In prior articles I shared how understanding the lead sponsor’s track record is key when vetting them. However, that often raises the question – how does one actually vet their track record, what questions to ask, and what steps to take to perform proper diligence.
In today’s quick snippet I share seven categories to pay attention to when vetting a sponsor’s track record.
1. Asset Class. Does the lead sponsor/fund manager focus on a particular asset class? Ideally the operator/fund manager will be the subject matter expert in a particular category or market. As such, it is important that they are focused and not spread across multiple industries. It is not uncommon to see some fund managers offer investments in a variety of asset classes (particularly in series or customizable funds), in which case you likely want to hone in on their ability to curate strong investments and monitor those investments (in a prior article I shared a few ideas on performing fund diligence).
2. Market. In line with the point above, it is important that the operator has local market expertise, network, and infrastructure. Over time this focused expertise compounds into a competitive advantage that translates into (i) off-market deals (ideally acquired at a better basis), (ii) knowhow of local rules and regulations or access to local resources that may not be as apparent to an outsider, (iii) networks of local vendors to procure better pricing or availability of materials, labor, or access to local resources.
3. Tenure Through Cycles and Deal Exits. This criterion is not meant to automatically exclude operators newer in the space (our firm actually has had great experience partnering with some of the newer operators). However, time in the market mitigates operational risk, as over time the operators build knowledge and experience that can help them structure deals more conservatively, plan better, or being able to pivot more efficiently during a period of challenge. People who have been in the business long enough have all gone through a challenging or painful experience, and potentially a loss. I am yet to meet investors who have 100% batting average. Looking for the perfect track record is not the point. However, it is important to understand what they learned from these challenges (losses) and how such experienced helped them become savvier investors over time and why they are confident they can avoid making the same mistake in the future.
4. Actual vs. Projected performance. This is absolutely key to understand, especially in periods of cap rate compression. I’d still give the operator credit for making a decision to exit when cap rates are low (i.e. top of the market) vs. getting caught up in the market hype or in hopes and dreams (aka greed) of better returns. However, what is more important to understand is how actual NOI performed relative to the originally projected NOI. This will give you a good insight into their operational expertise and track record. Achieving strong overall returns is important. However, so is the driver behind such results – was it luck and market bail out OR was it operational expertise. The converse is also true – if the operator performed well and achieved projected NOI but was faced with market decline or downward market cycle headwinds, which they do not control, this factor is just as important to acknowledge (vs. turning away, if return performance was below projections, and without peeling the onion.)
5. Key Man Risk Policies. What happens if the lead person is no longer around? Who will run the day to day operations? What is that person’s/that team’s experience and track record? If a team is not in place, does the lead have proper key man risk policy in place (many lenders may require it, if they recognize high succession plan risk). This is why, our firm likes to see operators with established management team members and systems and processes, where the management team can continue to run daily operations and/or easily step in to take the lead and see the project through completion.
6. Deep Background Checks. I have mentioned this in prior articles but want to highlight it again, as it is important. A well done background check can uncover important information that may not be otherwise publicly available. I often like to be upfront about performing one and give the operator the benefit of sharing anything of relevance and importance upfront. If you find something of concern that they have been upfront about, then at least you know they are not hiding and open to having a deeper follow up conversation about it to address any outstanding questions or concerns. And if they do not share, that is an easy red flag to put pencils down and move on.
7. Communication. Last but not least, this is one of the most important factors – transparency, frequency, and clarity of communication. You can always request various reporting samples to get a feel of how that sponsor communicates. Interacting with them prior to a deal and being part of their ecosystem, newsletters, educational content should also give you a good sense of how they communicate. Lastly, being able to obtain references via investor forums will provide a helpful third party perspective. You can also ask the sponsor for references of past or current investors. However, I am yet to meet a sponsor who would provide a contact of an unhappy past or present client.
With the framework above, you should be able to peel the onion on a sponsor’s track record at least one layer deeper to give you the comfort and confidence that the operator you are partnering with is the right fit for you and your investment requirements.
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.