How to Choose an Investment Partner: 5 Essential Criteria

November 7, 2019

How to Choose an Investment Partner: 5 Essential Criteria

Private equity investing is not for everyone. It is time intensive and often requires active engagement with your investment partners and business operators. When getting started, how can you determine the right developer to partner with?

There is, of course, no way of knowing in advance if a partnership is going to flourish or not. For a number of reasons, many of which may be completely unpredictable, even good partnerships can unravel. But by applying a disciplined due diligence process to your search for the right developer partner, you can improve the odds of your success as much as it is within your control.

How to Find Quality Investment Partners

I use a list of five key criteria to confidently identify potential investment partners:

  1. Track record.
  2. Deal alignment.
  3. Industry knowledge.
  4. Personality fit.
  5. No red flags.

Track Record

A strong track record is one of the best indicators you can find for someone’s investment chops, and it’s where I usually like to start.

How have the existing funds or stand-alone investments performed that this developer has sponsored? Is their performance independently audited? Also keep in mind that a track record can show more than just the performance of past investments. By evaluating deals a prospective partner has done, you can discover whether or not they run a tight ship.

Deal Alignment

When you’re investing your capital alongside a developer partner, ensure that the structure of the deal aligns the interest with the general partner (GP) and the limited partners (LP). By that, I mean you want to know that the general partner has skin in the game.

It’s okay that the GP gets a promote or some additional upside once the LP investors are successful. In fact, you want that — but you want that to be aligned where the GP is risking not just time but also a meaningful amount of their own capital. Otherwise, there’s no assurance that they won’t flake on you for the next opportunity if the fund isn’t working.

Industry Knowledge

Industry-specific knowledge of a targeted investment is a big plus. Specifically, it allows a partner to understand the nuances of a market, its ins and outs and what might be successful targets. But more generally, deep familiarity with the industry of focus can deliver insight into business cycles and the complexion of the market.

It’s one thing to know general investing principles and how to apply them broadly. But the right partner can bring to the table an intrinsic knowledge of how a particular market operates. In that situation, you can most effectively apply your equity in optimal market conditions, rather than work through a learning curve and miss the opportunities with the highest return.

Personality Fit

It’s hard to do business with someone you don’t like. If you don’t mesh with each other, a partnership will be strained, at best.

When you’re managing large amounts of capital with partners, you want to be sure you are intrinsically comfortable taking the same approach in your decision-making process. Do you trust them? Are they stable? Do you have a shared appetite for risk?

There are a lot of ways you can try to peel back the layers on a person and find out if the persona they project matches who they truly are at heart. I like to use a combination of background checks (social media audit, LexisNexis searches) and personality profiles (such as the Myers-Briggs or CliftonStrengths assessments).

No Red Flags

This one is really important, and I always say that if there are any red flags that come up in your due diligence process on potential partners that you need to be willing to drop the opportunity and walk away. Promising investment opportunities are a dime a dozen, so develop a willingness to move on from a potential partnership if it’s a wrong fit. It’s not worth the headache otherwise.

If you feel uneasy about someone, go with your gut. You don’t want to be in association with anyone who makes you uncomfortable. Even from a personal standpoint, dig in and learn whom you’re potentially going to be in business with. And if someone overexplains, giving you more detail than you asked for, I often find that to be a sign that they are trying to cover something up.

The Price of Experience

In the early days of Percipio Partners, when we didn’t yet have an established track record, we looked for investments where we could find them and didn’t have as thorough a vetting process as we do now. And importantly, we didn’t have the experience we do today in knowing how to critically evaluate and select investments. With our real estate investments we learned from our mistakes quickly and were able to keep our losses to a minimum. As we moved into investing in operating companies, we learned to appreciate an added layer of complexity and risk brought on by a necessarily heavy reliance on our operator partners.

One such example is an investment we made in an electrical contractor. We thought our capital and the application of our business processes on top of our operator partner’s existing business would be the catalyst for his growth. The Excel spreadsheet looked great with high margins and the expectation of rising revenues. But I learned with these types of businesses (I call them “guy in a truck”) that an individual can run the business, if it’s small — and maybe there’s a helper or something like that. The owner of one of these businesses can make a decent living off the sweat of his own brow, but scaling can be treacherous once the workload outstrips the owner’s ability to move the needle with his own labor.

As the scale of the business ramped up our disciplined processes fell by the wayside. Muddy pieces of paper piled up on the floorboard of his truck. Predictably, those notes on the floorboard were slow to be turned into invoices — if they got turned into invoices at all. All the while, the bills piled up.

Needless to say, this early foray into private equity ended badly. Fortunately, none of our investor partners were exposed to the loss. Although those kinds of experiences can be painful, I look at the money spent on them as tuition payments. You hope they’re not too big, but like putting your hand on the stove burner, you’ll learn to never make that mistake twice. There’s plenty of opportunity to make a new mistake on your next project or investment, but you’re sunk if you keep making the same one.

The Right Approach

At Percipio, we firmly believe that having a failed deal on your record shouldn’t be an automatic deal breaker. Some people do make that a rule when searching for the right investment partner, but as in all things, there’s a need for a nuanced understanding of every situation.

We’ve experienced our share of failure in the past. That example of our investment in the electrical contractor is a significant one. But from that experience, we see there are two critical aspects of how a firm handles a failure like that.

The first is the one I’ve already mentioned. At some point, everybody will experience a failure. The important thing is that each failure is viewed as a learning opportunity and a concerted effort is made to grow from it. Making a mistake once is understandable. Making it again, less so. And if the same issue continues to trip someone up, that’s a clear red flag to stay away from that particular partnership.

The second aspect of how a firm handles a failure can even be a positive indicator that you would want to engage in a partnership. With our electrical contractor, we had to eat our investment. But we shouldered that burden ourselves to ensure all the bills were paid and no investor partners lost money.

Honesty, transparency and responsibility are easier to talk about than demonstrate, but they are vital in any successful business endeavor. If you can see from a past failure that an entity has a history of attempting to absolve itself of responsibility when things go south, you can expect that tiger to keep its stripes. But if you can see a record of accountability you can enter into a partnership comfortably, knowing that you won’t be left holding the bag alone if things go sideways.

The principals of Percipio Partners understand the value of solid, reliable investment partnerships. If you are looking for an investment manager or partner, we’d love to talk with you and see if there’s a right fit. Reach out today and let’s discover how well we align.

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