once in a while, there’s a new product or strategy launched that
looks different, but it’s always the same. It’s still broken. The
reason these deals do not work for the investor is simple: they
Typically, when you make an investment, you are paid after
management fees, executive salaries and the costs of doing
business. In other words, the investors are paid last. In many
cases, the people pulling the strings in that company are actually
compensated for things that have no benefit to the investor. If
their management fees are fixed (as a percentage of assets
under management) and paid first, then their primary concern
will be assets under management rather than investor returns.
If the people in charge of your money are not compensated
based on the returns that you receive, then investor returns will
NOT be their priority.
Is the Exempt Market Different?
This is the million-dollar question! If you want to find out if a
deal is offering something truly different, you need to examine how
the issuer makes money and whether your interests are aligned.
In order to determine if there is true alignment in an offering, you
need to determine how the issuer makes money, how the investor
makes money, and then compare the two.
One of the biggest risks in the exempt market world is
called ‘Key Person Risk’. Most exempt market dealers and
exempt market products are run by a small group of people
which presents risk to an investor if something happens to these
people. However, because there are fewer people in control of
these investments, it allows us to learn how these individuals
are motivated. If you understand a person’s motivation and
perspective, their behavior becomes very predictable. It doesn’t
guarantee results, but it does help predict what these individuals
will try to do. The question then is how do you use that knowledge
to your advantage?
Assuming the business model makes sense and you believe
the issuers are capable of making a profit, the next step is to
examine how profits from the business or investment venture will
be split. Ask the following questions:
1. Who is paid first? The issuer or the investor?
2. Who is hurt first if times get tough? The issuer or the investor?
3. Is the issuer motivated by performance? Or are they
compensated equally whether they perform well or poorly?
4. Does the issuer have any money at stake in the deal – do the
have ‘skin in the game’?
In most traditional investments, investors are paid last and
hurt first. The signs of this are significant fixed management fees,
high salaries for executives and corporate bonuses paid prior to
investor dividends. This represents a significant misalignment.
So what is a better deal for investors? The ideal aligned
structure would see the issuer with ‘first loss’ capital in the deal,
the investor would get paid first, the issuer is paid after the
investor gets a set yield, and the issuer is heavily motivated to
get the investor out of the deal with a complete and profitable
exit. These structures are not easy to find, but they do exist and
are becoming more common all the time as investors recognize
But lets be clear, the purpose of alignment is not to guarantee
results, nothing can do that. But if you seek out alignment in your
investments you will have confidence that the people controlling
your investments have the interests of you and their other
investors at heart.
For more information contact:
“If we don’t change directions, we’ll end up where we’re going.”