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Navigating Investment Risk and Optimizing Exits: The Power of DSTs and LLCs

We compare Delaware statutory trusts and limited liability companies, including risk mitigation and tax-deferred exits for investors, and explore how they protect assets and facilitate strategic exits.

In today’s dynamic investment landscape, managing risk and crafting effective exit strategies is paramount for businesses and individual investors alike. Delaware statutory trusts (DSTs) and limited liability companies (LLCs) are increasing in popularity as investors recognize their utility in achieving these goals. This blog builds upon our recent webinar discussion and previous overview of DSTs and LLCs by looking at their role in risk mitigation and exit strategy development.

Diversification and risk management: A powerful combination

In consultation with your investment advisor, incorporating DSTs and LLCs into your investment portfolio provides the significant advantage of diversification.  It’s a strategy that helps spread risk across different asset classes, mitigating the impact of any single investment’s underperformance. But the benefits of these vehicles extend far beyond mere diversification. What are the unique features of DSTs and LLCs that contribute significantly to risk management?

  • Shielding assets from originator bankruptcy risk: The Delaware Statutory Trust Act (DST Act) and the Delaware Limited Liability Company Act (DLLC Act) offer robust bankruptcy remote protection. In the unfortunate event that an originator that contributed the assets files for bankruptcy, if structured properly upon advice of counsel, the special purpose entity (SPE) holding the assets remains shielded. This means creditors of the originator cannot access the SPE’s assets to satisfy claims arising from the originator’s bankruptcy.
  • Mitigating SPE bankruptcy risk:  Another concern in securitizations is the potential bankruptcy of the SPE itself. The flexibility provided by the DST Act and DLLC Act empowers the designation of a suitable decision-maker such as an independent manager responsible for navigating such situations. This proactive approach helps safeguard the SPE’s financial health.
  • Addressing liquidity risk: Unlike traditional investments that may require selling the entire entity for access to capital, DSTs and LLCs may be structured to function as securities. This translates to increased liquidity, allowing investors to sell their holdings incrementally. This feature provides a welcome buffer against market fluctuations and unforeseen financial needs.
  • Navigating the legal and regulatory landscape: DSTs and LLCs are often established in jurisdictions with favorable tax and regulatory environments. This strategic positioning helps minimize exposure to legal and regulatory risks that could potentially derail investment plans.
  • Managing interest rate risk: When financing is involved, DSTs and LLCs typically collaborate with large institutional lenders. These partnerships leverage the lenders’ expertise to mitigate interest rate fluctuations, protecting assets for investors.

How to craft an effective exit strategy

A key advantage of DSTs and LLCs lies in their ability to provide investors with flexible exit strategies. Some of the most common options include:

  • Cash buyout: This straightforward approach allows investors to receive a portion of their initial capital contributions. While seemingly easy, cash buyouts can trigger tax consequences, making them less appealing in certain situations.
  • 1031 exchange: Also known as a like-kind exchange, this IRS-approved strategy enables investors to defer capital gains taxes or tax liabilities associated with selling an investment property. This allows them to reinvest the proceeds into a similar property, effectively postponing tax obligations.
  • 721 exchange: Authorized under Section 721 of the Internal Revenue Code, this exchange allows real estate investors to contribute their physical property to a partnership in exchange for ownership interests within that partnership, all on a tax-deferred basis. This eliminates the need for a traditional 1031 exchange.

Unveiling the full potential of DSTs and LLCs: How CSC can help

The flexibility and diverse options offered by DSTs and LLCs highlight the importance of seeking professional guidance. In addition to speaking with your professional advisors, consulting with a team like CSC gives you the opportunity to leverage these investment vehicles to their full potential.

Our market-leading, holistic approach empowers us to support both the establishment of DSTs and LLCs, providing services to help you navigate the regulations to achieve optimal benefits.

By understanding the risk management capabilities and exit strategy advantages of DSTs and LLCs, investors can make informed decisions that effectively safeguard assets and maximize earning potential.

For more information, watch CSC’s recent webinar on the benefits of DSTs and LLCs.

This document is provided by CSC for information purposes only and does not constitute an offer, invitation or inducement to contract. The information herein does not constitute legal, tax, regulatory, accounting or other professional advice and therefore one should seek appropriate professional advice before considering a transaction as described in this document. No liability is accepted whatsoever for any direct or consequential loss arising from the use of this document.