Syndicate investing simply describes a situation in which there are multiple parties to the deal.  In many cases, the syndication is done in order to ensure that the minimum required capital that the company is trying to raise is met.  In this particularly tough market environment, you will find that far fewer deals get done where there is only one bank or one investor. As a company looking for funding, syndications allow access to a bigger pool of opportunities. As an investor looking to be a part of a syndicated deal, there are various factors that may make such an investment a better alternative to being a sole investor in a deal.

As the timeless proverb goes it’s usually not a good idea to put all your eggs in one basket.  The case certainly applies to investments in particular.  Syndicated deals offer investors an opportunity to invest without having to risk all of their capital.  While the total capital needed by the company may total $10 million dollars, PIPE investors with smaller amounts of capital may still be able to get in on the deal at much smaller amounts.  The trade off under this situation is the fact that the smaller investors generally are not able to drive the deal terms.  While it is the responsibility of all investors to conduct their own due diligence, it is not uncommon for many of the smaller investors, particularly individuals, to rely solely on the work that’s done by the lead investor.

While syndications offer safety in numbers, it also creates other potential risks.  One critical issue in particular is the concept of overhang.  In most PIPE deals, there is a projected timeline in which investors have the ability to exit out of their position.  Since these PIPE deals involve publicly traded companies, there is a real concern that if all investors try to exit at the same time, the company’s stock price will be negatively driven down.  This potential adverse effect is what we deem as overhang risk.  Such risk is can only be minimized by investing with only groups that you are familiar with.  Unless you are the sole investor, there are many variables that are outside your control. Investors should invest only within the comfort of their risk reward box.

In working with investors we are regularly asked to review portfolios. Buying life settlements requires extensive due diligence but often when you are first presented with a portfolio you can spot some red flags. Now these red flags don’t mean that you have a bad portfolio or that you should go running for the hills. Quite the contrary in my opinion if you are expert enough in your ability to do the due diligence required this might be exactly where you will find the best deals. But this is definitely an area of life settlement investing to keep your wits about you.

We were asked to help a client recently and as normal the first look at this $500M portfolio was a spreadsheet.

Red Flag 1: Who owns the portfolio? And more importantly are you talking to them directly? The fact is that spreadsheets are passed around this industry like dinner rolls. Long broker chains will kill any chance of a deal.

Red Flag 2: All policies are 2-3 years old. That means this is likely a BI portfolio or financed, so buyer beware of STOLI.

Red Flag 3: These recently issued at Preferred rates and new LE’s are now all short. Sure declines in health happen but if you are looking at a few dozen policies with that fact pattern in the same portfolio statistics would say something is awry.

Red Flag 4: Lots of insurance on single lives. It goes without saying that concentrating in relatively few lives is a risky proposition. But also when one portfolio has been assembled this way it should call into question the sellers motives and caliber of origination.

Red Flag 5: The Brooklyn specials. The simple fact is that there has been a good deal of questionable inventory originated in the NE area and a concentration from there is cause to increase scrutiny.

There are plenty of life settlement portfolios that have one or all of these flags. If you have the ability to do the due diligence necessary it could be a great opportunity to pick up some very discounted life settlement inventory.

Red Flag 4:

PIPE (Private Investment In Public Equity) deals remind me of the NBA draft. Of course there is no David Stern, but there are plenty of tacky suits and talks of upside.

Optimism reigns and potential dominates substance. This isn’t necessarily bad. Take John Wall for example. He showed enough promise in one year at Kentucky to become the #1 pick of the 2010 NBA draft. Wall’s collegiate numbers were compelling but not off the charts. It’s what Wall will do in three years that causes scouts to drool. Similar to John Wall, many young companies want to cash in when expectations exceed past performance. Why not? Expectations play a huge role in determining the present value of companies.

From an investor standpoint, the big rewards don’t come from drafting the All-American in the lottery; the true spoils come from finding the player overlooked by all the experts who becomes an All-Star. Investment bankers and companies know this. They position companies as “diamonds in the rough.” Proud CEOs tout tantalizing projections and heroic expectations of market share. We investors get caught up too, but we have the balance the hopes of a 500X ROI against the possibility of losing our shirt. Similar to the NBA draft, there are some Hall of Famers who get picked in the second round but the majority don’t last more than a year in the league.

We investors should keep our eyes out for the 6’10” freshman with crazy hops who has yet to average more than 15 points a game, but we can’t lose sight of the role players, those yeomen who do the little things to bring a team over a top. Therefore, PIPE investors should allocate funds to a spectrum of companies with a wide range of return opportunities. Maybe that stable consumer products deal may not get you staggering returns, but it helps form the core of the portfolio that allows the more high flying investments to shine. The Lakers drafted Derrick Fisher the same year they signed Kobe Bryant.

Whether we’re drafting players or companies, we’re all geniuses in hindsight.