February 1, 2018 • Nick Veronis, Caroline Rasmussen
Research by iCapital has found that about 40% of advisors assist their clients with private direct investments, in things such as commercial real estate, small or early-stage companies and even middle-market firms. Direct investments are found through a variety of sources, including angel investor networks and syndicates, but the most common way of finding them (as indicated by almost 80% of our survey respondents) is through friends and family. Clients frequently bring these opportunities to their financial advisors for assistance with due diligence and an assessment of how well the asset fits in with the clients’ stated investment objectives. It’s important to keep in mind, though, that even if direct investments can deliver portfolio benefits for experienced investors, they can also introduce significant risk. If a client learns about an investment through a friend, family member or work colleague, it does not lessen or in any way negate that client’s need for rigorous due diligence before he or she proceeds. Every deal will have its own nuances that require investigation, but we offer below a non-inclusive set of fundamental elements that should always be evaluated if you’re presented with an opportunity a client has found. It is worth noting that when professional private fund managers pursue an investment opportunity, they often spend six to 12 months conducting diligence and evaluating it. Diligence on the management team. An obvious first step with any direct deal is becoming familiar with the team that will be operating the asset. This means getting references—calling investors in past transactions and third-party advisors who know the space and its reputable players. The capability and credibility of the team (as well as whoever else would be taking your money, say if there is an intermediary or finder) should be established up front. This can save significant time and expense, because if doubts arise about the team there is little point in conducting further due diligence. What is the team’s track record? How can you verify that? And how many years of experience do they have in the relevant industry or asset class? How long have they been working together, and what are their respective areas of responsibility? There are always key individuals, as there are in funds, who will be critical to success; these often include the operational lead and the business development or sales head. In addition to understanding who the key players are that are responsible for past success, one must ensure those people are still incentivized to work the same way on this deal and devote the same time and attention, and that they are properly locked in. It is inadvisable to put money into any deal that does not feature a meaningful investment by the management team. Operational and market diligence. Investors must also develop an informed view on the underlying business itself, including factors such as the market opportunity and the company’s growth profile, the competitive landscape and the defensibility of company margins, as well as any secular trends that could impact the business. Understanding the primary operating metrics and revenue drivers is important; it’s also essential for you to examine the business’s historical data going back several years, even if it’s not a predictor of future performance. And it’s key to find research about the metrics for the business’s market size, its supply/demand dynamics, the barriers to entry for new players and the business’s cyclicality. Porter’s “Five Forces” analysis on industry competition can be a useful framework for looking at corporate assets. Even if a team has delivered home runs in their industry in the past, it’s important to understand how exactly that value was created, as the market may have changed. In addition to educating themselves about the asset classes generally, investors must develop conviction about a company’s business plan. What exactly does the management team plan to do, over what time frame, to grow the business? This work is vital to contextualize financial projections and make an informed assessment of whether the base case is indeed realistic or in fact skewed to seem more attractive. Financial diligence. Investors should ensure they are not overpaying or stepping into a financially precarious company, which means they must thoroughly investigate the financial profile of the business and its implied valuation (an earnings or EBITDA multiple for a corporate asset and a cap rate for a real estate deal), which can then be compared with similar assets. A comprehensive review of the income statement, balance sheet and cash-flow statements is essential. First « 1 2 » Next
Research by iCapital has found that about 40% of advisors assist their clients with private direct investments, in things such as commercial real estate, small or early-stage companies and even middle-market firms. Direct investments are found through a variety of sources, including angel investor networks and syndicates, but the most common way of finding them (as indicated by almost 80% of our survey respondents) is through friends and family. Clients frequently bring these opportunities to their financial advisors for assistance with due diligence and an assessment of how well the asset fits in with the clients’ stated investment objectives.
It’s important to keep in mind, though, that even if direct investments can deliver portfolio benefits for experienced investors, they can also introduce significant risk. If a client learns about an investment through a friend, family member or work colleague, it does not lessen or in any way negate that client’s need for rigorous due diligence before he or she proceeds. Every deal will have its own nuances that require investigation, but we offer below a non-inclusive set of fundamental elements that should always be evaluated if you’re presented with an opportunity a client has found.
It is worth noting that when professional private fund managers pursue an investment opportunity, they often spend six to 12 months conducting diligence and evaluating it.
Diligence on the management team. An obvious first step with any direct deal is becoming familiar with the team that will be operating the asset. This means getting references—calling investors in past transactions and third-party advisors who know the space and its reputable players. The capability and credibility of the team (as well as whoever else would be taking your money, say if there is an intermediary or finder) should be established up front. This can save significant time and expense, because if doubts arise about the team there is little point in conducting further due diligence.
What is the team’s track record? How can you verify that? And how many years of experience do they have in the relevant industry or asset class? How long have they been working together, and what are their respective areas of responsibility? There are always key individuals, as there are in funds, who will be critical to success; these often include the operational lead and the business development or sales head. In addition to understanding who the key players are that are responsible for past success, one must ensure those people are still incentivized to work the same way on this deal and devote the same time and attention, and that they are properly locked in. It is inadvisable to put money into any deal that does not feature a meaningful investment by the management team.
Operational and market diligence. Investors must also develop an informed view on the underlying business itself, including factors such as the market opportunity and the company’s growth profile, the competitive landscape and the defensibility of company margins, as well as any secular trends that could impact the business. Understanding the primary operating metrics and revenue drivers is important; it’s also essential for you to examine the business’s historical data going back several years, even if it’s not a predictor of future performance.
And it’s key to find research about the metrics for the business’s market size, its supply/demand dynamics, the barriers to entry for new players and the business’s cyclicality. Porter’s “Five Forces” analysis on industry competition can be a useful framework for looking at corporate assets. Even if a team has delivered home runs in their industry in the past, it’s important to understand how exactly that value was created, as the market may have changed.
In addition to educating themselves about the asset classes generally, investors must develop conviction about a company’s business plan. What exactly does the management team plan to do, over what time frame, to grow the business? This work is vital to contextualize financial projections and make an informed assessment of whether the base case is indeed realistic or in fact skewed to seem more attractive.
Financial diligence. Investors should ensure they are not overpaying or stepping into a financially precarious company, which means they must thoroughly investigate the financial profile of the business and its implied valuation (an earnings or EBITDA multiple for a corporate asset and a cap rate for a real estate deal), which can then be compared with similar assets. A comprehensive review of the income statement, balance sheet and cash-flow statements is essential.
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