For private lenders ready to transition from brokering individual loans or participating in fractional note investments, launching a debt fund represents a transformative step. A well-structured fund enables lenders to operate as true balance sheet lenders, deploying capital on their own terms while building a scalable business. However, the process of forming a debt fund involves legal, regulatory, and structural decisions that will shape the fund’s operations for years to come.
This guide covers the foundational elements every aspiring fund manager should understand before taking that step.
What Exactly Is a Debt Fund?
At its core, a debt fund is a pooled investment vehicle that raises capital from multiple investors and uses that capital to originate, acquire, or participate in loans. The fund is typically organized as a limited liability company (LLC) or limited partnership (LP), with investors purchasing membership interests or limited partnership units.
The fund manager, often referred to as the general partner or managing member, controls all lending decisions. Investors receive returns generated by the fund’s loan portfolio, which may include interest income, origination fees, and gains from loan sales. This structure is the backbone of direct lending operations in private real estate finance.
When Should a Lender Consider Forming a Fund?
Not every private lender needs a fund, but for many, it becomes the logical next step. The transition typically makes sense when one or more of the following conditions are present:
- Scaling beyond individual deals: A lender who has built a successful track record originating loans with personal capital or individual note investors may find that deal flow exceeds available capital. A fund solves this by creating a permanent pool of deployable capital.
- Seeking operational independence: Lenders who currently operate through correspondent relationships, white-label programs, or table-funding arrangements may want to establish their own lending identity and retain full control over underwriting and pricing.
- Reducing transaction friction: Raising capital deal-by-deal is time-consuming and inefficient. A fund allows the manager to raise capital once (or on a rolling basis) and deploy it across multiple loans without renegotiating terms for each transaction.
- Building enterprise value: A fund with a documented track record, audited financials, and a diversified loan portfolio is a far more valuable business than a loan brokerage operation.
Navigating Securities Regulations
Because a debt fund raises capital by selling ownership interests, those interests are securities under federal law. This means the fund must either register its offering with the SEC or qualify for an exemption. In 2025, most private lending funds rely on one of the following exemptions under Regulation D:
Rule 506(b)
This is the most commonly used exemption in the private lending space. Key features include:
- No limit on the total amount of capital that can be raised
- Up to 35 non-accredited investors may participate, though most fund managers limit participation to accredited investors only
- No general solicitation or advertising is permitted, meaning the fund can only be marketed through pre-existing relationships
- Investors must receive adequate disclosure, typically through a private placement memorandum (PPM)
Rule 506(c)
This exemption gained popularity after the JOBS Act and is increasingly used by fund managers who want to market their fund publicly. Key features include:
- No limit on capital raised
- Only verified accredited investors may participate
- General solicitation and advertising are permitted, including online marketing, social media, and public presentations
- The fund manager must take “reasonable steps” to verify each investor’s accredited status, which can be accomplished through third-party verification services, tax returns, or professional letters from CPAs or attorneys
Regulation A Tier 2
Some funds pursue a Regulation A Tier 2 qualification, which permits raising up to $75 million in any 12-month period. This approach allows non-accredited investors to participate and permits advertising, but requires audited financial statements and SEC qualification, making it more expensive and time-consuming than Regulation D offerings.
Choosing the Right Fund Structure
The structural design of a debt fund has significant implications for investor relations, liquidity management, and the fund manager’s flexibility. There are two primary structures:
Open-End Funds
An open-end fund accepts new investor capital on a continuous or periodic basis and typically offers investors the ability to redeem their interests, subject to certain restrictions. This structure is well suited for private lending because loan portfolios generate regular cash flow from interest payments, providing natural liquidity to fund redemptions.
Key considerations for open-end funds include:
- Establishing a clear redemption policy, including notice periods, redemption frequency, and any gates or suspension provisions
- Managing the balance between new subscriptions and redemptions to maintain adequate liquidity
- Setting appropriate valuation methodologies for the loan portfolio
Closed-End Funds
A closed-end fund raises capital during a defined offering period and locks investors in for a fixed term, typically five to seven years. This structure is more common in funds pursuing longer-duration lending strategies, such as construction loans or development financing, where capital is tied up for extended periods.
Closed-end funds offer the manager greater certainty of capital availability but require investors to accept illiquidity in exchange for potentially higher returns.
Structuring Investor Returns
How a fund distributes returns to its investors is one of the most consequential design decisions. The distribution model must balance the manager’s need for compensation with the investors’ expectation of competitive returns. Three models are widely used in private lending funds:
Waterfall Distribution
The classic waterfall model, sometimes called the “2 and 20” structure, features multiple tiers of distribution:
1. The fund manager receives an annual management fee, typically 1-2% of assets under management 2. Investors receive a preferred return, often 6-10% annually, before the manager participates in profits 3. Remaining profits are split between the manager and investors, commonly 80/20 or 70/30
This model aligns interests because the manager only earns incentive compensation after investors have received their target return.
Fixed Return Model
Under this approach, all loan income flows into the fund, and investors receive a predetermined fixed return on their investment. The fund manager retains everything above that fixed rate. This model is simpler to administer and appeals to investors who prioritize predictable income over upside participation.
Revenue Split Model
In this structure, all fund income is pooled and divided between investors and the fund manager according to a predetermined ratio. This model is straightforward but requires careful calibration to ensure both parties are adequately compensated.
Key Legal Documents
Forming a debt fund requires several critical legal documents:
- Private Placement Memorandum (PPM): The primary disclosure document describing the fund’s strategy, risks, fees, and terms
- Operating Agreement or Limited Partnership Agreement: Governs the relationship between the fund manager and investors, including voting rights, distribution mechanics, and removal provisions
- Subscription Agreement: The investor’s formal commitment to invest, including representations regarding accredited status
- Investment Management Agreement: Defines the manager’s authority and responsibilities
Moving Forward with Confidence
Launching a debt fund is a significant undertaking, but it remains one of the most effective ways for private lenders to scale their operations, attract institutional capital, and build long-term enterprise value. The corporate and securities attorneys at Geraci LLP guide fund managers through every stage of the formation process, from entity structuring and regulatory compliance to document drafting and investor relations. Contact Geraci LLP at (949) 403-3488 or visit us at 90 Discovery, Irvine, CA 92618 to begin the conversation.
