Marc Halpern on Due Diligence for Private Investments

0:01 >> Thank you, Mark, for being here. Mark is a co-founder of the Deep Due Diligence Investors Club. We have over 58 members. Mark actually had a high net worth investor club of his own called Part-Time Investors. And then he brought it over to Family Office Club and we formalized Deep Due Diligence Investors. And essentially, what really sets them apart is that they're investors who actually read every word of a PPM, that actually ask tough questions, do the real due diligence. And we'll get into what that means here. But they've put about $10 million of equity checks to work into deals. And you can submit deals to the investor club on duediligenceclub.com. So we get a lot of the deal flow. But we also set up meetings at events like this, etc. So Mark has the right background to do this because he's he's really the leader for the group in terms of being the face of the group. And his background is in a technical area of chemistry. And what we found is a lot of the people that do deep due diligence have technical engineering backgrounds. They care about the details. Some of them are doctors.

1:04 Some of them are here at the event today. And so Mark's been a great leader of the group and really help grown it over the last 2 years. And we're excited to have him here for the fireside chat. What else would you share with the room about your background, Mark? Well, yeah, the fact that I've been in I do breakthrough R&D. That's that's what I've been doing for five decades. And there's just a lot of similarities between uh identifying opportunities and managing risk and between breakthrough R&D and performing deep due diligence for investing. Awesome. So a lot of investors say that investing is about backing the right operator. Do you agree with that? Yes. Uh Yes and no. So the When we when we look at deals, we're looking actually at three different things. We're looking at the at the jockey, the horse, and the track. The jockey is the sponsor, you know, the right operator.

1:55 The the horse, of course, is the opportunity itself. And then the track is the macroeconomics. Sometimes it can be a local market. It might be might be national or global even macroeconomics, but it might might be the market. Um But when it comes to the sponsors, it really isn't just about them. So a lot of people say, "Oh, yeah, we we just invest in the sponsors." That's not enough. You we have to perform deep due diligence on the sponsor and the opportunity and the and the macroeconomics. And and two out of three is just not good enough. Got it. And out of those three areas, what do you think is normally what makes a deal fail most often? That's an interesting question cuz I get asked that a lot. And I remember I was once asked at a at a conference and we were a panel of like seven people. And they said each one, "What are the What's the number one thing that that is really important like for a sponsor in vetting a sponsor?" And I said, "Well, there's seven of them and anyone that fails, we're done. And one reason is because our deal flow is is massive. It's more than I can certainly handle." So So for example, if I'm seeing about 400 deals a year and I invest in four personally, I can I reject 99% So therefore, if you're missing one of

3:12 those, it's it's just not good enough. Got it. What do you look at first though when you look at a deal? The sponsor or the deal? Before you before I came to Family Office Club, this is pre-2020, I always looked at the sponsor first. Since I'm coming to Family Office Club, my deal flow has increased so massively that there's just no way that I can screen 400 sponsors a year. So what we're what we're doing right now is it's a little bit backwards, but we're actually looking at the deal first. But we're screening So what we have to come up with an extremely efficient screening process. And what We didn't plan any of this beforehand. I want to thank you, Richard, because you developed the We have a special AI tool that called the deal screener tool. I think I contributed like 28 parameters, but you did the bulk of the work. And what we do now is that actually anybody here that that's raising capital, you can go to the to the website uh and you can submit your private placement offering for free. Free is a reasonably good price, turns out. And then we then put it through our deal screener AI tool. And then we can usually tell within, 30 seconds or so,

4:29 if it comes anywhere near meeting our criteria. Once it's and then I don't use my own judgment on this. We have In order to be disciplined and to remove all bias, once it it meets a certain criteria, it's a score of 70, whatever that comes out to be, then I'm required to post it. Only then do we look at the sponsors because the amount of time it takes to screen a sponsor is is huge. And to screen a deal, it can be done in seconds. So it just it it just isn't practical for me to screen hundreds of sponsors every year. Now, there are new um There are sponsors, of course, that we know and that we we respect, we've invested, had a great track record with. Then there are other sponsors that we will not work with for any variety of reasons. But um But we do things a little bit surprisingly, we we actually look at the deal first really quickly so we can screen through hundreds of deals in like 30 seconds.

5:32 And then then we'll then we'll we'll we'll do deep due diligence on the sponsor. And part of that deep due diligence is you got to come to these meetings. Right, got it. Yeah, I interviewed Metta World Peace as a LA Lakers world champion. And he said he just doesn't reply to any cold emails cuz he's afraid it's like a phishing attempt or fake even if it looks legitimate. Maybe it's just a good fake email. And Tim Cohen earlier today said, "Yeah, cold emails, I never reply to those." And he's like, "Well, sometimes I do if it's like super credible, dialed in." So I think it's like one of the best use cases of AI is like if you ignore all cold emails coming to you, you might miss the best opportunity of your life. But we're all inundated with all of these things coming at us. So it's using AI to kind of save time, right? >> And we look at all of them. So I don't care I might get something that might look, well, this really looks crazy. No, we're disciplined. And I have to look If you submit it, we're going to look at it.

6:23 Got it. And uh you talk a lot about risk. So how do you actually think about minimizing risk in deals? Ah, so let's Yeah, let's talk about risk. So I I see risk in two different ways. You can minimize risk. You can You cannot eliminate risk. You can minimize risk. And then you can manage risk. The way we minimize risk is by performing deep due diligence on every opportunity before we invest. The way we uh the way we manage risk is through diversification. When there's no amount of deep due diligence you can do to eliminate the risk. I'll I'll just give you me two two examples. One of them was the first private placement I invested in was in 1987. I know that's before a lot of you were born, I'm just looking around here. And it was the best thing in the world.

7:11 Of course, we didn't have AI. We didn't have the internet. Actually, I have I think I brought to one of my one of the last presentations I made, the actual PPM was this thick. It was an inch And it was in it was opposite Fort Dix. Everything about it was really really great. The occupancy it was a multi-family. It was just You couldn't lose. Two years later, Reagan told Gorbachev tear down that wall. He did. And the next thing you know, the whole that particular project went bankrupt. How many people would have asked, and again, I'm 72, so most of you won't identify with this. But there weren't very many people in 1987 that would have asked the question, "Oh, you know what? Part of One of One of the the DDQ One of the questions on our deep due diligence list should be, what if the Soviet Union falls? Because if that does, well, this might affect our investment." It doesn't happen. Or how many of you invested in apartment complexes in 2019 would have said, "Hey, you know, there was a there was a pandemic in 1918, 100 years earlier, wiped out, you know, millions of people.

8:15 I wonder if there'll be a global pandemic that will cause a an eviction moratorium and will affect our So you can't really look at You can't predict all all risks. So let's say there are 50 just a arbitrarily. Let's say there are 50 factors that could affect that could negatively affect the outcome of an investment. If you do regular due diligence, like somebody gives a webinar, I've seen this so many times. Oh, it's a webinar, 45 minutes to tell you about the deal. And then they say, "And if you want to have a soft commit, click here." 45 minutes soft commit? Are you kidding? 45 minutes is barely enough to say, "I'm willing to go to preliminary due diligence." So you know You can't know everything. So if there was a list of 50 factors that could negatively affect the outcome of a of of an investment, regular due diligence, you might have You might identify 30. The deep due diligence that we do, you might identify 45. That's not 50.

9:10 So there's always going to be risk. That's why we have to diversify with portfolios. So But when you minimize the number of unknown factors from 30 to 45, you're actually decreasing your probability of failure by 75% and that's important. So you can't eliminate risk. You can minimize risk through deep due diligence. You can manage risk through diversification. Got it. Yeah, makes sense. I think it no matter how much due diligence you do, something could turn against the business or the person could just be smarter than average fraud and they passed every every single check potentially, right? So what makes your approach to due diligence different you think than what most private investors do? Besides like reading every word of a PPM, I guess. Yeah, challenge every word of every spreadsheet, reading every word of PPM even after AI's read it, which is Okay, we're a little bit strange. Uh I'm I personally I'm emotionally disturbed, I guess. Um but something that that we do that's different before I started the group, I did all deep due diligence myself. Again, as a scientist, that's what we do.

10:08 OCD about the deep due diligence. But then once I started finding a few other crazy people like the 5% of the private investors that do the kind of deep due diligence that I do, then all of a sudden we started getting together and performing joint deep due diligence in teams. And what's really interesting is that when you have when when you're looking at a at a deal and you have an airline pilot and a guy who works at the line with the electric company and a guy an ecologist and a stem cell researcher and a an IT guy and another guy who does concrete and does the part of our group and everybody's looking at the elephant from these different angles, then we get to see things everybody covers everybody else's blind spot. So so performing deep due diligence in teams is something that we do that is different and and my my performance has gone up since I've been doing things in teams. Got it. Yeah, I think it's super interesting. We had 30 members of the investor club at the super summit in December.

11:05 >> >> And so having 20 some people in a room while somebody pitches to that room and then hearing the unique questions and ways that things get unpeeled, I think it's really interesting for investors. And one thing I always think about is like the person educating you or helping you with due diligence, what are their natural biases? You know wealth advisors who just manage stocks and bonds, you know, their advice probably will lend to doing more things in the public stock market because that's just like their business, right? So they may be biased that way. Someone who represents a company, you know, is going to be biased in that way. If you hire someone, they're not going to have the diversity that a whole bunch of high net worth investors have and they're putting their own capital into the deal. If you hire a third party due diligence firm, they're going to do their their best. They might be real experts at due diligence, but if they're not putting their own money in the deal, are they going to care at the same level and do they have a team of 58 investors that all have different brains with 30,000 hours experience as a OBGYN doctor and chemical engineer? Like so it's just a different thing. But whatever tool you use, AI, a due diligence firm, etc., you should never trust it completely and you should also always also use a set of peers is what we found. So any comments on that before we go to the next question? Yeah, so so with the AI, let's make sure we understand this. We we love AI as a screening tool and sometimes as part of to confirm

12:23 things on the due diligence maybe. But in the end AI is not investing $100,000 each one of us is investing $100,000. You know, we might be doing a million together or something like that. So I think that's that's important. And the other thing is I don't want to knock the the large our members are people typically with a net worth, you know, we're accredited investors, but we don't most of us don't have a net worth of 20 million or 50 million where we can go hire a lot of people. I think it's great that the family offices when they hire all these experts, they might hire five experts and one by one guy will be maybe a financial an accountant you know, do some sort of forensic accounting and stuff like that. But when we have like 60 members that come from all these different backgrounds, it's just amazing what we can do together as a team.

13:12 What about diversification? Can you talk about that for a minute? Yeah. I might have to move my chair a little bit further from you because everything I've heard you speak like a million times. And okay, I shouldn't exaggerate. Probably 30 times and maybe five or six times you you use the word diversification which if I understand correctly means you can get so diverse that you don't really know what you're talking about. And and that which is which is valid. So the way I look at it is like this. If you have too little diversification, then you're really taking a lot of risk. And if you have too much diversification, well, you get to the point where you have to too much there's capacity that really doesn't work.

13:59 So I'll give you an example. My self-directed Roth 401k, yes, I have a 401k that is not invested in anything in the stock market. My self-directed Roth 401k is invested in 15 different asset classes. That is about my capacity for my ability to understand you know, litigation funds and mobile home parks and land developments and and just all kinds of non-correlated and correlated asset classes. So I think it's important to be able to here's another one. I won't mention names but somebody who I respect a lot says I've chosen five sponsors and they are the super sponsors of all time and they're and they're really great and and and I know the sponsors that he chose. They're they're they're fantastic sponsors. But if you have if you're going to limit your your portfolio and to five sponsors, that means you're going to have about 20% exposure for each one of your for your each one of the those sponsors and certainly asset classes. So I set a goal for myself that I want to have at least 10 asset classes. So therefore that required me to have at least at least 10 10 sponsors because I'm not going to have a a sponsor that's going to you know, cover two or three asset classes. I want them to be

15:16 to be to specialize. Got it. Yeah, that makes sense. A lot of the family offices I work with usually don't want to trust more than you know, 3 to 8% of their capital with any one counterparty. So that makes a lot of sense. So a lot of times we stress at our events that you should have a a one-liner, a one-pager, a one-minute video from the founder and that helps cut through a lot of stuff and get and help save people time. What advice would you have for sponsors in the room? There's 1,300 investor clubs globally. We have seven of them attending our event here today and tomorrow. You know, as head of an investor club but also as a high net worth investor who sees a lot of flow, the most valuable investors see a lot of deal flow. So what advice would you have for people raising capital here today? If you don't mind, I'm going to say something a little bit strange. Um take no for an answer and take no for an answer quickly.

16:05 What that means is I'm hesitant to even use this example. So I was speaking with somebody this morning and they're clearly the person was raising capital for some really fantastic business model, no question about it. But that business model was not compatible with the way that I do things. So we probably invested five minutes more than we should have talking about the incompatibility. Like he's trying to convince me that his model is good and I said, "Yeah, your model really is good. It's just it's not good for me." So what's the big deal here? Well, at these networking events which is really really important, then if you're a sponsor, you want to maximize the number of people that you want to meet at these events.

16:54 So it's a real shame for you to waste five minutes of your time after I've said no, not because the model is bad. The model was great. I was very impressed with this guy and what he was offering. But don't waste five minutes of your time talking to me when there might be another prospect out there because productivity in prospecting is the number of people you can the number of conclusions you can reach per unit time. I'm talking like a chemist. I'm sorry. So so take no for an answer quickly. Got it. What's the biggest misconception you think private investors have about succeeding in private investments? From the standpoint of deep due diligence, a lot of people will focus on the opportunities and like I I definitely perform deep due diligence on every opportunity.

17:42 But I think that investing in marriage and in industrial phase trans catalysis which is what I do, more than 50% of our performance in life depends on a handful of strategic decisions we make and less than half depends on the tactical execution. So what happens is that most people invest 99.9% of their time on tactical execution and optimizing the hill that how to conquer hill that they might not be the even the right hill. So I think that the most important thing before you start choosing the investments is figure out your overall portfolio strategy. You know, your allocation, you know, income growth, income and growth, you know, high high return high risk high return capital versus low risk low return and and those sorts of things. So I think setting your portfolio strategy is is is is more important to do that first and then later that's when you start with your that's when you start with your deep due diligence on the individual opportunities.

18:40 Got it. A lot of times I see family offices focusing on basically their their public markets with one to three providers, you know, direct investments into real estate, private equity, get diversification and then figure out one area to really grow their wealth aggressively. Usually internally with direct investments. So I see that pattern quite often. We have two really quick questions here. How do you stress test a person versus the business? Yes, so this is tough. Stress testing so the sponsors are are really crucial. A couple of comments I want to make. First of all, and this is just a personal philosophy of mine, I like to deal with sponsors who are also operators. So I don't like to have intermediaries because it's really hard to perform deep due diligence when you're when you have one or two levels in between.

19:30 That's one thing but the other thing and especially you know, the we all well, anybody says that they have a 100% track record these days is probably lying to themselves or to me or both. And the Fed raised rates from March of 2022 to July of 2023 and that really changed a lot of things for a lot of people. So one of the things that I look at is I want to understand the thought process of the sponsors in late 2022 and early 2023. So, I want to see how did they respond? How What was their decision-making process when they really faced adversity? And and it's not just say, "Oh, tell me about your worst deal and how you dealt with it." No, I want to know specifically what deals they had and how they responded. Like, there's one sponsor out there um who doesn't come to Family Office Club that I'll never invest with because even though they learned a lesson, they in order to keep the lights on in December of 2022 and January 2023 and February 2023 when they knew that the deals were not going, they kept on on offering deals because they needed to generate the fees.

20:39 That that's an example of how I would stress test. So, if anybody's going to be I know we have some meetings later with some of the sponsors here. Uh I'm I'm going to want to know how you reacted um to adversity, but specifically uh to the fed increasing rates if unless it didn't affect your business. Got it. We're a little bit over on time, but one last question. How do you conduct due diligence on someone who's clearly smarter than you in their specific domain? Oh. Well, first of all, most people are smarter than me. So, that's that's a I have to figure that one out. Um and in my domain so so there are there are a few things. If I really don't feel comfortable with that domain, I I do not I I don't proceed forward. And a great example was I'm not I don't know if they're here, but a sponsor we met um at the Super Summit was impressive to no end. I think some of our members invested with us and with with with the company and I just didn't have enough time to do the kind of deep due diligence. It was a field it was a technical field, but it was outside of my expertise. And I simply didn't didn't invest. So, and in this case um it was in the medical device field and we had an immunologist sitting there. We had a gynecologist. We had another physician. We had people

21:56 that had expertise in in the in this area and I was extremely impressed. I understood a lot of technology, but not enough. Not enough for for me. So, uh I I would like to defer to the other experts in the group. But, in this case, I just didn't feel comfortable enough. So, I I didn't invest. And it really bothers me cuz I really wanted to invest. Got it. Yeah, that makes sense. I think one rule a lot of investors live by is if they can't understand how value is created and if the person across from you can't make it simple uh and make it very clear what their edge is in the marketplace, then they just move on, you know, because it's not your job to come up with those reasons. Like, if they haven't made it clear, then it's just not clear. Um so, great. Let's give Mark a big round of applause. Thank you very much. Good job. >>