Lock-up provisions or limiting the units that can be redeemed per year to no more than 5 or 10% of the company. There are many variations of these types of provisions.
Ask A Question
What happens if everyone decides to exit a fund at the same time?
What happens if everyone decides to exit a fund at the same time? How can this be prevented?
Answers
An operating agreement should prevent that from happening.
This will need to be addressed in your governing agreement. Typically, when a fund invests in illiquid assets, redemptions are prohibited without the consent of the general partner/sponsor.
By not allowing anyone to withdraw unless there is a capital transaction (sale or cash-out refinance), unless they want to sell their interests to a third party, which should be offered to the other investors and/or manager first on the same terms offered by the third party, or making sure that there are limits on the number of people who can exit in a given year. However, to do this, you have to have a mechanism to generate the cash to buy them out and if you start raising money from new investors to buy out existing investors, it begins to look like a PONZI scheme.
Regarding what happens if everyone decides to exit a qualified opportunity fund (“QOF”) at the same time, this is a very unlikely scenario unless the QOF’s governing documents are not well drafted. Given the highly illiquid nature of a QOF, meaning that QOF’s will not be investing in assets that are highly marketable and will not hold large sums of cash in reserve, QOFs are not likely ever to have the cash at the ready to accommodate one-off redemption requests let alone many or all investors simultaneously. Since one of the chief tax benefits of investing in a QOF is the tax-free gain of the QOF if an investor maintains the investment in the QOF for 10 years, these investments are generally intended to have life cycles of a decade or longer. Thus, the well-drafted QOF operating agreement or partnership agreement should severely restrict redemptions of investors’ interests during the 10-year investment term to preserve the integrity of the fund. The QOF’s governing documents might contain an exception in the event of a sale of one or more QOF assets during the initial 10-year period or thereafter. Some QOF’s operating or partnership agreement permit investors to redeem a portion of their investment if and when the QOF sells an assets (otherwise the proceeds will be reinvested by the QOF to restart the 10 year period). Thus, a mass exodus from the QOF can be prevented by careful drafting of the QOF’s operating agreement or partnership agreement and those redemption policies should be well documented in the QOF’s offering document/private placement memorandum, which should also contain the concomitant risks to the investors of the restrictions on redemptions.
DISCLAIMER:the information found on this website is intended to be general information; it is not legal or financial advice. Specific legal or financial advice can only be given by a licensed professional with full knowledge of all the facts and circumstances of your particular situation. You should seek consultation with legal and financial experts prior to participating in any aspect relating to Opportunity Zones. Posting a question on this website does not create an attorney-client relationship. All questions you post will be available to the public; do not include confidential information in your question.