Sponsor skin in the game or experience
Investor · Indianapolis, IN · Member since 2019 · 62 posts · 64 votes
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?
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.
So true, Paul. Anyone that says they have never had a bad real estate deal has either not been doing this long enough, or hasn’t done enough deals. Never having had a bad deal is like the opposite of a track record.
So true, Paul. Anyone that says they have never had a bad real estate deal has either not been doing this long enough, or hasn’t done enough deals. Never having had a bad deal is like the opposite of a track record.
I agree 100%.
I had my share of bad deals - no one's perfect...and even with the most thorough underwriting and due diligence, there are always things outside of the sponsor's control. However, like Brian, I would rather take a bullet for my investors vs. having my investors lose money.
That's how we never lost money for our investors ever....even during tough economic times like 2008-2009 (in fact, we made so much money during that time).
@Ben Leybovich Thanks for asking!
First - I want to thank everyone for their thoughtful responses. I've received a ton of value from you all. @Brian Burke, @Brian Briscoe, @Alina Trigub, @Danny Randazzo, @Taylor L., @Ola Dantis, @Roni E., @Michael Ealy, @Michael Le, @John Fortes,
To sum it up, you want a sponsor who:
Track record is critical – But # of deals is only one metric, and if all of those deals have been done in the past 2 years with no exit, then that might only tell you that the sponsor can offer the highest price.
I think investors need to look at other sources of track record, such as other relevant business experience. We are, at the end of the day, buying cash-flowing businesses.
Has the sponsor successfully run another business, managed people, managed a budget, managed change, and provided positive returns?
Character – I didn’t originally include, but as @Tj Hines brought up - This is the MOST important! This is where the investor should spend time getting to know the sponsor. Do you believe the sponsor feels a moral obligation to do what is right?
What is their WHY? Does he/she have a calling beyond making the most money? Maybe ask for references.
Skin in the game – Alignment of interests is critical. People only do what they are incentivized to do. The best way to make sure the sponsor will act in your best interest is to make sure they are incentivized to do so.
Thanks All!
Kent
@Ben Leybovich Thanks for asking!
First - I want to thank everyone for their thoughtful responses. I've received a ton of value from you all. @Brian Burke, @Brian Briscoe, @Alina Trigub, @Danny Randazzo, @Taylor L., @Ola Dantis, @Roni E., @Michael Ealy, @Michael Le, @John Fortes,
To sum it up, you want a sponsor who:
Track record is critical – But # of deals is only one metric, and if all of those deals have been done in the past 2 years with no exit, then that might only tell you that the sponsor can offer the highest price.
I think investors need to look at other sources of track record, such as other relevant business experience. We are, at the end of the day, buying cash-flowing businesses.
Has the sponsor successfully run another business, managed people, managed a budget, managed change, and provided positive returns?
Character – I didn’t originally include, but as @Tj Hines brought up - This is the MOST important! This is where the investor should spend time getting to know the sponsor. Do you believe the sponsor feels a moral obligation to do what is right?
What is their WHY? Does he/she have a calling beyond making the most money? Maybe ask for references.
Skin in the game – Alignment of interests is critical. People only do what they are incentivized to do. The best way to make sure the sponsor will act in your best interest is to make sure they are incentivized to do so.
Thanks All!
Kent
I loved how you summarised the thread. Well done and good luck.