Investor Due Diligence on Passive Investing

When it comes to passive investing, the more information you gather about a company from the start, the better equipped you’ll be to make a sound investment decision. The good news is there are plenty of ways to learn about a company before taking the leap, and some of the best due diligence can be done by reading between the lines.

Look at an investment like a partnership between yourself and the company. You want to make sure you have all the information before signing on the dotted line. Follow these simple steps to help you identify whether a company is worthy of your partnership and ultimately worth investing in.

Review public information to verify offerings

You can review private offering filings with the Securities and Exchange Commission (SEC) in the public EDGAR database. Most private offerings require the promoter to file with the SEC, and the process for reviewing the information in quite simple.

Legal documentation review

Legal documents should include a Private Placement Memorandum (PPM), operating and subscription agreements, a business plan and investor questionnaire. You’d be surprised at what you can tell about a company, even with just a brief review of their legal documents. For example, if an offering does not have a PPM, not only is it likely a violation of securities law, but it means they are okay with cutting corners. That should be a pretty big red flag to potential investors.

The purpose of providing legal documentation is to give investors the information they need to make sound investment decisions. Without the proper legal documentation, you will not have all the information to be able to make the best investment choice. Looking at who prepared the legal documents is another way to gain some insight into the offering. Some companies will try to save money by hiring services to prepare cookie-cutter documents that no where near the caliber of a reputable securities law firm. Again, if they are willing to cut corners here, how do you know they aren’t cutting corners elsewhere in their company.

Verify company track record

Investing in a single-owned start up or ‘Mom-and-Pop’ shop is a riskier investment than say an established company with a solid track record. You don’t want to invest with a brand new company who would be ‘testing the waters’ with your hard-earned money. Find out if the company has a track record of partnering with investors and how that’s worked out for them in the past. You may want to ask if they have a proven team with proper systems in place, if they have experience in the sector and what happens if the principal dies.

Do they offer accountability in reporting?

Look to see if the company prepares quarterly reports or holds quarterly calls with investors. These reports should update investors about whether or not the investment is on track based on the goals and expectations set at the beginning of the investment. A good indicator is not when things are running smoothly, but when things go wrong, as they tend to do at one point or another with all investments. You should expect even more communication and accountability when something is off track. That is a good measure of the integrity of a company.

Ask the right questions

Asking the right questions of a company you are considering an investment with could mean the difference between a confident decision to invest or encouraging you to walk away. There are many benefits to having a one-on-one conversation with those at the head of the companies you invest in. Participating in an investor call gives you the perfect opportunity to ask the hard hitting questions and get your information direct from the source, without the middle-man.

Ask questions like “Who are the emerging competitors in the industry?” and “What aspect of the business is giving you the most trouble now?” Be sure to cater your questions directly to the type of investment. So if it’s a real-estate investment, you might ask about proximity to the investment, third party influence in management, etc. If your investment is in the retail sector, ask about where the sales are trending and how will they account for variable costs, etc.

Steer clear of “Guaranteed Returns”

If an investment is promising guaranteed returns, that is as good a sign as any to head for the door and not look back. While it is okay to promise preferred or fixed returns, there are simply no guarantees in investing. A promise like that is a sure-fire way to know there is something fishy going on and you don’t want anything to do with fishy when it comes to your investments.