Funds are a powerful tool for scaling capital, serving investors, and building a reputable lending platform – but understanding proper fund formation is crucial. Understanding how your fund is structured, how to comply with securities laws, and how to navigate the unique licensing requirements of each state are key to establishing a successful fund.
Whether you’re seasoned lender or new to the industry, below is everything you need to know about fund formation.
What Is Fund Formation?
Fund formation is the legal process of creating a pooled investment vehicle—usually a Limited Liability Company (LLC) or Limited Partnership (LP)—through which private lenders raise and aggregate investor capital to originate or acquire loans, typically secured by real estate.
Fund formation involves multiple layers of legal setup:
- Entity Formation: Selecting the right entity type and jurisdiction (often Delaware or your home state).
- Offering Documents: Preparing a Private Placement Memorandum (PPM), Operating or Partnership Agreement, and Subscription Agreements.
- Securities Law Compliance: Ensuring that your fund is properly exempt from SEC registration—typically through Regulation D of the Securities Act of 1933 (“Reg D”).
- Ongoing Oversight: Meeting federal and state regulatory obligations during capital raising and throughout the life of the fund.
Reg D: 506(b) vs. 506(c) Exemptions
Most private lending funds rely on Reg D to raise capital from investors without registering the offering with the SEC. The two most common exemptions are:
Rule 506(b):
- Permits up to 35 non-accredited investors, but most funds stick to accredited investors only.
- No general solicitation or advertising allowed. Investors must have a pre-existing, substantive relationship with the sponsor.
- Ideal for managers raising capital through personal friends/family or professional networks.
Rule 506(c):
- General solicitation and advertising is allowed. Funds can be marketed openly via websites, social media, email, etc.
- All investors must be accredited, and the fund must verify their status through tax documents, CPA letters, or third-party verification.
- Popular for sponsors looking to scale marketing and reach a broader investor base, especially larger, more institutional investors.
Both 506(b) and 506(c) preempt state-level registration, but states can—and do—require “Blue Sky” notice filings, fees, and compliance with their own securities rules.
State Licensing: The Business Purpose Mortgage Lender Trap
Many private lenders are surprised to learn that even business-purpose loans—those not covered by consumer protection laws—can trigger licensing requirements in certain states. And when you’re forming a fund, that risk can multiply.
Some key points:
- States like California, Arizona, Oregon, Nevada, North Dakota, and others require a lender license to make or arrange loans, even if those loans are non-owner-occupied or business-purpose.
- These rules may apply to the fund entity, the manager, or both. The correct placement of the license at the right entity is crucial.
- In some jurisdictions, servicing loans or offering fractional interests (i.e., pooling investor capital) also requires separate licensing.
- Violating state lending laws—even unintentionally—can result in penalties, loan unenforceability, or civil liability.
If your fund lends nationwide, or plans to syndicate across state lines, it’s critical to map out where your loans will be made and whether any lending or servicing licenses are required in those states.
Why State Compliance Matters—Beyond Licensing
In addition to licensing, every state enforces its own securities laws—Blue Sky Laws—that impact:
- Whether you must file a notice and pay a fee in that state if you have resident investors.
- How your entity is treated for tax purposes, including potential state income tax exposure.
- What types of disclosures or investor protections are required.
Even if you’re fully compliant at the federal level, ignoring state-specific requirements can lead to enforcement actions, investor rescission rights, and reputational damage.
Bottom Line:
Launching a private lending fund involves more than just forming an LLC and raising capital. Between Reg D compliance, state Blue Sky filings, and mortgage lending license requirements, it’s a complex legal landscape—one that varies dramatically based on your investor base and lending footprint. The most successful fund managers treat formation as a strategic step, partnering with experienced counsel to build a structure that’s compliant, scalable, and ready to grow.
At Fortra Law, our Corporate and Securities team brings deep industry knowledge and a practical, business-minded approach to fund formation. We advise private lenders, fund managers, and real estate investment professionals on everything from entity structuring and offering document preparation to compliance with federal and state securities laws and securing proper licensing. If you’re ready to launch your fund with confidence, contact our team today.
