by Marc Halpern, Part Time Investors LLC
September 22, 2023
Some passive investors make money investing in private placements. Some passive investors lose money investing in private placements. Some passive investors make money AND lose money investing in private placements.
The #1 factor that determines how often you make money or lose money as a truly passive investor in private placements is how well you perform DEEP due diligence.
Consider the following facts:
Unlike investing in public equities, an investor has the ability to identify and evaluate most of the factors that determine the upside potential of a private placement opportunity, the downside risks of a private placement opportunity and the quality of the sponsors and operators who actually manage the private placement opportunity.
Risk is a byproduct of not knowing or ignoring known or unknown factors that can have negative impact on the outcome of a decision, such as the decision to invest in a private placement opportunity.
The more comprehensive investors are in their analysis of the upside, the risk factors and the sponsors and operators who manage the private placement opportunity, the less is the probability that known and unknown risk factors will negatively affect the outcome of the investment chosen by the investor.
In other words, DEEP due diligence GREATLY minimizes risk when investing in private placement opportunities.
At the same time, no matter how comprehensive an analysis an investor performs, one cannot 100% totally eliminate risk since not every risk can be anticipated in every single situation. A good example is that no investor could have reasonably anticipated COVID-19 prior to 2020. In contrast, investors SHOULD have asked themselves prior to 2020 “what will happen to a private placement investment if interest rates increase,” since that reality is common, periodic and even inevitable, unlike a global pandemic. Increasing interest rates was an “anticipatable” risk in 2019 while a global pandemic wasn’t.
In our course “High-Return Private Placement Investing: Best Practices & Risk Management,” we teach how to evaluate the upside potential and the downside risks when investing in private placement opportunities and we teach how to identify best-in-class syndicators, fund managers and project sponsors.
A reasonable goal for performing DEEP due diligence on a private placement opportunity is to develop a confidence level of about 95% that the investment will be successful. If all we do as a passive investor in a private placement is listen to a 45-minute webinar before deciding to invest, then that level of due diligence is NOT deep enough to justify a 95% confidence level. We must perform DEEP due diligence to become that confident.
On the other hand, if an investor wants to achieve confidence of a 100% probability of success before investing in a private placement, that investor will suffer from analysis-paralysis and not pull the trigger to be an investor. There is indeed a huge difference between 95% confidence level and 99.9% confidence level.
At the 95% confidence level, an investor can achieve high returns for a well-diversified portfolio of private placement investments since the majority of investments at that well-supported 95% confidence level will succeed and very few will underperform or fail. Portfolio-wide performance is what counts and we should not be paralyzed by the fear of failure of one investment out of a portfolio of many diversified investments.
However, when an investor makes the investment decision based on nothing more than watching an impressive 45-minute webinar, that is not enough DEEP due diligence to achieve a 95% confidence level. The investor is rarely able to achieve an 80% confidence level that the investment will meet expectations based on a 45-minute cursory examination of the details and the difference between an 80% confidence level (20% probability of failure) and 95% confidence level (5% probability of failure) is huge!
In discussions with many syndicators, fund managers and project sponsors, we learned that only about 10% of investors examine the entire private placement document package (usually about 150-170 pages) and only about 5% of private investors actually study the package and ask deeply probing follow up questions of the syndicators, fund managers or project sponsors.
As a passive private investor, I ALWAYS study all the materials provided in the private placement document package and I ask deep probing questions. I actually make sure to understand and challenge every upside assumption, understand and challenge every downside risk, understand and challenge every line in every spreadsheet and I perform DEEP due diligence on two levels of the sponsor and operators until I am satisfied that they meet best-in-class characteristics.
In other words, I am part of the 5% of passive private investors who perform DEEP due diligence on private placement offerings before investing. I feel that is absolutely necessary before I wire $50,000, $100,000 or $250,000 to invest in a syndication, fund or project over which I will have no control and no liquidity over the next few years.
Even then, my portfolio of private placement investments doesn’t bat 1.000. My portfolio does enjoy high returns and very attractive performance in terms of passive income and passive growth of net worth. But not every single project meets expectations. Some private placements exceed expectations, most meet expectations and a small minority fall short of expectations.
I am sure that if I did not perform DEEP due diligence on every opportunity, my portfolio would contain more projects that would not meet expectations and my overall performance would suffer.
Is it worth performing an extra few hours of DEEP due diligence on private placement offerings before wiring money? I think that the answer is a slam-dunk YES.
But not everyone has the patience or mental bandwidth to perform DEEP due diligence. Are you part of the 5% of passive private investors willing to minimize risk and achieve higher returns?
If you are an ultrahigh net worth individual or family office (typically minimum net worth of $10 million), you have the resources to outsource DEEP due diligence to experts. But most of you reading this are like me and we have to perform DEEP due diligence ourselves.
If you would like to learn how I perform DEEP due diligence while building a high-performing portfolio of well-diversified private placement investments, attend my upcoming course on October 21, 2023 “High-Return Private Placement Investing: Best Practices & Risk Management.” If you prefer to wing it without performing DEEP due diligence and risk a lower performing portfolio, you don’t need to take this course, but your performance will be lower than it could be.
When you do take the course “High-Return Private Placement Investing: Best Practices & Risk Management,” you will have the opportunity to join others who took this course in the “DDD Mindset Club” which is a closed group of passive investors who are members of Left Field Investors (check out membership at www.LeftFieldInvestors.com). The DDD Mindset Club will provide you with the opportunity to network with like-minded DEEP due diligence investors in the upper 5% of conservative passive private investors (like me) and even form alliances to jointly perform DEEP due diligence on private placement offerings.
The only question that remains is whether you want to be part of the elite 5% who perform DEEP due diligence and achieve high returns or do you want to wing it and take additional risk on top of the known risks that can be addressed by DEEP due diligence when investing in private placement opportunities. It's your choice whether to take action to improve your performance as a passive private investor.
