The fund is managed by Hawthorne Income Fund Manager, LLC, which is owed by Doug Smith. The manager can be removed and replaced by a two-thirds vote of investors (by number) and investor interests (by investment amount). This is a lower threshold than is typically seen with private equity funds and is therefore pro-investor. This removal and replacement process is outlined in Section 7.03 of the Company Agreement.
People are making money in the vast majority of private equity investments that we have seen. There is an occasional fund or investment that that ends badly, and these are the ones that are widely discussed and/or covered in the news.
It is very rare, but a fund manager could have a business model that makes no or minimal profits, instead providing investors with “returns” by falsifying statements and/or distributing “returns” from the capital provided by other investors. This is difficult to do with third-party administration and audited financials, which are in place with this fund. This fund also makes a substantial profit each month in the form of interest income.
Equity funds that borrow against their assets, and therefore place that debt ahead of their investors in the capital stack, expose their investors to some risk. If the asset values drop or do not increase as planned, the debt can get paid back first, leaving investors with little or nothing. In contrast, this is a debt fund that does not owe any debt but instead owns it.
Lastly, many people have lost most or all of their investment simply by investing in something that was high risk. Examples of high-risk investments would be startups, cryptocurrencies and unsecured loans.
Any fund manager could mismanage or squander funds. Fortunately, this is fairly rare because most managers are seasoned professionals who wish to 1) maintain a solid reputation, 2) avoid legal problems, and 3) secure repeat investors and referrals so that they can do more deals.
Mismanagement of this fund is largely prevented by this fund’s structure and strict lending criteria. The only thing that could feasibly be stolen is liquid capital, which typically represents a very small percentage of fund assets. In addition, most of the fund’s cash is only accessible to Doug and two key employees.
Fund capital is highly accounted for via our partnership with Cobalt Fund Services, which is an accounting firm that handles bookkeeping and reporting. Another accounting firm, Whitley Penn, conducts an annual audit and provides a report of its findings to our investors.
In addition, we provide regular emails and reports that show the properties and notes that the fund is lending against.
Finally, all fund investors are welcome to stop by our offices anytime during normal business hours to view the checking accounts, loan paperwork, QuickBooks reports and more.
Investor capital goes into the fund. The fund is an entity known as Hawthorne Income Fund. It could not go out of business or file for bankruptcy because it is not operating as a business in the traditional sense. Instead, it is an entity that owns assets and has no debt.
The borrowers are entities that Doug Smith owns. Those are Hawthorne Land and Hawthorne Interests. Those entities are unlikely to go out of business for multiple reasons. But if they did, the fund’s secured liens against their land and land notes would remain firmly in place.
As was mentioned in the prior FAQ, in a far-fetched worst-case scenario, the fund has mechanisms in place for fund management or fund investors to foreclose on assets that the fund has loaned against. It could either hold or sell them at that point.
The fund lends to Doug Smith’s entities, which are primarily Hawthorne Land and Hawthorne Interests.
In the “flow of funds” FAQ, you can see that the structure of the fund provides for ample liquid capital for Hawthorne Land each time it sells a ranchette. This capital, along with capital already available in Hawthorne Land and Doug’s other personal and business checking accounts, provides substantially more resources than are needed to service the loans made to Hawthorne Land.
Hawthorne Interests should not have an issue covering loan payments either, as it receives more income each month from its borrowers on each note than it must pay to the fund each month for the associated fund loan.
In an unlikely and unforeseeable worst-case scenario, the fund has mechanisms in place for fund management or fund investors to foreclose on assets that the fund has loaned against. It could either hold or sell them at that point.
The fund is a lender. Lenders are unlikely to get sued unless they are violating lending laws, which the fund does takes great care not to do.
In any case, the borrower would generally need to sue the lender, and Doug’s entities are the borrower. Doug has no reason to sue the fund that he and his team created to serve as a “friendly lender.” In addition, any suit would almost certainly get tossed out because his entity is managing the fund.
As with anyone or any company involved in a business undertaking, Hawthorne Land, Hawthorne Interests or Doug Smith could get sued. Innocence and/or insurance would protect us in most cases. Access to our own capital reserves would resolve the issue in other cases.
Regardless, the fund has first liens on our assets and would therefore be in a first position to get paid should assets need to be sold to resolve legal issues.
Doug is in excellent health, but the fund and business have structures, systems and processes in place that should remain in place if Doug passes away. Current team members are capable of rising up to fill his shoes, and a new but seasoned executive could even be hired.
If the team does well, the business will grow at the same pace or faster. If it falls short, business will slow down. In either case, existing fund loans, all of which are secured by real assets, will stay in place, and fund returns can continue being paid out.
In addition, the fund can continue lending against assets that meet its strict lending criteria.
If any investor wishes to withdraw his or her capital before or after Doug’s passing, he or she is welcome to request that as outlined in the “return of capital” section. The fund’s management is required to carry out those requests or face negative consequences.
It is important that we choose our buyers wisely when selling on owner financing. This provides the fund with solid collateral on its loan against such notes, and it leads to a steady stream of payments coming into Hawthorne Interests over time. Those payments provide the cash flow that service the associated loans made from the fund to Hawthorne Interests.
We heavily screen our buyers and involve a RMLO (residential mortgage loan originator) for each owner financing sale. This dramatically increases the probability of a successfully performing note. Regardless, some loans will go into default. When they do, we continue paying the fund on its loan as we foreclose on the property or have the buyer deed it back to us.
If we take ownership, the fund’s note loan converts to a land loan. It then reverts back to a note loan when we sell that land on owner financing to a new buyer.
The outcome for Hawthorne Interests can be positive or negative each time this scenario plays out. We are always able to collect a new down payment and are sometimes able to sell the land for more the second time around. This is more likely if land values have appreciated over time and/or the buyer made improvements to the property.