How fast can a private market investment opportunity go south on you after you invest?
Six months. That’s the fastest I’ve heard from my conversations with colleagues, but your mileage may vary as a loss can happen in any time frame. From funding to bankruptcy in roughly six months, he watched a $50,000 investment turn into a $50,000 potential tax deduction.
Let’s back up for a moment. I’ll recount his story as he told it to me, so think of me as your narrator in this tale.
Here’s how he told it to me:
A little more than five years ago, a former colleague of mine approached me about a private opportunity. His family office already invested in the deal and he liked what he saw, so he offered to arrange a meeting with the executives from the private company.
I trusted my former colleague, and still do to this day, so I will always listen to what he has to say. Additionally, I knew the investors in his family office. While I know them to take some risks, I also knew they were shrewd and savvy. In my experience, I had never seen them randomly throw money at an opportunity without examining it carefully.
Fact is few folks accumulate a net worth in the mid-seven or low eight figures acting like fools.
I personally knew and had done business with one of the private company executives at the company offering shares.
In hindsight, all of these items combined should have been the primary reason for me to not even entertain the offering at all.
It was too personal.
Rather than entering due diligence with an eye of doubt, I entered with a light of optimism.
The Positives of the Pitch
As I listened to the executives pitch their strategy everything sounded great. It was a retail operation focused mainly on summertime outdoor furniture. Although the business was established for years, it recently ran into problems as the founder opted to drain the company of cash rather than expand operations or marketing. That pushed this into the “turnaround” category in my view as well, as the company was underperforming compared to peers and facing financial obstacles.
While I’m not usually a fan of dumpster diving, pulling a floundering or failing company out of the trash heap, the CEO had successfully done it before in retail. And he did it with a retail apparel company focused on sun and swim.
That turned this from a negative to a positive.
The business plan approach was simple enough. Close underperforming locations, update inventory, and change the locations of some of the remaining stores. In some cases, the relocations meant simply moving from one side of a busy street to another so customers could more easily access the location.
Simple, relatable, and understandable is a plus for me when it comes to business plans.
The executives all participated financially in the offering as well. I love when insiders and management buy shares in an opportunity alongside me. Same price. Same terms.
Lastly, the former owner of the business was taking an earn out and a note payable rather than receiving a lump sum cash payout. Again, another favorable move as it means more cash stays in the business and the former owner has incentive to help the new ownership.
Everything sounded solid, so I pulled the trigger.
If only my gun fired blanks instead of cash. As you realize by now, six months of malaise updates was the only thing I got back besides a tax deduction in the form of a 100% loss of the investment.
So, what went wrong?
- I let personal relationships create a situation where I viewed the offering through rose-colored glasses. I came into the opportunity searching for reasons to invest rather than walk away.
- I needed a bigger shovel and more patience. Management offered cost estimates to change showroom locations but when push came to shove, the price to break their leases far exceeded estimates. I should have asked for a copy of the leases.
- Updating inventory means write-downs. Unfortunately for me, I wasn’t too familiar with this market, so while I’m thinking 20% to 30% discounts to get rid of older inventory, the final slash landed closer to 70%. The result was the company generating significantly less cash from the sale of old inventory than expected.
- While management participated in the offering, they also paid themselves handsome salaries. They were able to de-risk some of their risk, and while I understand folks need to earn a living, when your business is facing a potential cash crunch that is not the time to be drawing big salaries.
- In-fighting caused strife within the company and impacted decision-making. In my defense, this one is incredibly difficult to see from the outside. I won’t go into details, but it spiraled quickly out of control with results being one exec resigning, lawsuits from private investors, and one executive simply disappeared for a month.
That’s pretty interesting stuff and an eye-opening account about how even experienced players in the private opportunities space can make errors and judgments or miss important details. It’s a reminder to diversify, to study, and never simply take someone’s word. Do your research, understand what opportunities you’re considering, and keep your eyes wide open.