“All your money will be invested in real estate with a guarantee of 12% returns.” This is what you are told by someone asking you to invest with them. You think to yourself; “This sounds like a solid deal and this person was referred to me by a respected local company.” Two months later your entire investment is gone and you found out that none of the money was invested in real estate. Now let’s assume you are approaching 60 years of age and are now forced back into the workforce in an economy with unemployment remains high. Now you think to yourself; “How could I have been so dumb and how am I going to compete for a job with all these younger people?” “What do I do now?”
My eyes are starting to water as I write this article. This was the last story I heard about someone losing their money by a bogus investment. These are the stories I hear almost every week but this was especially sad because this lady could not afford to have her money stolen from her and now could lose everything.
How do you protect yourself from a person or an investment that is not legitimate when the person selling it to you sounds so smooth and educated? How do you know if your money is safe?
Before you make an investment like this it is important to understand what exactly you are getting for your money. Most of the time these investments are private equity. This simply means that the owners (the equity) are from private people and not an institution. The person putting the deal together is normally a private person too. Equity investments carry a certain degree of risk with them. With equity there is no guarantee of anything, in fact if things go bad you will be the last paid. For example if the project goes bad and ends up getting liquidated the order in which investors are paid back their investments is:
- Secured creditor (normally banks or investors making a loan secured by an asset)
- Unsecured creditor
- Preferred equity holder (this is not as common)
- Common equity
It is possible to lose all your money as an equity investor because there is nothing left when everyone else is paid off.
I don’t dislike equity investments at all. In fact that is exactly how I structured our mortgage fund but it is important to understand the good and the bad. The good part of an equity position is that you get a portion of all the profits the venture or company makes so your returns are generally much higher. You are subject to the risks of the company so if the company makes smart investments it is a smart investment for you.
If you are buying equity your will generally either get stock in the company or membership interest in a partnership or LLC. Your diligence should first understand what it is you are buying and then what the company, partnership or LLC does with your money. You will probably want to see a track record and maybe look at some past deals. In our example above the equity investor was told that she would be secured by real estate. In this case she should have look at other projects completed by this group and checked public records on the county websites to be sure she is being told the truth. She could have also asked to see recorded documents with the county’s recording information on it. She will also want to check into the person that is offering the investment. Background checks are a good idea and a track record for the individual is a good idea. If the person has a license through the state the background check and employment and residence history has already been looked into by the state. Not having a license does not mean that they are bad people or doing something illegal but it will require further investigation by you. Again in our example it was later discovered that the person with the opportunity had a criminal history that was not disclosed.
Here is a list of steps that I would take and questions I would ask when looking at a private equity investment:
- Do I understand what I am buying (units in an LLC, stock, etc.)
- How does the investment work? How does it generate income, how does it pay its investors, when does it pay, what are the risks and expected returns. This is all the basic stuff you should know and weigh the rewards to the risks. This should be easy because it should be disclosed to you.
- How do I know the person selling this to me and should I be able to trust them?
- How long has the person been in business or at least doing this type of investment?
- Do they carry any licensing to do this and can I verify that? If not you should check criminal record to be sure they have not stolen money in the past.
- What is the track record for the investment and the person selling it to me?
- Can I talk to some current investors?
- Do the principals and sales people have money invested in it?
I really believe that you should go through each question/step before you commit to doing any business with them. If it is an option you might also consider investing a smaller amount at first and add to it later. This however is not always possible.
Be careful out there but don’t be afraid to make investments and reach your goals.