There are a couple of things you need to understand before you start investing with a sponsor. You can’t just work with anyone who wants to work with you. You want to be able to do a background check on who they are, what their experience is, what their strategy is, and much more. Join Lauren Wells and Christopher Seveney as they share the top 5 strategies you need to implement before you start working with a sponsor. Make sure you understand what it is you’re investing in. Know the terms of the deal and how your sponsor is going to manage it. Once you know that the better off you’ll be. Start doing your due diligence today!
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Top 5 Strategies You Should Implement Before Investing With A Sponsor
In this episode, we want to talk about the top five strategies you should implement when researching a sponsor or thinking about whether or not you are going to invest with a specific sponsor. To kick that off, Chris, why is this important? Let’s start there.
This is one of the most important aspects of investing that people brush aside a little bit. Somebody mentioned to me once the example provided was, say, you have a rental property and you are putting a tenant in there and let’s say a rental property is $1,000 per month. You do credit checks, background checks, you basically do a full cavity search on this person for $1,000 a month, but then you’ll turn around and want to invest $100,000 or $50,000 in some types of syndication.
You are going off of a nice Facebook ad or somebody who heard of that company but never invested in them and is going off of third-party information. It’s extremely important whenever you are giving anybody or even $500 to understand who that person is, that sponsor is, who the company is, and we are going to talk about the strategies or things that you should pay attention to.
I would call it a controllable risk. Every investment has risks. No matter what stock market or real estate, there’s a risk, and a lot of them are outside of your control. For the most part, whether that is because the economy is influencing it or whatever. With this, you get to choose who the person that you invest with is.
I feel like it’s one of the things that you can control as far as doing your due diligence and knowing who that person is and what they are about. You are already investing in something that has some risk to it. Why would you not do the due diligence on the person when you know that is something you can control, whether what type of person you are investing with?
It’s such an important factor to consider. A lot of times, people gloss over it a little bit. The first rule I always tell people in investing is to do your due diligence on every single person.
Throughout the show, since I joined, we have probably talked about this quite a bit. In every single episode, it comes up because it is so important. Let’s start with number one, know who you are dealing with.
First and foremost, before you get on a call with somebody, first you do want to set up a call and get them on the phone to make sure they have a legitimate phone number and an email address, and it’s not a JohnSellsHomes@Gmail.com email address. Do some research.
I had someone who reads the show email me jokingly like, “I should get a new email.” They are going to invest in our new fund, and he jokingly was like, “I read the show. I guess it’s time for me to get a new email.” His wasn’t even that bad, but that’s funny that you bring that up.
If you are looking to raise millions of dollars, if you can’t spend $10 a month on a domain email address, to me, that seems odd as part of the business process. First, you want to get them on the phone, Zoom, or meet in person, but do your due diligence on that person. Google them. Look them up on LinkedIn.
A lot of us people in space can run skip tracing for $0.50 a name where on a public search check if they have a criminal record. Check if they have judgments against them. Do a thorough evaluation of who that person is and what’s your background, but it also is important when you get on the phone with them because if you see on LinkedIn, Facebook, or something that they might have been from an area familiar with, or might have an interest. Also, you could ask them about that because you also want to know what it is. How do they run their business? Put a little bit of backstory about why they do what they do as well.
Looking at their LinkedIn and their social media, you’ll get a good sense of who someone is. If you’ve been on social media, you can start to sift through the people who are all talk or all-flash versus those who know what they are talking about. I think having a LinkedIn profile for me is when it comes to real estate is something that I would be like, “If you don’t have a LinkedIn profile, I don’t know. To me, you don’t stand out as credible.”
One thing I will mention too is there was one in Ohio where the football coach was arrested or indicted on a $53 million Ponzi scheme from a small town, like everybody in the town. A lot of the elderly in the town and he was raising all this money, and next thing you know, he had two sports cars, out of vacation home, but was allegedly stealing the money. You want to be careful with who you invest with.
Segueing into number two, understanding the sponsor and their experience. You look at their profile and you know who they are. That’s step one. It’s like evaluating a property. You do all the due diligence, full title and everything. The equivalent is knowing who you are dealing with. Doing that initial background research on who they are and how they present themselves, but then understanding what experience do they have in this specific asset class. Not necessarily what experience do they have in real estate, but what experience do they have specific in notes, multifamily, or whatever that might be.Whenever you're giving anybody a significant check, you need to understand who that person is. Click To Tweet
I use a different comparison. It’s like if you are in search of a nanny or some type of childcare. You a want to do a background check on them, and then you also want to understand] their experience like you’ve mentioned with real estate. I go back to childcare because of the loving father I am. It’s like understanding their experience because some people may be very good at marketing and be able to sell a product. The product is their experience, which is extremely lacking.
I started my first fund several years ago. There was another investor who did the same thing. He started a fund. He never bought a note in his career and he was starting a fund to buy notes. I’m sitting there scratching my head like, “He spent $20,000 on documents to create all these documents to start a fund to raise money, but he’s never bought a single note or spent his own money or his own blood, sweat, and tears into this business.”
I’m of the opinion that you want to have somebody who’s put their own money in the deal or in the past, but understands the business and it’s somebody who has the experience. A lot of people, when we were talking about this earlier, the last few years, anybody could make money in real estate. A lot of people were in the last few years. Now that we are starting to see the tides turn a little bit. The Warren Buffett saying, “I love this. We are going to see who’s been caught swimming naked because once the tides roll back, you are going to see who got caught with their pants down essentially.”
It’s a 90-year-old guy, so you can get away with saying stuff like that. I’m repeating what he said. A disclaimer. It’s important to understand their experience. Somebody mentioned to me another example was like, “Being on a flight, you want the pilot who’s been through the storm. You don’t want the guy going through a bad storm on his first flight.”
I was going to use that analogy. A driver’s license. Do you want this kid who got his driver’s license driving you or so?
On a fund, if it’s a large investment, it’s not always someone who got their license, but it’s driving a Mack truck because there are more components to it.
When it comes to a fund, it also isn’t just the sponsor. I think it’s the team as well. What type of people do they employ? You go to a company page and look at those people as well. Do your initial scan. These sponsors are the main person, but I always think it’s important to see what team they built as well.
When I refer a sponsor, I’m more referring to that team. There’s the leadership of that sponsor and there are 2 or 3 people or 1 or 2 people at the top, and then they have a lot of people who assist with them or as important or more valuable. A lot of times, they are the ones sometimes proverbial rolling up the sleeves and managing the assets.
Number three would be understanding their investment strategy.
I’d say we are doing these in order. The first two are critical and then once they pass the 1st and 2nd gate, the 3rd is, “What is their strategy? Is this something you want to be a part of?”
Can you give me an example for our industry?
For us in the mortgage note space, our primary goal is to try and keep people in their properties. Disclaimer, it doesn’t happen all the time, unfortunately, but that is our primary goal. Other investors who will buy distressed debt solely to foreclose on that asset. It’s either that person repays the entire loan or they foreclose. It’s important to understand that because, especially in this world, several years ago, Corporate America shifted a lot to a lot of ESG. Making sure companies are still based on the bottom line.
Environmental Social and Governance. A lot of people think of the SG as Social Good.
Ours is the S in regards to the social side of things of trying to keep people in their homes, avoid the blight, avoid additional crime for people breaking into those houses, using it to be a drug house. A lot of things can happen in that case, so we want to look at that. The other thing to understand about their strategy is the fund in the fee structure.Just like evaluating a property, do due diligence on the person you're dealing with. Click To Tweet
How are their fees aligned and is it aligned with the right goals and mindset? What I mean by that is, is it fee-heavy for acquisitions? Are they going to sit there and try and acquire lots of assets and turn around and sell them really quick because they are trying to profit from themselves versus, like in the note space, trying to work and help others?
Is the fee structure a preferred return? Is the investors get paid first if there are all these management fees if there are 10% of management fees that the fund is collecting upfront? Are you getting paid first? Is the structure where there are the expenses and then the preferred returns, or is it loaded with fees? I come from the general contracting background and trust me, you have fees, and then there are other things that might not be fees that still could count towards fees and they make sure they get their profit all upfront.
This asks all the what-if questions about the five strategies you would employ. This strategy, number three, understanding their investment strategy, is where I hear a lot of investors or would imagine a lot of investors would ask the what if. What if this happens? The worst case is them understanding the risk behind your strategy or the risk they are willing to take behind your strategy. Not only can they get behind whatever strategy you have and do they have faith that you can execute that and that you have a good strategy in their mind, but also, does that sit well with their risk thresholds? We talk a lot about risk. That’s where this fall.
A perfect example of that is we primarily invest in first position mortgage notes, but if we were a fund investing in underwater second position mortgage notes, meaning that the equity in the property is less than the note. Whereas if they file bankruptcy or are forced to sell the house, you are going to get no money from that and could get completely wiped out. Some of the questions people should ask is what happens if. The what if sets a great example I didn’t think of. That’s involved because you want to know what the risks are because everyone’s going to tell you all the rosy things, but have they outlined all the risks for you?
Do they have an offering circular posted on their offering page? That lays them all out. This next one is something I can speak to is understanding their reporting process. I immediately noticed that there is not a lot of transparency and accessibility for investors and seeing how things are going. There’s no set standard in the real estate investment world.
How often should people be reporting to you, what they are reporting and how they are reporting? If you can, log into a portal and see what distributions you are getting. Something that’s important is to figure out what’s important to you as far as how much you want to be able to access and see, and then what does that sponsor provide?
Do they provide a monthly email? Is it a newsletter? Do they record a video? Do they do a live video where you can ask questions? That’s one aspect of it, but then I also think there’s on their own transparency and reporting where do they have some place where investors can go and log in and see this is how these are my contributions to the fund. These are my dividends. These are the distributions that I have received. This is when I should have received them to see that the financials are very transparent from their end.
I beat the drum on this or pounding the table, whatever analogy you want to use on this in regards to the financial reporting. I’d like to think I have done a very good job over the years of being very transparent and open with the investors I have worked with in the past and keeping them abreast of the good, the bad, and the ugly with every deal.
My career started with my own money. Then I started doing JV deals and then rolled them up into the funds. Even at the JV deal level, I would send a financial statement out to that investor every month of all the information on the fund. They are like, “This is awesome. You are the only person that does this.” I’m like, “How do you know how well the deal is going if you don’t see any financials?”
I talk to them and stuff. Maybe your friend or your spouse is like, “We are doing okay with the bank account.” “What does that mean? Can I see how much money we have in our bank account?” It’s the same thing. As you grow and do funds, it’s that financial reporting that is very important to know the health of that business or the health of that entity.
Are they making money? How much are they making? Are they investing all of the money? That’s very important in a fund to make sure that they are getting all that money out the door. This is the simplest way to tell whether somebody is the real deal. If you ask them, “Send me a sample of a financial report you’ve sent another investor.” If they can’t quickly grab something, screenshot and blackout the names and all the information on it, and send it to you, that should be a very big red flag.
I think it’s that but also then having that other aspect of it from an investor relations side, since that’s what I do of giving them a place to go to look at stuff at their own pace at their own time. Let’s say you email that out, send it out, and also housing it somewhere where they can log in whenever they want to access it. I feel it’s something that is so common sense but isn’t something I see very often in this world. If I was new to investing in real estate, I would be like, “Where do I go to see my information or get my tax documents?” Make sure it’s going to the right bank account, all that stuff. It’s super important.
I look at it because my wife is in finance. She’s the one who runs most of the finances of our family. If I go went and invested 25,000 in something now, then this is how I run my business. She comes to me. “Great. It’s $25,000. What’d you invest in? Let me see it. Let me log in. Let me do this.” My wife always wants to double-check. Make sure certain things. That’s the philosophy it’s like that I think of because I’m like, “If it was me, I want to be able to go see what’s going on.”
I still have comfort. I don’t need to watch it every day, but once in a while, I will check in like, “How’s it going?” A place that I can go on my own to look and say, “There it is.” If I need a printed report, for example, say, I’m refinancing a house. They are like, “What do you have for investments?” I can’t go pull that report or I’m chasing somebody down for it. I gave them money, but I can’t show you I gave them money. If you sit back and think about it, you want to scratch your head and like, “What you told me doesn’t make sense.”Make sure you know what you're looking for when you're asking for a referral so that you can get the best one for you. Click To Tweet
Leading us into our last point would be number five, referrals. Referrals are super important, but everyone will have people they will send a letter to. Everyone has their shining stars or investors that they will be able to send you. It’s more about knowing what you are hoping to learn if you are asking for a referral.
If you are asking for a referral, have specific questions ready to ask that referral rather or be able to tell the person like, “I’m looking for a referral who’s worked with you. Let’s take it outside the notes space on a flip in this area. I’m looking for someone who invests or referral who has invested in one of your funds or done a JV deal with you.” Those are very different experiences. The same person, but they might have different questions.
I’d say from the investor perspective and from someone who gets asked for referrals all the time. My question is always like, “I can provide you with the best referral. What are you hoping to learn?” Know what you are hoping to get from the referral other than to like, “Sponsors are great. They are awesome. I get my money.” That’s what most people’s answer is going to be. Make sure you know exactly what you are looking for when you want to speak with a referral so that you can get connected with the best referral for you.
As a sponsor, think of it as going on a job interview and you are the employer and the sponsor is somebody trying to get a job. Take the doctrines of PPM, Private Placement Memorandum, offering circular like, “Here’s what we are offering.” A resume. They are going to hand you this beautiful document that is pristine and makes them look like they are the greatest thing since sliced bread. They are going to give you that. Who’s ever handed a crappy resumé to somebody. You are not going to put like, “Here’s what I suck at on my resume.”
This interview went great. Give me three referrals. They are going to give you three of your drinking buddies who have you worked with for twenty years and who are going to say the greatest things about you anyways. Referrals, it’s good and bad because, like you mentioned, you want to get honest, but you also want to try and get some.
You almost want to do some sourcing on your own, but the biggest key also take away from references or referrals is, if you hear somebody say, “He’s a good guy.” What do you mean by that? Did you give him money? I see a lot in real estate space, a lot of people refer people to other people. I will be like, “Did you use them? Did you give them money?” “No, but this person did.”
You then go to that person. “Did you do that?” “No, but this person told me.” You then look at fifteen people down and you never found anybody that worked with the person, but the guy has got 500 YouTube videos about how awesome he is. Somebody watched a video and said, “This guy sounds pretty good. He gave me some good content,” and then that’s how it spun out.
It comes back to what are you hoping to get from the referral. Is it a character referral? That’s several different people. It doesn’t even have to be an investor. Is it someone who’s invested with them? Is it someone who’s worked with or for them? There are so many different ways. I say, “Ask for referrals if you want a referral but also know exactly what you are hoping to get from that referral and what questions you have for them.” Whoever’s providing the referral, whether it’s a sponsor or someone on their team, can provide you with the best person to fill your answers to answer your question.
What are your final thoughts on all this?
My final thoughts would be to be like anything. Do your due diligence. Know what you expect or what your expectations are. I’d say those two things. Do your due diligence and know what you are willing to accept as someone you are giving your funds and investment.
I’m going to pull a little football analogy on here. When you look at the sponsor or deal, the sponsor is so critical. It’s like the quarterback in football is the analogy I will use. If you’ve got somebody like a Tom Brady who has been around for many years, you know what you will get from him. Consistency and very good results. If you go with somebody less experienced, they are going to have much better games and they are going to have much worse games. You never know what you are going to get on that rollercoaster, if it’s a newer sponsor.
That’s something that each individual person. It’s like you get to choose. You want the consistency. Do you want that Tom Brady or do you want to take that bigger risk? That’s like an individual decision, but at least then, if you do your due diligence, you talk to each person, you see their historical returns, you know where they are at, then you can make a better decision about that. You are not going into it blind, thinking you are getting a Tom Brady. Any other final thoughts?
Back to the beginning, like we said, “Take your time. Do your due diligence. Ask questions. Make sure you are comfortable with the sponsor’s team and who you are talking with. Make sure you understand what it is you are investing in and what the terms of that investment are. The more they can communicate and everybody understands the deal itself and their experience and how they are going to manage it, the better off it will be.
You pretty much already said it. With that, we should do another episode on questions to ask a sponsor.
We went through all these five top strategies, but people would probably like, “I understand these strategies, but how do I implement these strategies?” We have got a bunch of questions that we can provide and we can talk about that as you are going to interview a sponsor. You can ask or get some basis to reformulate those questions to get the information that you’d be looking for to make an intelligent decision.
I’m good. I will let you take her home.
Thank you so much for joining us on this episode. If you enjoyed the show, share it with a friend, subscribe or leave us a review. Until next time.