Updated · Part of the CRE investment glossary
What it does in a syndication
A syndication typically forms an LLC to own the property, directly or through a subsidiary. The sponsor’s entity is the manager, and investors are members, often in a separate class from the sponsor. The operating agreement is the contract among them; the PPM summarizes it for investors.
State LLC statutes supply default rules where the agreement is silent, and many, including Delaware’s, give members wide freedom to set their own terms. That is why two deals with the same headline terms can pay out differently: the details live in the agreement.
The distribution waterfall
The distributions article sets the order in which cash is paid. A common structure returns investor capital and pays a preferred return first, sometimes adds a GP catch-up, then splits the remaining profit between investors and the sponsor (the promote). Operating cash flow and capital events, such as a refinance or sale, often follow different waterfalls.
Read the definitions with the waterfall. Whether the pref is cumulative or compounding, whether it accrues on contributed or unreturned capital, and whether promote hurdles use IRR or equity multiple all change the payout. Tax allocations of profit and loss sit in a separate article and follow their own rules.
Fees, voting and control
Beyond the waterfall, the agreement sets how the deal is run:
- Sponsor fees: acquisition, asset management, construction management, refinance and disposition fees, how each is calculated and when it is paid.
- Manager authority: what the manager may decide alone, such as leasing and day-to-day operations.
- Major decisions that need member approval, often a sale, a refinance, new debt, new members or amendments, with the vote threshold for each.
- Removal of the manager: whether members can remove it, whether only for cause, and what happens to its promote.
- Conflicts: affiliated property management, related-party transactions and other business the sponsor may pursue.
- Exculpation and indemnification of the manager.
Capital calls
Many syndications raise all of their equity at closing, but the operating agreement decides whether the manager can ask for more. A capital call clause states when calls are allowed, how much notice members get and what happens if a member does not fund. Common remedies include:
- Dilution of the non-funding member’s percentage interest, sometimes at a penalty rate.
- A member loan from the members who fund, repaid with interest before the defaulting member receives distributions.
- Loss of voting rights, or a buyout of the interest at a discount.
- Voluntary calls, where only the members who fund earn the return on the new capital.
Transfers, reporting and exit
The remaining articles decide what investors can do with their interest and what they will see:
- Transfer restrictions: transfers usually need manager consent and must comply with securities laws, since the interests are unregistered. Agreements also commonly bar transfers that could cause tax problems, such as treatment as a publicly traded partnership.
- Rights of first refusal, and drag-along or tag-along rights on a sale.
- Reporting: what investors receive and when, such as quarterly reports and the annual Schedule K-1.
- Tax matters: for an LLC taxed as a partnership, who serves as partnership representative in an IRS audit under the centralized partnership audit regime.
- Dissolution: when the LLC winds up and the order in which sale proceeds are paid.
What to watch for
Disputes and payout errors usually trace back to one of these:
- A waterfall in the deck or PPM summary that does not match the agreement. Model from the signed agreement.
- Fee bases defined far from the fee, such as an asset management fee on gross revenue versus on equity.
- Unclear dates: when a contribution counts as received and when the pref starts to accrue.
- Amendment clauses: check which changes the manager can make alone and which need a vote, or each affected member’s consent.
- A distribution model that was not updated after an amendment.
Primary sources
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.