In a perfect world, fund formation simply involves a strong investment strategy, document preparation, capital raising, and closing. Sponsors, legal counsel, tax advisors, and other stakeholders each focus on their respective roles and work toward a smooth launch. In reality, however, competing priorities and tight timelines can often lead to mistakes that delay the process, increase costs, and undermine a sponsor’s credibility with investors.
Waiting to Raise Capital Until Documents Are Ready
One of the questions we are frequently asked is when a sponsor should begin raising capital. Contrary to what many assume, we generally do not recommend waiting until every fund document is finalized before approaching potential investors. Instead, after we have reviewed the sponsor’s pitch deck to ensure it complies with applicable securities laws, contains appropriate disclosures and disclaimers, and avoids statements that could be viewed as misleading or promissory, we encourage sponsors to begin developing investor relationships. At the same time, we simultaneously prepare the comprehensive fund formation documents. A critical stipulation of this approach, however, is that the fund structure, investment terms, and sponsor economics have been definitively established and are no longer subject to negotiation with prospective investors. This parallel approach allows sponsors to build momentum without sacrificing legal compliance. By the time investors are prepared to make commitments, the offering documents, including the governing agreement, private placement memorandum (if applicable), subscription agreement, and related materials, are typically complete and ready for execution. The result is a more efficient capital raise, allowing sponsors to focus on telling their story while presenting investors with a polished, well-structured offering when it matters most.
That said, beginning outreach early does not mean beginning without guardrails. Before approaching investors, sponsors should have a clean entity formation, a defined investment thesis, and a pitch deck vetted for securities-law compliance. Premature or overly promotional outreach—particularly under Rule 506(b), which prohibits general solicitation—can constitute “gun-jumping” and jeopardize the very exemption the fund intends to rely on. Used correctly, early engagement is about cultivating relationships and gauging interest through non-binding indications, not closing commitments before the offering documents exist. Misalignment Between Governing Documents and Economic Arrangements
Informal commitments, term sheets, and side letters shared with investors early may speed up the funding process, but they can also expose sponsors to conflicts with the governing documents. Misalignment most often surfaces in the economic terms that matter most to investors-management fees, carried interest, the preferred return or hurdle, the general partner’s (GP) capital commitment, expense allocations, and key-person provisions. If the terms discussed informally with investors do not match what eventually appears in the limited partnership agreement, private placement memorandum, and subscription documents, a sponsor must either renegotiate or, worse, explain a discrepancy after capital has already been committed. This not only costs time to fix and increases legal fees but also casts doubt on the sponsor’s credibility.
Side letters deserve particular attention. Terms granted to one investor, such as reduced fees, enhanced reporting, or co-investment rights, can ripple across the investor base through “most favored nation” (MFN) provisions that entitle others to elect those same terms. Sponsors who agree to side-letter terms without tracking them against the governing documents and the broader investor pool risk creating obligations they cannot uniformly honor. Maintaining a single, consistent set of economics across the pitch deck, term sheet, limited partnership agreement, and private placement memorandum is the most reliable way to preserve both flexibility and credibility.
Securities Compliance Issues
Most private funds rely on an exemption from registration under the Securities Act of 1933, and the majority operate under Regulation D-typically Rule 506(b) or Rule 506(c). Under Rule 506(b), a sponsor can raise an unlimited amount from an unlimited number of accredited investors and up to 35 non-accredited but sophisticated investors. Still, the sponsor cannot engage in general solicitation or advertising and must furnish prescribed disclosure (similar to that required in a registered offering) if any non-accredited investors participate. Under Rule 506(c), the sponsor may publicly solicit and advertise the offering. Still, every purchaser must be accredited, and the sponsor must take reasonable steps to verify each investor’s accredited status rather than relying solely on the investor’s self-certification. Determining who qualifies as an accredited investor-whether based on income, net worth, professional certifications, or entity-level tests-is a frequent source of confusion, and getting it wrong can undermine the exemption. Sponsors who overlook these requirements risk losing the exemption entirely, which could give investors rescission rights and expose the fund and its principals to regulatory scrutiny and potential liability.
Beyond selecting the right exemption, sponsors must also satisfy ongoing procedural requirements that are easy to overlook. A Form D must be filed electronically with the SEC, generally within 15 days after the first sale of securities or commitment from investors, and corresponding state “blue sky” notice filings and fees may be required in each state where investors reside. Missing these deadlines can create compliance gaps that complicate future closings and follow-on fundraising.
Sponsors should also confirm at the outset that no “bad actor” disqualification under Rule 506(d) applies to the fund, its principals, or other covered persons, as a triggering event can disqualify the offering from relying on the Rule 506 exemption altogether. Depending on the fund’s structure, additional regimes may come into play—including the Investment Company Act of 1940 (where funds typically rely on the Section 3(c)(1) or 3(c)(7) exclusions) and the Investment Advisers Act of 1940, which may require the sponsor to register as an investment adviser or qualify for an exemption. Addressing these questions early avoids costly restructuring once investors are already engaged.
Other Common Pitfalls That Create Delays or Investor Concerns
Beyond the mistakes mentioned above, sponsors can also delay the formation process through operational and structural missteps. Common issues include starting investor outreach too late, delaying due diligence, and failing to prepare an onboarding plan on time. Sponsors might target an unrealistic fund size and spend more time chasing milestones than finalizing the fund, and unclear fee structures or inconsistent accounting records often concern investors and stall their commitment. Other frequent pitfalls include overlooking tax structuring-such as blocker entities for tax-exempt or non-U.S. investors to manage UBTI and ECI concerns, and the timing of key tax elections; delaying the selection of critical service providers, including the fund administrator, auditor, and banking relationships, which can bottleneck a closing; and failing to address governance and conflicts up front, such as forming a limited partner advisory committee and setting policies for allocating co-investment opportunities. Operational readiness-capital call mechanics, subscription processing, and KYC/AML onboarding-should also be in place before the first close rather than improvised afterward.
Conclusion
By identifying and understanding these avoidable mistakes early, sponsors can plan more effectively, reduce risks, and ensure an ideal outcome. At RR&A, we work with sponsors to identify potential issues and implement the right structure from the start. If you are preparing to raise funds, we invite you to connect with our team for a comprehensive discussion.
Disclaimer: The information and material on this website is general information about our practice and firm. This information does not offer specific legal advice and the use of this information does not create an attorney-client relationship with RR&A or any of its attorneys. The information on this website should not be used for legal advice, and persons should not act upon the information on this website without engaging professional legal counsel.
Taylor is a Law Clerk at R. Reese & Associates in the Dallas-Fort Worth office. To learn more about Taylor, visit her attorney page.
