whether the LLC will be member-managed or manager-managed, then outline the responsibilities and authority of those in charge. The decision defines the structure and sets the tone for the entire agreement.

Membership Criteria

List all existing members, their ownership percentages, the process for admitting new members, and the different classes of membership. Clarify categories, such as A or B shares (technically membership units but often referred to as shares). Each class may have distinct responsibilities, distribution amounts, and voting rights.

Voting Rights and Process

Even in a manager-managed LLC, you’ll want to grant some voting power to members, particularly for significant decisions like capital events. This way, you can guarantee their buy-in when it’s time to sell or make other critical decisions. Also, explain quorum requirements and procedures for voting on important matters.

Management Compensation and Fees

This section grants the manager the right to receive compensation. Enumerate all relevant fees for asset management, construction, and property management, detailing the payment schedule and method.

Capital Contributions

Arguably the deal maker or breaker for any potential real estate syndication investor, this part explains:

  • The process of receiving funds from investors
  • Any limitations on these contributions
  • The designated accounts for deposits
  • Procedures for initial contributions and future capital calls

Capital call, which happens when additional funds are required when the project is already up and running, is often controversial and generally unfavorable. The one responsible for identifying the need as well as the process for addressing it must be clearly defined in this portion of the operational agreement.

Distribution of Returns

Provide details on sharing profits and losses among members. Specify the timing and method of distributions, including the order of payments based on different membership classes. Describe capital event scenarios where the return of capital is paid out.

Dissolution Procedures

As a natural course, the syndication will eventually conclude its business and distribute all remaining funds. Describe the process, ensuring an orderly wind-up of affairs and protecting everyone’s interests.

Additionally, consider whether to include a right of first refusal for the sale of membership units. If a member wishes to sell their units, this gives the company or manager the first opportunity to buy the units, possibly during a capital call, to guarantee the units stay within the organization. Although selling shares in an LLC is typically restricted, it is permissible if allowed by the operational agreement.

Subscription Agreement Inclusions

After you and your partners have signed the operational agreement, it becomes officially closed, but you need this auxiliary document as a mechanism to add new investors. Each investor signs a subscription agreement, binding them to the operational agreement and subjecting them to its rights and responsibilities.

These are the key sections you’ll need to understand:

Representations and Warranties

This section involves mutual promises from both the issuer and the subscriber. The former confirms their authority to offer the investment, while the latter affirms their capacity to make the investment.

Each investor must confirm they have received, read, and understood the PPM and had the opportunity to consult with their attorney. If it’s a 506C offering, verify their accreditation. These assurances verify the legitimacy of the transaction and establish trust between parties.

Acknowledgment of Transfer Restrictions

Identify limitations on investors transferring their shares as it affects the liquidity of their investment. Being transparent helps prevent future misunderstandings and ensures all parties are fully aware of the conditions under which they can sell their interests.

Questionnaire for Concerned Parties

Collect essential information from investors covering financial status, investment experience, and other relevant details. This will determine if they meet the necessary qualifications and comply with securities regulations.

Moving Forward with Operational and Subscription Agreements

Well-structured operational and subscription agreements are indispensable for real estate syndicators. They provide a solid foundation that helps clarify roles, responsibilities, and expectations, thereby minimizing the risk of misunderstandings and disputes.

Operational agreements give a detailed outline of how your LLC will be managed, a clarity that is crucial for smooth day-to-day operations and strategic decision-making. On the other hand, subscription agreements lay the groundwork for a transparent and secure relationship between you and your investors, which ensures everyone is on the same page.

Understanding and implementing these agreements correctly is more than just compliance. It fosters a professional and reliable investment environment that protects your interests as well as those of your investors. Whether you are new to real estate syndication or have been involved in multiple projects, including such supporting documents significantly enhances the credibility and efficiency of your ventures. Need a real estate syndication or fund attorney with experience in Operational and Subscription Agreements? Shams Merchant is the top-ranked real estate private equity and syndication attorney in the country, representing clients in real estate crowdfunding, syndications and funds. Shams is an expert in real estate syndications, crowdfunding, funds, securities law, and private placements for commercial property investments and development. Shams has been featured in numerous national publications like Law360, the Austin Business Journal, BisNow, and The Real Deal.