Sponsor skin in the game or experience

[Kent Ritter]

For those passive investors out there, which matters more to you - That your sponsor has money in the deal or that he/she has a successful track record?

[Brian Burke]

I would vote "experience." 

One challenge with this question is that "skin in the game" and "money in the deal" are two completely different things.  Money in a deal does not represent skin in the game.  Nor does it automatically align interests.  In fact, it is possible for money in the deal to cause a misalignment of interest.  Don't get me wrong, I have no problem with asking if a sponsor is investing in the deal, what I have a problem with is believing that it matters.

I think that the best combination is experience and actual skin in the game.  Actual skin could be the sponsor signing on the loan covenants, rather than hiring that out to someone else, thus making them personally liable if they commit fraud, bankrupt the entity, or abscond with the money that was supposed to be allocated to other things such as property tax payments.  Plus if the sponsor is the one signing on the carve-out guarantees and is the primary loan guarantor, it means that the sponsor has the financial capacity to qualify, i.e. has met the net worth and liquidity requirements of the lender.  Sponsors who qualify and sign on their own are strongly disincentivized by the heavy hand of the lender to abandon the project or misappropriate funds.  

Actual skin is also a sponsor's track record, which is likely far more valuable to them than, say, a $100K co-investment.  Reputation risk is real for any sponsor that has been around long enough to have earned one.  It takes a lifetime to build trust, and a second to destroy it.  Inexperienced sponsors cannot bring such a track record to the table so by default they have a lot less to lose.

Investors don't measure a sponsor's cash investment in a deal because it's important, it has become important only because it can be measured.  What is really important is the moral character of the sponsor.  If they have a character flaw, the investment in inherently flawed.  But character is hard to measure, so the natural path of least resistance is to use "money in the deal" to "check the box."  Ultimately, this doesn't work.