Warehoused Investments
What if the reporting entity acts as an investment warehousing provider for a fund that has not yet been created as a legal entity?
Investors have an extreme FOMO. When an apparently good investment opportunity shows up, they want to get in on it. Today, we will discuss specific scenarios we observed in the past regarding investments in token projects that are warehoused.
Raising the money and opening funds takes a lot of time. But sometimes a great investment opportunity knocks on the fund’s door before all formalities are settled. What happens next?
If this investment opportunity matches the objectives and strategy of the fund that is not yet closed, the general partner/advisor1 or the affiliated legal entity steps in and acts as the warehousing provider for the fund. This warehousing provider executes the investment purchase agreement before the fund’s first close date.
Once the necessary funds were committed:
Advisor sends capital call notices to investors.
Investors transfer cash to the fund’s bank account.
The fund now deploys money to repossess the investment.
The warehousing provider assigns and the fund assumes the investment in exchange for consideration, which is separately negotiated. Typically, this price reflects the third-party valuation or the cost of the original purchase and funding.
Shahrukh Khan here has published a great Substack post where he explains what the “warehoused investment” is and when it is being used from a legal perspective.
Treatment
The intent of the transaction is to make the purchase on behalf of the fund. In practice, the reporting entity (which is acting as a warehousing facility) might perceive this transaction as if it were acting purely as an agent. The reporting entity transfers to the fund “the rights and duties of a party under an existing contract” 2 rather than “the ownership of assets and property “3.
As a result of this perception, the reporting entity might not be willing to recognize gains or losses on the transaction in the financial statements of the warehouse facility’s entity. However?
First, it is not uncommon to warehouse investments on behalf of funds that have not yet been formed as legal entities. It is difficult to argue that the reporting entity acted as an agent for the fund that did not yet exist when the investment was acquired.
Further, transfer conditions may limit the ability to transfer the investment to the entity on whose behalf the purchase was made.
Let’s consider the accounting guidance provided by FASB from the perspective of the reporting entity acting as a warehousing facility.
Scenario
We use the following assumptions:
The underlying investment is a token that is not traded on an exchange.
The fund is not legally formed as of the date of the original purchase of the underlying investment.
The warehousing facility does not issue debt to a third party to finance the purchase of underlying assets.
The original purchase agreement is between the warehousing provider and the investee and does not identify the legal entity on behalf of which the facility is acting. Further, no formal agreement was executed between the fund and the warehousing provider.
The terms of the wareshoused investment are not fully disclosed to prospective capital allocators before they commit to investing in the fund.
The applicable law does not grant the facility enforceable rights of recourse towards the fund.
Question 1: Should the reporting entity recognize a loan issued to the fund for which the investment is being warehoused?
Answer 1: Depends on the specific terms of the agreements, but not in the scenario described. This is because NO separate enforceable agreement is entered into between the reporting entity that warehouses the investments and the fund on behalf of which the investment is being acquired.
The fund does not issue a debt security instrument. The fund may elect to purchase some but not all of the assets held by the warehouse facility. No legally enforceable creditor’s rights are created until the assets are assigned to the fund at a later date.
Question 2: Should the reporting entity recognize the underlying warehoused investment as an investment made on its own?
Answer 2: Yes, if the reporting entity (the warehousing provider) has the power to direct the use of the investment prior to the assignment to the intended entity.
Question 3: Should the reporting entity recognize gain/(loss) on the disposition of the warehoused investment?
Answer 3: The accounting for derecognition of the investment under the described scenario will be within the scope of the guidance on derecognition of respective accounting categories of assets. The accounting for the disposition of the investment to a non-customer will likely be in scope of FASB ASC 610, Other Income. Hence, the reporting entity will record gain/(loss) at the time of the transfer of control.
The term “advisor” in this post combines the advisor themselves and the legal entity that the advisor owns or controls.
“Warehoused Investments” by Shahrukh Khan
“Warehoused Investments” by Shahrukh Khan