Summary
Sooner or later, someone at the country club will pitch you an investment. Constantine S. Hatzivassiliou, CEPA®, a partner at Certuity and a former professional golfer, lays out a process for keeping your liquidity private, setting your rules in advance, doing real due diligence and declining without straining the relationship. His bottom line: friendship should earn someone a meeting, not a check.
Spend enough time around successful people at the country club and eventually it happens.
You finish a round, sit down for a drink, and someone you have known for years mentions an investment opportunity.
Maybe a friend is raising capital for a real estate project. A fellow member is backing a growing business. Someone has access to a private company that is supposedly preparing to go public. The pitch usually carries the same unspoken message: You know me. You trust me. You should take a look at this.
As a former professional golfer, a longtime club member and a wealth advisor for more than 20 years, I have watched this scene play out many times at the country club.
The hard part is rarely getting access to these opportunities. Successful people tend to have plenty of access. The hard part is deciding which opportunities deserve your capital — without letting an investment decision damage a relationship that may have taken decades to build.
That requires a process.
It often starts with “Let me show you something.” Photo: Unsplash
It often starts with “Let me show you something.” Photo: Unsplash
Discretion is your first line of defense
When someone has a meaningful liquidity event — the sale of a business, an IPO, an inheritance or another significant jump in wealth — my first advice is usually simple: Keep the details private.
You don’t need to announce how much you made, how much liquidity you have or how much capital you plan to invest.
People eventually hear things anyway. And once they do, the opportunities start arriving.
Johnny’s restaurant group is raising capital for its next location. Victoria has a real estate syndication. Derek has access to a private placement in a company that is “about to go public.”
Some of these may be excellent investments. Others may be highly speculative, poorly structured, wrong for your financial situation or simply someone else’s problem in search of your balance sheet.
The less people know about the size and timing of your liquidity, the easier it is to tune out the noise and judge each opportunity on its merits.
Decide in advance whether you’ll mix friendship and capital
The qualities that make the country club valuable also make investing within it complicated.
These relationships often span decades. You play golf together. Your spouses are friends. Your children grew up together. You vacation together. That shared history can make saying no surprisingly difficult.
I have watched people invest not because they had real conviction in the opportunity, but because they didn’t want the next round of golf to be uncomfortable. Others worry that declining will be taken as a judgment of the person who brought them the deal.
That is a dangerous reason to deploy capital.
Some families solve the problem with a simple rule: We don’t invest in deals brought to us socially. There is nothing wrong with that approach.
Other investors take the opposite view. They believe longstanding relationships give them insight into a person’s character, work ethic and integrity that would be hard to get from a traditional investment presentation.
There is value in that, too. But knowing someone’s character is not the same as understanding the investment.
Whichever camp you’re in, decide before a particular opportunity is sitting in front of you. A policy set in advance is much easier to follow than one invented while your friend waits for an answer.
Friendship is not due diligence
If you are open to private investments that come through personal relationships, your diligence should become more rigorous, not less.
Private investments can involve limited liquidity, concentrated risk, complicated ownership structures, capital calls and far less transparency than investors get in public markets. A relationship should never substitute for understanding the economics of the deal.
Here are the questions I want answered:
The economics
- How does the investment actually make money?
- What assumptions have to be correct for the projected return to materialize?
- What are the management fees, performance fees, transaction fees and other expenses?
- How much leverage is being used?
The risks
- What could cause the investment to permanently lose capital?
- How long is the money locked up?
- What happens if you need liquidity sooner than expected?
- Could there be future capital calls — and what happens if you choose not to participate in one?
- What is the realistic exit strategy?
The terms
- How much is the sponsor — the person or firm running the deal — personally investing?
- Are you investing on the same economic terms as the sponsor, founders and earlier investors?
- Are there different share classes or preferential rights?
- Who controls the company or investment vehicle?
- What reporting will investors receive, and how often?
The track record
- What has the sponsor done before, including investments that did not work?
That last question matters a great deal.
Almost anyone can explain their winners. I want to understand what happened when an investment went against them. How did they communicate with investors? Did they acknowledge problems quickly? Did they protect their own economics at the expense of outside investors? Did the story change when the numbers deteriorated?
Those answers often tell you more than the original pitch deck.
Check references outside the club
References are valuable, but I prefer that at least some come from outside your immediate social circle.
Country clubs are communities. Members naturally want to preserve relationships and the social fabric of the club, which can make them reluctant to criticize a fellow member — even when their own investment experience was disappointing.
So talk with people outside the club who have invested alongside the sponsor before. Did results match expectations? Was communication consistent? Were distributions made when expected? Were there unexpected fees or capital calls? Most important, how did the sponsor behave when circumstances became difficult?
The goal is to change your decision-making framework from:
“I know this person, therefore I trust the investment.”
to:
“I know this person. Now I am going to independently determine whether the investment deserves my capital.”
Those are very different statements.
Weigh the deal against your entire financial life
A private investment does not exist in isolation. An opportunity can be perfectly legitimate and still be wrong for you. Before investing, consider how it fits alongside everything else you own.
If much of your wealth is already tied up in a privately held business, for example, adding another illiquid private investment may increase a risk you already have too much of. The same is true for real estate concentration, leverage, geographic exposure or investments that depend on similar economic conditions.
This is where an experienced advisor can be particularly valuable. An advisor’s job should not simply be to decide whether a deal is “good” or “bad.” It should be to determine what could go wrong, how much capital is appropriate to expose to the opportunity and whether that risk makes sense in the context of your broader balance sheet, liquidity needs and objectives.
Give yourself a graceful way to say no
Eventually you will review a friend’s opportunity and decide not to invest. That doesn’t have to damage the relationship.
I encourage clients to establish a formal investment review process and let people know about it. Then the conversation becomes straightforward:
“Thank you for showing this to me. We run every private investment through the same diligence process with our advisory team. We reviewed it, and it isn’t the right fit for our portfolio.”
That is very different from saying, “I don’t believe in your deal.”
An objective process puts distance between the personal relationship and the investment decision. In many cases, your advisor can take the tougher questions directly to the sponsor, so you remain a friend rather than the person grilling someone about leverage, valuation and downside scenarios over dinner.
There will always be another investment opportunity. There may not always be another 20-year friendship.
The goal isn’t to avoid doing business with friends. Some extraordinary investments are created by people we know and trust. The goal is to make sure friendship earns someone a meeting — not a check.
Good investments are worth pursuing. Good friendships are worth protecting. With the right process, you usually don’t have to sacrifice one for the other.
Constantine S. Hatzivassiliou, CEPA®, partner at Certuity. Photo courtesy of Certuity
About the author
Constantine S. Hatzivassiliou, CEPA®, is a Partner at Certuity, a nationally recognized multi-family office serving affluent families, entrepreneurs, executives, foundations and endowments. A former professional golfer, he advises clients on the complex financial, tax, estate and business planning decisions that accompany significant wealth, helping families coordinate every aspect of their financial lives through a comprehensive family office approach.
The views expressed are those of the author, are for informational purposes only, and should not be construed as investment, tax or legal advice or as a recommendation to buy or sell any security. Investing involves risk, including the possible loss of principal, and private investments in particular can be illiquid and speculative. Consult your own advisors before making any investment decision. Certuity, LLC is an investment adviser registered with the SEC; registration does not imply any specific level of skill or training.
