Fake Skin in the Game Warning for Sponsors of Investment Deals | Summary and Q&A

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July 9, 2021
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Private Investor Club - 4,000 Investors
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Fake Skin in the Game Warning for Sponsors of Investment Deals

TL;DR

Managers claiming to have "skin in the game" by investing a small amount of equity in a private equity deal while charging high fees can lead to negative investor perception and potential deal failure.

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Key Insights

  • 👾 Managers who claim to have "skin in the game" with minimal equity while charging high fees can be seen as lacking alignment and transparency.
  • 🤲 Different investors may have different priorities, such as maximizing financial ROI or getting their cash back quickly.
  • 🤱 Catch-up fees can significantly impact returns for investors and are often not well understood.
  • 🤱 Providing clear communication and transparency around fee structures and alignment can attract sophisticated investors.
  • 🛝 Ground-up real estate development projects require solid financing and a structure that balances risk and return.
  • 🔬 Honesty and straightforwardness about a manager's capitalization and ability to invest can foster trust with investors.

Transcript

a lot of times there are managers who say oh we have skin in the game um and we're doing a private equity deal and make the numbers easy let's say it's 100 million dollar deal uh well we're going to put up 10 of the equity needed well if the deal is 70 debt and 30 equity that means they're using 70 million of debt 30 million of equity um 10 percent... Read More

Questions & Answers

Q: What is the most appropriate management fee for a fund sponsor?

The appropriate management fee depends on the manager's capitalization and needs. If well-capitalized, forgoing a management fee and only charging a profit share can express confidence and alignment. However, other managers may need to charge a smaller management fee to cover expenses while aiming for a higher profit share.

Q: What is the normal percentage for gross royalties in a royalty deal?

Normal gross royalty percentages in a royalty deal range from 1% to 5%. Franchise companies like Subway or Pizza Hut typically pay a 5% to 7.5% gross revenue royalty.

Q: What if a portion of the use of proceeds goes toward buying out the current owner, but the investor insists on using all the investments for business expansion?

In such cases, it may be necessary to talk to different investors or raise additional capital to accommodate both objectives. One investor can be engaged solely for the growth investment, while another investor can be brought in specifically to buy out the current owner.

Q: In built-to-core multi-family investments, what kind of deal structure do investors prefer?

Ground-up real estate development projects usually involve a construction management fee. Investors generally seek a 17% to 20% Internal Rate of Return (IRR) but may be willing to accept a slightly lower return in exchange for a conservative, less leveraged structure. Transparency and alignment between the developer and investor are crucial.

Summary & Key Takeaways

  • Managers claiming to have "skin in the game" by investing a small amount of equity while charging high fees can be perceived as fake alignment, leading to investor skepticism.

  • Investors appreciate honesty and transparency regarding a manager's capitalization and ability to invest in a deal.

  • Management fees and profit sharing structures can vary based on the manager's capitalization, previous deals, and specific expenses involved in the deal.

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