An Essential Guide to Private Investing

Welcome everybody, and thank you for attending today's webinar. I'm David Shaw, the publishing director for Family Business Magazine, and I hope that you and your family are all in good health and looking forward to a great summer. Today, we're going to be discussing direct private investing and, uh, there are many advantages for family offices and for family businesses to engage in some private investing, including the potential for higher returns. But private investing can also pose challenges if you're not prepared properly. There are five separate but interrelated areas of consideration that all investors should address before and after making any direct private investment. And we'll be addressing those today. But before we get started, we're gonna talk about a few, um, housekeeping issues. Uh, we, we welcome your questions, uh, and comments throughout the event. Uh, you know how to do this if you've attended before. If you haven't, there's an ask a question bar below the video screen. Please use that and, uh, let us know what you're thinking, what questions you might have. We will go for no more than 60 minutes today, and we'll get to as many questions and comments as possible. So, joining me today for this conversation on direct private investing is Bruce Roberts, who's the CEO of Carfin. Bruce has over 35 years of experience as an investment banker and entrepreneur. In 1995, Bruce founded Carolina Financial Group, which includes Carolina Financial Securities, uh, small and medium business focused corporate finance firm. And Carol, LLC, which is a technology supported private securities distribution firm. Each is a registered broker dealer with finra. Uh, welcome Bruce. Uh, it's, uh, I'm glad to have you today. How are you doing, Uh, David? Doing great, and certainly very happy to be here and happy to be, uh, covering this topic. Fantastic. Excellent. So, our agenda for today, just to provide some context, we're gonna be going over these five areas in when evaluating a direct private investment, establishing your investment goals, evaluating the security, analyzing the company itself, what kind of due diligence you need to go through, and what post closure of the deal monitoring you need to do. Um, but before that, Bruce, can you give us a little bit of an, a background on carfin? Sure. Happy to. I think your opening intro was, was spot on. Um, I personally had been working in New York at one of the major investment banks. We used to call them bulge bracket firms in, in corporate finance. So my role was to, to raise capital for, for our clients. And these were by and large household names, large companies, um, mm-Hmm. And then, um, made a lifestyle move to, uh, Western North Carolina. Uh, whereas I tell people it was time to get a life and because being an investment banker in New York is kinda 24 7, sort of, sort of life and tough to raise a family. And fortunately, we, we had a growing family and so we made it, we're from the southeast. And so my wife and I, you know, moved to, uh, Western North Carolina. Um, it turned out I started getting contacted by, by individuals who were this thing called an angel investor in 1995. I didn't know what an angel investor was, but to sort of, I, I quickly, uh, began to try to support them and that led us to, to re to registering as a FINRA re registered broker dealer. And as you said earlier, we now have actually two FINRA register broker dealers, um, that day in day out are working with companies that need capital debt or equity that can only really be raised in the private markets and in the world of capital markets, uh, in the United States, and to a degree worldwide. The capital markets are enormous, but it's somewhat of a backwater in the sense that you don't have a lot of guardrails within which companies position themselves to come to market. And if looked at from an investor's perspective and everything, I'll say today, while it's geared from the investor's perspective, if you're a perspective razor of capital, just put yourself in the other seat and, and look at it that way. Um, 'cause you need to, like any business, you need to know your customer. And in the case of securities industry, an investor is your customer, certainly our customer. But, uh, we focused on direct private investments. That's a contrast that to funds. Um, a large amount of capital, of course, is deployed through either private debt funds and they've seen an explosion in recent years, uh, post recession, great recession. As bank lending constraints have increased. And that we believe is only gonna become even more the case in recent months with, you know, the, the, the, uh, collapse of some of the larger regional banks. Right. And we're already seeing that in the marketplace. We can talk about that later. Um, but we, we've made a, these are transactions where you're investing directly in a security that's issued for the most part by a private company, um, which I suspect would be the case for most of the, of the members that you have for the family business network. Yep. Um, so our, our primary clients are in terms of either high net worth individuals, family offices, uh, or private funds. We issue debt. We, we raise either debt or equity and every security that we, we create as bespoke in the sense of, we start a process by trying to analyze the circumstances of the, of the party that needs the capital. And from that, that's what of naturally leads you to either a debt or an equity direction. Sometimes it's a hybrid, it's debt with some equity, uh, component to it. And then we bring that to that market, as you said, through Carin. We have a proprietary database and CRM application, which lets us track about 13,000 investors that are roughly split between 7,000 high net worth individuals, about a thousand families, family offices, and the remainder about 5,000 funds, which triage into equity or debt. And from there, equity would triage into venture or private equity, private equity being investors in cash flowing companies by and large. Right. And then on the debt side, it could be, um, asset backed lenders, it could be cashflow based lenders. Uh, again, that's, that's kind of our magic is, is discerning what's the right security for a company to issue and who's the logical market for that security from this, this universe of folks that I mentioned. So, and importantly, we are a member of finra, uh, in the United States. Uh, you are not arou, uh, it's, it's illegal to raise money, uh, as a third party raise money for before another party and then to be paid for that. And so, uh, the simple litmus test is if the compensation to that party is based on one, uh, the success of, of, uh, of that transaction, raising the capital and funding the entity, and then two, it's a basis of percentage of capital raised. That's a pretty good bright line test for whether somebody's acting like a broker dealer. And, uh, I'll say one last thing. We are a fairly unusual firm. FINRA firms go most smaller firms, and we're about 20 people a across the country from Texas to Florida to Atlanta to, uh, largely North Carolina and then up to New York. Um, so one, ones z twosie, if you will, but, um, smaller firms generally are not bankers. They're seller selling organizations that are selling a public security, a mutual fund, to variable annuity. So if you've not heard of a firm like us, I say don't be surprised because I, I continue to be surprised that, that they don't exist. And I just got back from our national conference last week in Washington, and, uh, that remains the case. There's not a proliferation of small banker firms, so, Hmm. With, with, uh, what do you attribute that to? I mean, how, I guess I'd like to ask it this way. How prevalent is direct private investing, uh, among, among family offices and high net worth individuals right now? I mean, what, how, how do you see that fitting within their overall portfolio? It, it's, it's large and it's growing now as a percentage of assets deployed. It's relatively small in terms of the percentage of of families that participate. It's a growing category. Hmm. Um, you know, the, I can know that Fidelity has a family office group, I think they call it fog and, um, surveys they've done with the relationships. They have suggests that somewhere on the order of 80% of all family offices either are active in direct private investments or are positioning themselves to be. So, and there's a lot of reasons for that. I think one of 'em is just discretion, uh, having discretion over how your funds are deployed. Um, in some cases, for example, most families have generated their wealth through some demonstrable expertise in some industry category, and it would be logical that they probably know more about that industry category than your average, than your average person walking on the street. And why wouldn't they leverage that, that information? It may also be that they have current holdings that can essentially mitigate risk by making a direct private investment a third party company. But they can be a customer, they can have a vendor relationship, and it could be anything. Um, and of course, there's, there's return. Uh, now we're coming out of a period of zero interest rates. So, you know, in that world, take the debt offerings that we do, they tend to fall in a 12 to 15% current income range. Um, they haven't, they're not gonna move in this, in interest rate environment either 4%. I'll explain that in a minute, but, but the point is, if you're in a zero interest rate environment and you're a family that needs to generate current wants, needs to generate current income from its portfolio, Mm-Hmm. But then obviously the treasury market wasn't giving you much and, and even the corporate market wasn't very exciting. Um, with a 4%, you know, increase in rates nominally across the board, that's certainly more attractive than it was. But still, um, the public markets would never, should never approach the, the private markets because the, the risk, um, a company that can issue in the public markets is generally what we would call investment grade. If it's a, if it's a debt, could be high yield, which would be below that. But either way, they're liquid securities where some broker dealers making a market in it. In the private market, it's a buy and hold market. It's not to say it's impossible to get outta security, but you shouldn't expect it. Um, and normally if you need to get out of a security, it may be happening at the time when you don't wanna get out a security in terms of how that company is faring. But, but, but because it's a buy and haul of security, because they just aren't the guardrails that you have in the, in the public markets. So in the case of debt would be a credit rating, as I mentioned. Mm-Hmm. In the case of the equity market, it would be a listing on an exchange. So if you're gonna be on New York or nasdaq, you've gotta have audited financials. Well, in the private world, by and large, they're probably not audited. They might be reviewed, but even there, so it's kinda the wild west of investing. But I would point out, if you look at the wealth of certainly America, and you can go back, there's a, a wonderful book I would recommend to anyone called VC in American History. And it goes back to the Whaling Days of America, which I believe is around 1730. And Nantucket was one of the most affluent communities in the country. And amazing records of agents that would sponsor a wailing, you know, voyage, select the captain, select the ship, and, and they can actually track the rates of return that came off those whaling ships. And of course, they, they, they fished out, if you will, not that they're fish, but the whaling population declined, and they had to go around South America and end up in Pacific, and the economics blew apart. And of course, oil became what was used for lubricant instead of, instead of, well, oil petroleum was used. But the point is that wealth certainly wasn't coming through a New York stock exchange lizard company. Mm-Hmm. You know, it was a private finance and it was a group of individuals who got together. And then that wealth by and large, uh, helped launch textiles in America. Right. And the whole history. But even today, you know, the early investment in companies, the angel investment of our individuals, uh, by and large there are incubators and accelerators, but the early, early money is, could be friends and family or other, just, you know, organized angels. And, um, in North Carolina where I live, they have the Charlotte Angels, and of course they're all over the country. Um, but I would argue there actually is a huge gap in the market, particularly earlier stage companies. We actually call it the Valley of Death, where that angel money has been raised, they need more capital to, to grow the business. And the venture community, which becomes increasingly formalized, generally kicks in when you've got about 5 million in revenue. So that leaves a lot of room to invest in a company that has a product, has a customer, but, you know, figuratively speaking, needs more gas in the tank to, to progress, you know, in terms of building the business. So, Hmm. It's worst market. And that's, you know, uh, I'm at it 28 years now, so, um, starting to figure it out. But, you know, yeah. There's a lot of moving parts. Well, I mean, one of the, one of the things that, as you're talking, it strikes me something that I've heard from, from a number of families is, you know, access to deal flow is an important kind of thing. And even thinking about the whalers, you know, it's risky, but you gotta know who you know, you've gotta know what deals are possible there. What with direct private investing is access to deal flow, the big issue? Well, you know, yes and no, I guess, uh, access to good, well curated deal flow is challenging. Okay. Um, you know, there's always someone looking for money to launch the new, new thing. Um, and to the extent that folks in our audience are wealthy, then, you know, they're probably accustomed to, to being approached for investment in such things. Right. They probably got a lot of barriers around. So they aren't approached all the time or their, you know, their phone would be ringing off the wall over time. Their email would be filled up in their text. But getting into a network where there's leadership in the round where someone with experience, uh, and we'll talk about, you know, the, these, these guidelines that we're gonna talk about, uh, are not universally known. This is not sort of, oh, you're investing in venture capital or private investor, you know, here, here you go, you should do this. Now we, we have found ourselves compelled to create, uh, educational content so we can begin to share what we've learned, you know, some hard lessons learned with, with investors and, and, and with issuers for that matter. So, but to get into deal flow, I will say most communities have an angel network. Probably wouldn't take a lot of work. Uh, a little bit of Googling, and you'll find out who in your region, uh, is, is investing in early stage companies. Um, I will say when you start to look at the next stage, which is tend tends to be where we are, that is a bit harder. And, um, most of our transactions actually come from our investors, um, where they've made an earlier stage investment and they've hit a wall in terms of how much financial exposure they want to have to a company and work out of a logical, a logical call. And then our, our stock and trade is to figure out, okay, who are the logical investors to, to, to fill that gap? Mm-Hmm. And at some point you do kind of work your way into an institutional market, uh, but, but it is very, very tough and challenging to close an investment with a venture capitalist. And, um, that probably hasn't gotten any easier with the demise of Silicon Valley Bank. Not that we do a lot of business with, with the sil with the Valley, but, um, you know, they were, they probably touched half of the venture market in one way or another. And that's, yeah, it's remains to be seen what impact it's gonna have, but I, I don't think it's gonna be good. So it's probably gonna be lead to illiquidity, I would say, you know, as an in through the investors who might be on the call, this is a wonderful time to start rolling up your sleeves and thinking about this category because, uh, the regional banks from where I sit, uh, are, are pulling back. Um, you know, we're sitting here December 23rd, or sorry, May 23rd, 23. And, um, combination of rates going up, their capital positions being eroded. Uh, it's a pretty dramatic, uh, thing that's going on behind the scenes. And I think we'll begin, if you're trying to borrow money from a bank while they have retreated from making loans to operating companies a long time ago, whatever they were doing is gonna be even less so now. Mm-Hmm. So even more mature companies, uh, are gonna find that, uh, you know, the, the banks are trying to shore up their balance sheets and maybe calling in loans and things like that. The flip side is, as an, as an investor, if you've got someone that is competent in this area to follow, if you don't have experience yourself, or obviously this is what we do, so we look to lead transactions in that regard, um, then this is a great time to get in. You're gonna find good value. Yeah. You can become the lender of choice as opposed to the regional bank or the local bank that's having some liquidity problems, More mature companies will be coming to market for, for lending in particular. Yeah. Uh, and so, uh, and, and again, we're, when we look at a company, we're agnostic in terms of whether it's debt or equity. What we're trying to say is, what's the right security for that issuer? And how does that juxtapose to all the investors? We to some, some subset of the investors that we know, uh, where there's a fair, fair trade in there. Okay. Good. Well, let's, let's dive in then to, uh, to, uh, some slides here. Um, you, this is the first of the five areas, and you were addressing risk earlier. So can you talk about, you know, four people on the call for family offices and family businesses interested in direct private investing? Let's talk about getting the goals set up. Right. Well, I mean, this is hopefully what every, every anyone would do with any portfolio of any size. But I, I just wanted to reiterate, you know, Private investing tends to be reactive. It's not a conscious decision that, oh yeah, I want to allocate so much of my portfolio to this asset class. Um, and so, you know, it does make sense that, that you do that as a first step. Ironically, those with greater wealth tend to allocate more to the alternative investment. And within that, the direct private investment world, alternative investments would include real estate, commodities and other areas. Direct private investment for this purpose is, we're talking predominantly about, uh, investing in operating companies. But I think a conscious decision to say, okay, how much do I wanna allocate here? It's illiquid, it's higher risk, what kind of return do I need? And at the top bullet there, it's current income or capital appreciation. The, the, the simple rule of thumb is a younger family, younger in the sense of gen one, two, gen three, you know, doesn't have the liquidity needs in terms of distributions to its beneficiaries as an older family might where you, you're into multi-generations. And there's obviously families in this country at this point that are, you can imagine a Ford or, or a Rockefeller or someone like that that's made their wealth, you know, hundreds of years ago. Um, and by the way, or you know, in the case of the Rockefellers, Venrock was one of the first venture firms in America. So really have been pioneers in at least the venture side of the space. And, and much more broadly. So are you, look, do you need current income capital appreciation? A little of both. Um, then it gets down to risk tolerance. And, and I would say, um, while debt, even in this world is a safer investment, should be a safer investment than equity because most of the lending that we're involved in is secured by something. And you've got multiple sources of repayment. The general obligation of the issuer collateral, you don't wanna have to realize on collateral, but you need to know that path is there. So you've got a couple ways to, to get your money back. Um, then you get into equity, which by its nature is not secured and is below debt in terms of liquidation preference. So if a company's in trouble and they have to sell their assets, the the lenders are gonna get, um, gonna be redeemed before any equity is distributed to equity investors. And then you get into what kind of equity deal is it preferred or is it common as the name would suggest A preferred equity is senior liquidation the common. But the point is, you know, if you're in the equity world, you probably should take a general view that on any given transaction you can afford to lose that money. And in the case of the debt world, while you are looking for additional supplemental current income, these can't be securities that on a date certain have to redeem or some major impact on the lifestyle of the beneficiaries of this pool of capital. Uh, this is discretionary investment. And that's why you find larger families would say fewer beneficiaries can allocate more to this asset class than smaller investors with more beneficiaries. Because, you know, the urgency depending, you know, of making those distribution of beneficiaries is not the urgency, but the imperative is much greater. You know, when you've got fewer amount, more mouths defeat if you will. Uh, and, and that's what you consistently see some families, uh, who've recently say sold a business or something like that, um, you know, they're looking out 20, 30 years before they really are in any ways worried about current distributions. They just wanna know their wealth is building. Right. E even if on paper. Right. Um, whereas again, more mature families, some component would often be in a current income. And given the 10 years we're coming out of in a zero interest rate environment, you can imagine they've been challenged and that did pull more people into the marketplace. So. Well, and, and one of the, what you're saying in there though too, is that in this kind of investing, you're really, you're thinking the long term you're wanting to hold onto this investment without having to, um, do anything for a period of seven years or more. Is that generally it? Well, some of the VCs that I have the most respect for would tell you on a venture investment have about a 10 year horizon. 10 my experience. That's about right. Um, uh, it's not that you wouldn't go into something that promises to be a shorter liquidation period. And clearly if you've got a company that's doing a financing in anticipation of an IPO or selling the business, then you know that that's part of it. But either way, you, you need to, you need two things. You need to be, uh, a available to, to ride it out if something happens. Gimme a good example. Uh, COVID, uh, we have done a lot of finance in the, uh, in the aircraft repair market. Hmm. And as airlines basically shed themselves of their repair capabilities, it create a lot of smaller companies that are either about parts or repairing engines or what have you. And in our world, it's great because they're modest sized transactions, let's say two to 5 million, and it's an asset rich world. So you've got secondary sources of repayment. Well, March 20, uh, you know, passenger travel fell off, cliff planes were parked on the tarmax, and, um, there wasn't a lot of repair going on on. So, uh, um, in that case, what we did for that security is we extended the ma we went into forbearance. So we didn't foreclose, um, we went to interest only. So we didn't do the amortization. In fact, we did it three times 18 months worth. Now the con the deal actually has redeemed several months ago, but, you know, everyone made a return on their money. They just had to wait to get the, the funds back. And that's getting back to the, the portfolio. That's why one thing I haven't mentioned, which is critically important, once you've set, call it 10% allocation to this type of investment, now you wanna say, how many investments do I have to get to, to get diversity across that portfolio? You never, I don't care how good a deal looks, you just don't wanna be overly exposed to any one deal. And, and there is, this is, there's a lot of things you can do to mitigate risk in this, but the one thing that clearly you can do is to not put too many eggs in one basket. Right. And, and I would even say for the equity investment, you say you have, don't even put all of the capital. You might commit to that investment in the first round. 'cause there's a good chance they'll be back for more. And you'll wanna basically be able to stay with that round to avoid dilution or otherwise support the company. Got it. Okay. Well, earlier, uh, so let's, let's talk about debt versus equity here. That's a, that's another one of your elements, which is what are we, what, what are we looking to invest in here? Right? So once you've figured out what am I trying to get out of this part of my portfolio, then the next logical questions, well, what kind of security should I be investing in? And will those securities to that, what they pro, what they promise to deliver in terms of the type of return? And, and by and large it falls into two buckets. It's either current income, IE you're getting a, a check or an a CH every month or quarter. Um, by the way, we tend to do it every month because we want to know as soon as possible if a company's starting to hit a have some challenges Mm-Hmm. The sooner you know that a company, uh, is faced with some kind of a challenge, the quicker you're gonna be involved. And in our case, we actually manage this part of the process for investors so that we wanna know, so we can intervene as quickly as possible. 'cause time's not your friend when a company's in trouble, right? Um, or, but, so it's current income or capital gains. Um, and, you know, again, that kinda gets back to what you're trying to achieve with a portfolio. But, you know, debt by and large is where you'd go to for current income, a debt security, an equity security, um, and in the case of a a C corp, that's gonna be stock in the case of an LLC, which is quite common to find. And, and we do many, many of financing using LLCs, excuse me, which is obviously a pass through for tax purposes. Right. Um, uh, that would be a membership interest. Sometimes they call 'em units. So, uh, you know, which pond should you be in or how should you allocate across this broader allocation, what you do current income versus what you do in capital gain or, or in, in equity. And then that's the first place I'd go is, okay, um, I'm gonna take an extreme example. So early stage company pre cash flow, uh, once you raises five man of a five year note and pay you 12% interest, and let's just say for argument's sake, it's gonna be interest only for the first year, and then the next four, it's gonna amortize over the next four years. I'm gonna stop there, and now let's go to the next slide. Okay. That gets you to step number three. Is this the right issuer to deliver on the promises that are implied by the security that's being offered to you? So I made that example before because a venture stage business by its nature doesn't have any cash flow. And if you don't have any cash flow, you can't service debt. Now you can raise more money to pay the interest, but that's called capitalized interest. That's not paying off interest from operating cash flow. And so, you know, I would argue in the case that I just gave you that, no, this venture stage company is not an appropriate issuer for a five year note at 12% paying interest only. Now, to not be confused, there's a lot of convertible node offerings that happen that you may think of as debt, and technically they are, and they have a liquidation preference. If the company is liquidated. Again, a liquidation preference, meaning it's like a waterfall, you know, there, there are those obligations of the company that are at the top, and that would typically be indebtedness and those that follow, which is, which be some type of equity. So if you do a convertible note, your senior liquidation, but if you think you're gonna get current income out of it, I think you're probably mistaken. And it's really just a con, a, a, a, a construct to put offsetting value. I I happen to be in the camp that says, if you're, it, it's an, it's equity risk, even if it's senior liquidation to other forms of equity. But the underlying risk of the business, will it perform? Will it grow? Will it find customers? Can it sell its product profitably, et cetera? You know, it, it's an underlying, it's an equity risk. So what I'm talking about more is what a bank might have provided you at one point in the history, um, which is true debt, uh, of some term, um, is the, is the firm able to service that debt? And there's ratios you can use fixed charge coverage ratio, which can lead you to, to know that et cetera debt. You tend to look backwards in terms of the ability of the issuer to service the security. Equity is about hope, equity's about equity gains. And so you tend to look forward somewhat backwards, but you know, you're, you're, you're making a bet on the future. Whereas with debt, you're saying, okay, this is what they've done before, can they keep doing that so that I can have a nice return and then, you know, have my, have my capital repay. Mm-Hmm. And as you noted earlier, uh, your preference, is it your preference, the debt side versus the equity side? No, not really. Um, it, it really, it starts with the issuer. Uh, this is the good, a good example. You know, when we're, I'm presenting this from the perspective of an investor who's shown an offering a security, and they're sequentially going through a process to figure out if that security is right for them. As a banker, I'm presented with an issuer that says, you know, I need $3 million. Um, and usually they need it yesterday if it's a venture stage business. And then our role is to say, okay, is this, um, is this a company that, that, you know, we believe we wanna get behind? And, and so with more of an equity focus, let me kind of focus on the issue and give you some sense. This is another presentation, but I'll give you the CliffNotes version. Um, we use a construct that we've created called The Lane. And if I say, you know, does a company have a lane? You kind of intuitively know there's some business focus they've got where they can consistently find success. Mm-Hmm. Well, one end of the lane is an opportunity, a business opportunity that's generated by a customer need or want at the other end of that lane is a product or a service that's being delivered or is being contemplated by the company that we might, we might be getting behind to, to finance You, you start with what is the customer's need or want? What is their why? 'cause that is, in essence why this business exists. It exists to satisfy a company a customer's need. If they can't identify a customer's need, then it's a solution looking for a problem. And that's not necessarily an impossible scenario because in venture, particularly deep technology venture, almost by definition, um, these are people looking over the horizon and say, you know, we could be doing this or we could be doing that. There's this thing called the internet, right? And if we only had this ability to be interconnected and move digital content around, and obviously that's where we were in the nineties. Um, but, but broadly speaking, from an investor's perspective, what you're gonna be presented is, uh, financing. And you need to understand that issuer and, and the lane does a good job. By the way, there's two types of challenges that we, we would circle around that a customer that a company will face. One is product or service related, how they actually make or deliver whatever their, their basic prop, you know, product or service is. That tends to be where investors put in my opinion, too much emphasis because most of your particularly venture stage companies fail, not because they can't produce the product at some scale to satisfy a customer, but they can't generate customers fast enough before they run outta money. So little companies don't run out, out outta money, they run outta time. And so we put a lot of energy in understanding the customer dynamic. We certainly have to understand the product, but that alone, I is not enough. And, and, and unfortunately, you know, we've been at this a while. It's just consistently, you see, uh, where they fall short. And at least in my case, uh, I, I I, I want to, I wanna really get in the head of the customer. I wanna stand with the customer acquisition cycle is, and I wanna understand what infrastructure the issuer has to manage sales. Are they using a CRM and is that, you know, and I mean, get into the CRM, you know, with this day and age of screen shares, here we are, it's pretty easy to have someone put up their, put up their CRM and you can tell pretty quickly, is that a living, breathing application that's driving sales or is that something that, you know, somebody bought one day and they set it up and it kind of collected dust, figuratively speaking. Mm-Hmm. So I can't, you know, this issuer bucket, this is hard. Okay. And frankly, you're not gonna go to Wall Street and find that your average banker has, has a framework with it, which to do this. Um, but, and that probably is why a lot of VCs tend to be industry specific. We can be generalists because our investors are so specific, and we're one phone call away from somebody who's generally expert in about any field that we might be contemplating from a financing standpoint. We've got our own expertise, but, but the, the nature of our network dramatically. Interesting. Okay. How often do you see a, a mismatch though? You've talked about the security, the company, how often do you see a mismatch between the security offered and what the company does? Um, Quite regularly actually. Um, because the people that are, you know, generally speaking in this world, it's not like they have a banker that's advising them that does this for a living such as we do Mm-Hmm. And so when I see the deal, I'm kind of a proxy for the, in, you know, the private investment market and, you know, the, the disconnects, um, cer certainly can be valuation if we're talking about equity. Um, it, um, um, it could be liquidation preference. You know, this is kind of a, a, uh, a li o market, you know, in the accounting term last in, first out. So not completely, but by and large, that last round of financing typically has a liquidation preference over the first round. And, uh, and, and sometimes in a willingness to, you know, if the, if the, if the company has taken longer to get to a certain point, and by and large, most of 'em do, that doesn't mean it can't be successful. It just means the hockey stick they envisaged, um, didn't, didn't quite work out that way. Um, and, and by the way, I would even go on to say that rare to almost never does a company at its financial projections, if it's a venture stage business, why sales, they, they grossly underestimate the challenges of making sales because the entrepreneur is a half full person. And depending on the customer, they are probably very risk, risk averse. So for example, you know, one of your worst scenarios would be venture stage company wants to sell to some government entity. Mm-Hmm. Well, that party on the government side, you know, their, their brass ring is retirement. And retirement suggests they haven't made a mistake yet as a purchasing agent or something. And so they're gonna be very risk averse, same's true for bigger companies. The classic is, oh, we wanna sell our product at Walmart. Well, two problems with that. I mean, first of all is Walmart, right? I mean, how much shelf space, I mean, and it is not that Walmart would ever take something on and blow it across our whole system. Any one of the bigger buyers is gonna take an incremental approach. And it might be regional, it might be even local. Um, but, um, you know, of course the other problem is people decisions are made at, at a large company that you would never have any sense of. So I tend to take the approach that little plays well with little, and I look for companies, even if they have aspirations of selling to the larger counterparty, I wanna see a component of smaller customers because they're more like-minded. The small company, um, is buying this because they have some urgency, and the big company has got franchise value and does it. Now, I will pass on another read for folks. It's an older book, it's called The Innovator's Dilemma. You're right and written by Clayton Christensen, who was, and perhaps still is at Harvard, quite well known in venture circles. But there you're getting into the dynamic of a sustaining technology, you know, a better cell phone, if you will, extreme example, and a disruptive cell, a disruptive technology, the cell phone when it first came out. And, and, you know, disruptive technologies that really take hold tend to become sustain sustaining improvements that, that take 'em to another level. So, um, I got, I'm sorry if I meant throwing too much at you, but No, no, That's really good. So I, my big takeaway there is, uh, you know, I think we can go into some of the due diligence aspects that, that you have as the fourth step is to maybe add a plus X number of months or years to a financial plan to make sure the, that the hockey stick is, is realistic. Uh, by and large, I'd cut whatever they show you in half. Okay. Run an IRR calculation based on that lowered expectation, and then see if that still holds up as the, if it's a, for example, in venture, you ought to be penciling out on balance about a 50% rate of return in a venture investment. And so, you know, find someone who can help you run a cash flow forecast and, you know, again, cut the numbers in half, right? And see in that scenario, what does it generate? And that's a pretty good way to figure out is what they're offering me, at least at that base level, um, in the zip code of what I need to get out of this based on the risk I'm taking. Right? When you say 50% rate of return, you're saying 50% of the, um, projected rate of return, correct? No, I mean, nominally 50% IRR based on whatever share price or unit price you've bought at. Got it. When you look at a projected liquidation value, you probably ought to be in that, in that zip code. If it's private equity where you're investing in a, a cash flowing business, it, it doesn't have to be necessarily that aggressive. It's certainly higher than 25%, but 25 to 35, I would say tends to be the range. Okay. Obviously hires better, but, uh, on a going in basis, based on what they show you, that that's another way to do sort of a sanity check going in if they're showing me equity, and yep. They need equity, but the business just doesn't project to grow enough to, uh, to get me there. So. Excellent. Okay. So let's talk due diligence. Well, let me just say what I just went through in terms of the lane becomes very important as a preliminary step to due diligence. And, and by the way, um, the lane is described in our website, um, carin.com, in the knowledge base, you can find it easy enough through the search or in the library. So if you wanna really spend any time with it, it's there. And look, it only co it only took me about, you know, 27 years to figure it out. So this, this is not a world where here's the, you know, you're, it's an er, it's an evolving world, which I, frankly, from a professional level find fascinating given how much of the economy is dependent on these sort of cash flows, and yet the knowledge that's required to, to, to do it on a fully informed basis or mostly informed basis, right? And which kind of is a good segue into due diligence. So once you've figured out the lane, then you've got these kind of categories where you're collecting information. Um, now what you have to, you know, what you have to be careful of is you're not just collecting data And you, it doesn't result in information. Uh, this day and age, it's easy enough to collect PDFs and screenshots of articles on web pages and, and what have you. But if you've looked at the lane first, then from there you should say, well, what, what are the most critical elements of this company? Now, let me just say, before you even get into the business itself, it starts with the people. Now we do personal background checks, um, and you would be amazed what you find, Mm-Hmm. Uh, it's not regular, but it's not uncommon to find someone with a securities violation that, you know, a Alexis Nexus search will find out. So absolutely, positively, don't rely just on a Google search, find a way. I'm not suggesting you have to hire a private investigator, although depending may not be a bad idea. But, um, you know, there are information sources, and obviously I mentioned LexisNexis, which do a wonderful job of giving you a sense of not just a judicial history, but their, their civil history. Um, you know, for example, one of the things we look for is someone that's got a lot of, uh, litigation in their history, either as a, a target or as a someone bringing the litigation. Uh, some of it certainly can be explained, but you know, if you find that somebody's got seven lawsuits to their name over a business life, that's pretty unusual. Um, I mean, there's exceptions to everything, but in an entrepreneurial setting, I think it is. Mm-hmm. Um, liens and judgment searches, you know, uh, do they have big tax liens hanging over them over for whatever reason? Um, have they had bankruptcies? Um, bankruptcy isn't necessarily a walk away in every scenario kind of background. There's, there's always, you know, it's worth under, but you sure need to know, uh, by the way, I'm gonna sit talking outta the other side of my mouth. There's been a, a trend in recent years that failure is good, and I've never really bought into that either. I think you do everything you can to avoid failure, um, but there are some circumstances that are bigger than you. And, um, COVID might be one of those examples, right? Where just the world as we know, it's turned on its head, and there's just no way your enterprise could, could succeed. But I will say, when you're talking to those people, um, beware the entrepreneur who can't speak in financial terms, because that's how we measure success in business, is are we profitable? Do we have cash flow? Are we creating equity value? And understand those things, you need to be able to talk in terms of balance sheets and income statements, right? And so to the extent they say, well, you know, I don't do that. That's my finance guy over here. I I don't have time for that. Uh, I would also say secondly, and again, these are lessons learned. I mentioned earlier a sales process. Next to that, I would put financial management. Hmm. Um, small companies chronically under invest in financial management. And I dare say many entrepreneurs don't know what a general ledger is. Um, much less how to maintain the, the, the accounting around it, much less have broaden the system to do it. And QuickBooks could be adequate, but a larger company needs to evolve to something that's more robust, that ties into inventory management and, you know, cost of goods sold and things like that. Financial, you know, cost accounting and, and has hired someone who has the capability to build out that side of the business and where that person has enough of a voice in the company to say, no, this is not in the budget. Or, we need a budget. You know, those sort of things. So financial management's a hot, a hot button with me. Um, if, if I could do one thing over again over the last 28 years, it would've been to prioritize that on the front end, and I think I would've stopped, well, I would've, I would've forced investment in that area alongside all the other things they were trying to do. And we would've been flying blind in terms of what was going on with the company. Hmm. Um, you will find, and it's gonna get to the next point, when someone needs capital, that's the most important thing on their, on their agenda. When they've got the money, they've moved on to some other, some other imperative. And, and so you, you do need to, and we'll give there in a minute, but you do need to have a mechanism to follow up. But looking at these items, these are literally the categories that, that we go to and, and which ones you would all of them can be important. Um, which one you wait at a different time in terms of the state of the business, um, is relative. And again, using the lane as a construct to understand the basic business. So a development stage company, um, say in the medical sector, um, do they need regulatory approval? Have they got patents filed? Even if they're not issued, you know, are they at least filed and pending? Um, on the other hand, a more mature company, a more mature industry, um, what does, what's the state of their assets? You know, the, do they have a planned maintenance program? Uh, if they're a capital intensive business, learn that one the hard way. Mm-Hmm. Um, you know, uh, most companies surprisingly don't take better care of their equipment than people take care of their cars. And it's pretty shocking how, how infrequently a company has a formal plan maintenance system with a maintenance planner on their staff. Again, I'm talking about mostly a capital intensive business. So each of these categories, this provides a bit of a guideline. I hesitate to call it a checklist because I think it needs to be a much more thoughtful process about which of these are just critical informations to validate. Again, once you've figured out that the people you're, you're dealing with haven't served 10 years for securities fraud, um, once you feel like the people you know, their backgrounds are appropriate, then, then, and you feel like you understand what the business is about, then you just sit back and ask yourself, okay, what, what can go wrong here? And I would also, don't undervalue your personal experience or your common sense. Um, I didn't come at this as an experience venture capitalist, I'd rate billions over $30 billion for major companies. And, you know, my learning curve has been very, you know, has been very steep. So, but your common sense, your past experience, follow your gut. Um, and frankly, if you don't feel comfortable with a counterparty that's taking your money, um, walk away, there's always another deal. There's plenty of companies that need capital. You're not missing the next apple in all likelihood. Mm-Hmm. Uh, or, or Google, or whatever the case may be. And, um, um, I don't throw a lot at you, but, uh, no, no under value your experience. 'cause it's worth a lot. I, I find it rare that people talk about common sense and, and really listening to your gut, because I, I think more often than not, we always wish we had. Well, a corollary to that, by the way, is, uh, spreadsheets. I just wrote a piece for Forbes that, uh, it was supposed to have been entitled Lies, damn Lies and Spreadsheets, and most people probably know of the, of the, uh, lies, damn lies and statistics. And this was my modern day version of it. They put a little bit different title on it. But the point of it is, in this day and age, we start with a spreadsheet that is as often too complex. You know, if you do a back of the envelope analysis, um, that's where you ought to start. So that when you get to the spreadsheet, you can add the complexity and better understand some of the nuance. But if it doesn't work on the back of an envelope, move on. Yeah. It's not gonna work much better. 7 million rows and columns. Right? Exactly. Okay. So Excel, but you don't really know what they do. Right? Right. Um, so when you, uh, when you've done these first four steps and you've done the due diligence and it's passed the gut check and you've stroked the check, next up is how do you stay on top of it? Stay engaged? Um, first of all, the, the, the document that summarizes the transaction you're investing in is called a summary of terms. And usually towards the end of that summary of terms, there'll be a section called information rights. So, and the company will make certain commitments, monthly unaudited, quarterly unaudited, financials, investor presentations twice a year. It's really for you to dictate as the investor, they want your money and you can dictate, you know, how frequently should they be telling you what's going on. So that, that starts with a term sheet where they're contractually obliged to do that. Now, that's easier said than done because particularly for earlier stage investments. Um, so let's assume we've got entrepreneurs that are well-intentioned, they care for their investors, et cetera, et cetera. Um, they're trying to get product out the door and try to sell it and try to generate some cash flow. And because they know that's what the investors wanna see. So it, it really is a challenge to get current communication with these companies. Now we have on our case certain automated features where notifications are going out on a regular basis, you know, as we speak. Sorry for that as we speak. We have, um, over 90 transactions outstanding. So as you can imagine, we need some automation to stay on top of these companies to try to get information out of them. But most far and away not very few people would have that. Um, and, um, some mechanism where, you know, you've got a direct tie, whoever's responsible for giving you that, sorry for that, that information, uh, from the, from the company. So, um, Sounds to me like lots of deals are flowing in. Well, always something, but, uh, you know, but I would also say, um, you know, if your thought is, oh, it's a passive investment and I'm gonna put it in, put the money in and, you know, clip coupons in, in private investing often is not, it won't work work that way there. These are fragile companies and, you know, trying to, trying to grind out of, uh, some success. Um, you need somebody in the company who is responsible to tell you what's going on, and that you need to both feel like, okay, we agree we're gonna do this, and, and, but the other reason to stay engaged is if things come off the rails. And we certainly have had, you know, companies have defaulted and worse Mm-Hmm. Um, being on the spot as quickly as possible is, is critical. Um, and, uh, if you're not, if you're not there and you're expecting the system to just work for you, let's, let's just say the more aggressively you're engaged, um, you know, say it's debt and you've got certain assets that protect you. Uh, I mean, I've lived through full on chapter 11, moving to chapter seven bankruptcy processes as a senior creditor and representing, in this case about 40 or 50 investors. And you gotta roll up your sleeves and, and understand what rights and protections you have. You got a lawyer up and be, have good counsel who's respected in that court, court community, and just be prepared to go to work because, uh, you know, it's a dog fight. And, uh, again, that's why you want diversity. Uh, if you have one like that and it, it really is, you know, a challenge to, you know, it just hadn't worked out, then, you know, first of all, the documents have gotta be right going in. So you have those protections. 'cause if you don't have 'em going in before you move your money, it's not gonna show up later. Mm-Hmm. Even assuming they're there, you need competent counsel to re to protect you and to, uh, because the game in a, in a adversarial litigation is the lawyers on the other side of the table. It's not about doing what's right, it's about protecting their clients. Right. No matter what the documents say. So I don't mean to be overly negative and maybe in this presentation I'm scar the heck outta people in terms of this sort of stuff. But, but obviously we've done it for 28 years because, um, we, I think we have a pretty healthy respect for the issues you need to address to be consistently successful. Well, I, I think it's refreshing, Bruce, to hear, you know, the, the, your frankness, because not all investments work out and people expect them to do. So it could be, you know, you're, you're gonna be set up, set up for a failure. On that engagement side though, is can you be too engaged? What's the, what's the point at which your engagement hinders the company itself? I think you can, I mean, you, you, you, that's a great point, David. I mean, you wanna let management be, be management, but I would say, you know, a quarterly touch is not unreasonable. Mm-Hmm. For what's going on with the business. Now, I'm not a big fan of measuring companies by quarterly performance. I know we do it in the public markets, and if I were king, I'd change it to semi-annual because I think you wanna know what's going, it, it just, it, I think it's unrealistic personally given, particularly for younger companies where a few things that are fairly binary can have a dramatic impact on the success of the business. Right. You know, they tend to be overly concentrated in one customer or not. They've got one, they're a one line product company and it maybe it takes an extra six months to get it done, to get something going. That's where, you know, my earlier comment about discounting the projected cash flows dramatically is a healthy practice because, um, certainly in young companies, what can go wrong will go wrong and some of the stuff will go wrong, you just can't make up. Yep. Indeed. Interesting. Yeah. The, the idea of, uh, quarterly, um, or the, what goes on in the public markets is it can really distort, um, it create distorted results and distorted behavior. So you're an advocate of letting a little bit more time go to not have that Happen. You're in a high risk category. You need to have a longer horizon you need to be prepared to be flexible. That's not to say you need to be a pushover. It just in somewhere in the back of your mind, you know, this is not Apple, this is not, you know, a major public company. This is a fragile young company. Now that gets back to the pri pro quo expected return should compensate you for that. Right, right. Or, or you know, you, and I would say also, don't beat yourself up if the stock market's taken off. And you look at the public portfolio and it's like, wow, well why did I do all this? It's a hedge, you know, it, it's getting diversity across the broader portfolio, um, and then diversity within this portfolio. Mm-Hmm. And that to me, by the way, our tagline as a company is meaningful investments, vital capital. And it speaks to the two sides of this equation. Meaningful investments, when you're doing direct private investments allow you to put your capital in something you care about. So, for example, we're financing a company that makes a, basically a suitcase that can sterilize surgical instruments without water and without electricity. And in a natural disaster world where electricity is compromised in a developing countries where, you know, getting an autoclave and everything that it takes to support an autoclave for surgery is really, really hard. Mm-Hmm. And, you know, this is a smaller portable device. We're just bringing it to market. So it's a venture stage deal. Got its risks, but, you know, good team behind it. But the point is, we're gone to investors who otherwise would be donating money to causes that would support children in developing countries, you know, or, or young families in developing countries, um, are trying to avoid just in general support developing countries. It also works in a military environment. You can imagine in Marial, that would've been a pretty handy thing to have in the months that they were in that, you know, that they were under siege. Right. So it's meaningful. And then that's what we look for is so that the investor gets some satisfaction above and beyond the rate of return. The rate return needs to be there, but they have a chance with direct private investments to, to have their cake and eat it too. Excellent. Okay. We have actually have like three minutes left. So, um, can we dive just briefly into what you referred to at the beginning, um, the opportunity that's coming right now in doing some private banking and, and lending in, in the face of, uh, some of the larger banks, perhaps pulling back where, what are you seeing there? Um, well, I I, I've had input at different levels. One at folks I know that are senior officers or regional banks who are just having to pull in the horns, uh, pulling in, pulling in the horns, meaning restrict their, limiting their, their lending ability largely. 'cause if you understand how a bank's balance sheet works and the regulated nature of it, they often have significant losses within the bond part of their portfolio. And I will get deeply into it other than to say if they have a, a paper loss that's a hit to their regulatory capital and that hit to their regulatory capital has an impact on how many of the loans they can make, which by their nature require a higher capital allocation than their bond portfolio required. So ironically, they put their money in, say treasuries. Treasury rates went up. When rates go up, value goes down of the outstanding securities and that's a hit to their capital. So there's, there's that. The other thing, banks gave up, you know, the world of going to your local banker and getting a loan for your young company, uh, has suffered dramatically as banks have consolidated and they've consolidated underwriting within the banks. So, you know, the, the person that's making that loan is not based on your character anymore. It used to be, you know, credit, do you have a history of paying it, paying your, paying your loans collateral? Is there a secondary source repayment and character? Which in my mind is as important as the other ones. Well, that person that's a hundred or a thousand miles away that's looking at your loan based on an algorithm, doesn't know who you are. I mean, sure they can look at your, they can look at your credit history and stuff, but you know that that's often not enough. So you knowing locally who you're dealing with and their reputation is important, and that's just a wide open market for, for those who wanna, who wanna, you know, deservedly get a higher rate of return for a current income investment. So. Fantastic. Well, Bruce, this has been a masterclass. In fact, one of our comments that came through was asking whether this was recorded, uh, for fur so it could be reviewed further by some of their team members. And yes, this is a recorded webinar. It will appear on our website, the Family Business Magazine website, and on the carfin website. Uh, so, you know, please, uh, please do, uh, refer some of your colleagues to, to checking this out. I, I learned a ton. Um, so Bruce, thank you very much for your time today. Um, and I would just like to note that, you know, we will be addressing issues of wealth investment and more at our Family Business Legacy conference in September in Dallas. So please, uh, feel free to join us there, uh, to talk more about issues of family office investing, direct private investment and more. Bruce, again, thank you for your time. Thank you all for your time today. We'll look forward to seeing you at the next webinar. David, it's been my pleasure. Thank you. Thank you.