Management’s motive/objective - The next step is to
evaluate the reason for management to come out to the market
with an offering. This exercise allows us to determine if they are
in business for the right reasons. What we really look for here is
whether management has genuine interest in generating returns
for investors and themselves, or is the offering a way to line their
own pockets first, ahead of investors.
Skin in the game – The easiest way to quickly evaluate
management’s commitment to an offering is to verify if they have
invested alongside investors. If management is willing to put their
own money at risk alongside the investors they recruit, it is one clear
indication that management and investors interests are aligned.
Alignment of management and investors’ interest – Another
way to evaluate whether management and investors’ interests
are aligned is to verify the structure of the offering. In this step,
what we look for is the way management is compensated for their
services. Management compensation is typically structured as an
annual management fee or an upfront fee, and a share of profits
after investors receive a preferred return. We believe that a strong
management team deserves a higher than average compensation,
so investors may have to pay a higher fee for their services.
Therefore, higher fees do not always indicate a bad management
team. The annual management fee or an upfront fee should be
reasonable and structured in such a way that management is paid
for their time and effort. However, the profit sharing component
should still align management and investors’ interest – for example,
a structure that flows cash to management first before investors
is a key red flag. In addition to the compensation structure, it is
important to keep a check on the fund’s operating or General and
Administrative (G&A) expenses. Most offerings allow management
to get reimbursed for the G&A services they provide. A review
of the financial statements of management’s previous offerings
gives us a good idea on whether, and how, they have been able to
control G&A expenses.
Reference checks – Our final step is to conduct reference
checks. References are typically previous investors, and/or
business partners.
Ultimately, as the saying goes, “valuation is an art, not a
science”, and this is also applicable for management evaluation
and assessment based on both tangible and intangible
assessment information. We believe it is important for investors,
dealers and analysts to trust an issuer’s management team, and
therefore, management should take measures to ensure that they
earn and keep that trust. In order to raise capital, management
teams have to promote their offerings, however, it is our job as
investors, dealers and analysts, to weed out the promotional puff
and get investors the straight facts.
For more information contact:
Siddharth Rajeev
srajeev@researchfrc.com
