The Most Crucial Step in Vetting Investment Opportunities

The coach calls the shots. When you’re down by one point with 10 seconds to go, this is the person that will be an important part of the overall success. In the example of investing, the coach would be the sponsor or operator. Diving deep into who the sponsor is will be critical for a successful investment.

The biggest mistake you can make is to consider returns first. Nobody has a crystal ball and projections are simply projections. There’s a 99.9% chance that the underwriting is going to be wrong. Interest rates, population growth, cap rates all change and it’s nearly impossible to predict this with accuracy. Don’t get me wrong, numbers are important, but I would argue character and integrity are more important.

There are a variety of industries that you can invest in and understanding why a particular sponsor is in a specific industry, or asset class, is another important component of your due-diligence. Can the sponsor explain why they are in an asset class in depth? For example, if an operator is investing in multifamily, don’t just ask why this asset class versus storage or retail, ask what class of property, what strategy (development, value-add, acquisition) and what market they’re focused on. Think about the ways their particular industry can fail too and also consider the demographics they’re targeting.

You’ll also want to assess what expertise they have and what their unfair competitive advantage is. If they don’t have experience in this investment realm, then you’ll want to ensure their operating partner does. No experience isn’t necessarily a deal breaker, but understanding everyone’s role and how often the experienced operating partner will be involved will be important to consider.

As with any sport, the team is crucial. Investing is a team sport too and each player will have a responsibility on their team. You won’t typically have access to the lead operator when you’re vetting larger groups but you can still ask how many deals they’ve exited, what challenges they’ve faced, and if there have ever been any capital calls and why. You can learn a lot about groups through their challenges. Cycles are inevitable and how an operator responds in these times is crucial. Ideally, you’ll want to partner with someone who has weathered multiple economic cycles or at least has proven that they get through the speed bumps and hurdles and still come out on the other side. Ultimately, you have to trust the team. Make sure you understand how they get their deal flow, how they’re attracting investors and who’s running the deals.

You’ll also want to know how the company operates from a character and credibility perspective. Making a dating analogy, it can be a warning if the person you’re getting to know has several ex-wives or husbands. Similarly, reputation matters and you’ll want to consider how they’re perceived by others too. Ask for referrals and don’t be afraid to be specific with who you want to be introduced to. Two referrals is reasonable and you’ll ideally want someone who has been a long-term investor and relates to you in some sort of way. If you’re a doctor, you can consider asking for a referral who is in the medical field too. Ask the operator: Do you have somebody that’s similar to me? Would one of your longest term investors be willing to speak with me?

Background checks are another way to assess reputation. I consider bankruptcies, past legal proceedings as well as analyzing their financial statements. This helps me get an overall picture of their financial positioning to ensure that the company will be operating down the line.

I also like to ask what external activities they’re a part of, looking out for any that are taking up more than 20% of their time. This helps me understand how much attention they can truly give to making wise investment decisions.

Assessing their current Assets Under Management (AUM) and track record is also insightful. Here you can get a sense for what the team has been able to accomplish. Past results do not guarantee future success, but it does provide proof of concept. I also like to ask how many employees they have so that I can assess their ability to appropriately allocate resources. How many investors they have can be interesting to note as well.

It’s important to pay attention to communication and details too. How are they presenting themselves? The way that someone does anything is how they do everything. If at any point you’re not comfortable with an operator or sponsor you should definitely hit pause or walk away. It’s important to remember that there will always be another deal and it’s not worth trying to force an investment. Not all opportunities are for everyone.

At the end of the day, don’t be scared to ask questions. If the operator is hesitant to answer a question, it can be a red flag. Good sponsors should want you to feel confident in your investment decisions. Some other possible requests to consider are asking to meet team members or tour one of their properties. On the legal side of things, look up records and make sure there’s an LLC filed. You could also find an SEC attorney to review the PPM.

Extending beyond what I've laid out here, I also have my list of due-diligence questions. Please DM me here on LinkedIn if you'd like me to send those your way!