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Due diligence is a key step for financial advisors who allocate client funds to alternatives. But a fast-changing alts landscape, along with a volatile economy, has created new challenges for wealth managers in recent years.
Brad Updike, attorney at Mick Law P.C. LLO, joins the show to discuss due diligence and alts investing for advisors amidst the current turbulent economy.
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- An overview of Mick Law, and the services it provides to financial advisors.
- How due diligence in the alts landscape differs from that in the publicly-traded sphere.
- Details on the due diligence requirements for FINRA firms who want to sell alternative investments.
- On overview of the due diligence process, including some surprising areas of coverage.
- Common mistakes that financial advisors make in regards to due diligence, as well as the common practices of advisors who do it well.
- Details on Mick Law’s upcoming events.
Featured On This Episode
- Events (Mick Law)
Today’s Guest: Brad Updike, Mick Law P.C. LLO
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to “The Alternative Investment Podcast.” I’m your host, Andy Hagans. And today we’re talking about alts investing in a turbulent economy. We have had a very turbulent past couple of years. And what does this all mean for financial advisors and wealth managers who are investing into alts? And joining me is Brad Updike, who is an attorney at Mick Law. Brad, welcome to the show.
Brad: Hey, good to be here. Thanks for having me.
Andy: It really is very timely, because, you know, in a turbulent economy, due diligence, you know, it’s more important than ever before. So, I know we have a lot of ground to cover today, and I know that a lot of our audience of advisors and family offices is already familiar with Mick Law. But for those of us who aren’t, could you give us a brief introduction to your firm and your…?
Brad: Excellent. Yeah, I’d love to. We’re a law firm. We’re based in Omaha, Nebraska. Our staff consists of nine lawyers, most of whom work out of our Omaha office. And what we do is we provide underwriting and due diligence support to a network of about 300 broker-dealers, investment advisors, and family offices that raise money in non-traded alternative investments, debt, and equity.
Andy: So, you all are a leader in that due diligence area, you know, in alternatives. And I wanna zoom out a little bit, you know, almost philosophically speaking, you know, due diligence, it’s such a key part of the alts industry, of the alternative investment ecosystem. So many RIAs, so many wealth managers depend on Mick Law and firms similar to yours. And maybe that contrasts a little bit with traditional investments, right, with our stocks, our bonds, ETFs, mutual funds. Why is there, in your view, such a core need, so much emphasis on professional due diligence in the alternative space?
Brad: Oh, sure. Yeah, we start from the premise that we live in two worlds from a securities product perspective, as you just mentioned. You know, we have the public companies. These are very highly-capitalized firms, whose debt and equity trade on public markets, your Dow Chemicals, your EQT companies. Those both, for example, they trade on the New York Stock Exchange, which has a market capitalization of $22.1 trillion. The second world is non-traded sector, the alternative investments, which is where our firm is involved. Alts include, like, 1031 products that are sold by private placement. That would be, like, DSTs, real estate, LLCs and LPs, Qualified Opportunity Funds. You gotta include in that mix your oil and gas programs, and then other products sold by private placements. You also have this registered non-traded product universe that includes non-traded REITs, BDCs, interval funds.
So, yeah, you got two different worlds. From a volume perspective, I think you alluded to this before, you know, the alt sector, it’s pretty small compared to the public universe, but it’s hardly insignificant. On that point, and this is on an annual basis, there are about 20,000 Form D filings that are made by various companies annually, generally seeking about $1 trillion in debt and equity capital. So it’s a pretty big space. That’s not to say $1 trillion gets raised every year, but that’s what’s being sought, if you look at these filings.
Andy: So, Brad, one question. So, if there’s 20,000 filings, how many of those actually end up making it to market? Do all 20,000 of them make it to market, or only a portion of them?
Brad: I would say most of the ones that are retail syndicated by your broker-dealers and investment advisors, I’d say a lot of those do tend to close. Out of the 20,000 filings, about 15% to 20% involve broker-dealers and investment advisors, FINRA firms. So, yeah, it’s still a pretty significant number. Within the sectors that we’re most active, DSTs would be one of those. Nine point two billion was raised from 40 different sponsors last year. That’s represented growth of about 30% year over year if you compare that to what was raised in 2021. Another sector that saw quite a bit of growth was oil and gas, believe it or not. One point one billion was raised by about a dozen companies that we covered, which represents 100% growth from what was raised in 2021.
And another thing that people may not realize, Qualified Opportunity Funds, those haven’t gone away. I know that the 10% to 15% basis step-ups went away, and there’s talk in Congress about maybe reinstating that. But there’s still some pretty significant tax features of these Qualified Opportunity Funds. You get to defer your capital gains through 2026. And then you get that fair market value basis step-up in 10 years, if you hold the investment that long. So, yeah, notwithstanding the fact that those basis step-ups went away, you know, the Qualified Opportunity Fund structure is still pretty compelling.
Andy: And your view, you know, if you’re an RIA, if you’re a wealth manager, you need professional due diligence, right, in terms of… Because very few wealth managers have the ability, or really, time, I should say, probably more pertinent is the time, to diligence, you know, these offerings themselves.
Brad: That’s true. On the public side, it’s a little bit more maybe BD advisor-friendly. You know, you have the periodic SEC filings that have to be made, on a quarterly basis. You have an underwriter that’s actually in the process. That’s an investment banking firm that’s going out. They’re researching the company, they’re conducting interviews, they’re assessing the risk, they’re valuing the company, and they’re placing a price on that security. Whereas in the private placement side, you don’t have that. You don’t that have periodic filings. You don’t have an underwriter. But what you do have is pretty stringent due diligence and suitability requirements, which is where we bring value. What we’re doing is we’re going in and we’re essentially performing a type of, like, underwriting function for the broker-dealers and advisors, to help them determine, you know, whether or not this is an investment that merits their time.
Andy: Understood. And so, you know, I think you did a great job of kind of summing up the whole universe of investable, you know, in alternative investments, you know, most of these offerings. Is there a particular area where Mick Law… I guess, all this universe, you know, you mentioned DSTs, Opportunity Zone Funds, energy. Are there any of those product types that you all don’t do diligence, or are there…? And I, also wondering, are there any where you’re particularly strong, where you’re a recognized leader?
Brad: I guess in terms of, like, economic sector coverage, there would be probably three areas of primary focus, real estate, energy, and then private debt and equity. Our underwriting services tend to be I think more heavily used in the private placement arena. Although, yeah, we do have a couple of attorneys that are also very well-versed on the registered non-traded side as well, and look at a lot of interval funds, BDCs, and registered products.
Andy: Okay. Well, so, let’s talk about advisors and some of these FINRA rules. Because I’m actually not an advisor. A lot of people don’t know this about me, I guess, unless they’ve been listening to the show for a while. But I’m not from the, you know, asset management industry. I’m not a financial advisor. I’m just an LP, so I’m not really in the industry. So, I’m curious, could you give me some of the background on due diligence requirements for FINRA firms that are selling alternative investments? You know, what are the legal requirements? If I’m an advisor, whether a broker-dealer or an RIA, and I want to sell alternatives and place client funds in alternatives, what are my legal requirements?
Brad: Oh, okay. Yeah, it does… On paper, you know, if you compare the due diligence, maybe obligation of a registered investment advisor to a BD, you know, on paper, it looks like there’s compelling differences, but not really. Because if you think about it, you know, the broker… The RIA, while they’re not subject to the FINRA rules, you know, they do have fiduciary duties to act within their client’s best interests, so I would say that a lot of the guidelines and things that you’re supposed to do as a broker-dealer, you should be doing as an RIA.
On the broker-dealer side, there’s a lot of rules and guidance that cover due diligence and suitability. I think your main rules would include Rule 2111, which requires a broker-dealer to perform enough due diligence and research to make sure that this is an investment that’s suitable for at least one type of investor. But layer on that with Regulation BI, which was just passed a couple years ago, that requires broker-dealers, FINRA member firms, to actually do a couple different things. They have to understand the conflicts of interests that are involved with respect to all types of securities, public and private. It also requires a thorough understanding of the fees, the risks, and the costs that are involved in these products. They have to understand that, and there’s a suggestion that they’re supposed to be undertaking a comparative analysis of comparative products, in order to put, you know, the clients in the best opportunities. So, yeah, you’ve got those three…
Andy: So, yeah, and Brad, so, yeah, you kind of brought up an interesting point there. So, with a broker-dealer, they’re generally gonna have the suitability standard. But to, I guess, ascertain that an investment is suitable for a particular type of client, we have to do due diligence to even meet a suitability standard. And then, as you pointed out, any kind of a fiduciary, like a registered investment advisor, they’re gonna have to act as a fiduciary. And it’s almost, I guess, implied that you’d have to do due diligence to place client funds, to be a fiduciary to act in the client’s best interest. So, it really comes with the territory, regardless of what kind of financial advisor that you are. Would you say that’s fair to say?
Brad: Yep. Yeah, I think it’s an onerous standard. I mean, with your registered products, you know, you have… I think those are in favor a little bit more with the bigger broker-dealers, because, yeah, you have the SEC’s involvement in the process. There’s a comment period. The prospectus gets turned in to the SEC, and there’s usually a couple rounds of comments, just to make sure that the risk disclosures, in the eyes of the SEC, at least meet, you know, their eye test, their smell test. And then you’ve also got the NASAA guidelines that are followed in the register of products, which mandate certain minimum, like, voter rights, as well as transparency and access to financial statements and other operational-related information about the product.
Andy: Understood. So, here’s a question I have. In regards to advisors, or from an advisor’s point of view, or broker-dealer’s point of view, how much of the due diligence is on an offering, versus a sponsor or a manager? I mean, you know, realistically speaking, it seems like sometimes advisors or firms will kind of learn to trust a certain brand name, so to speak. Like, maybe, for instance, a sponsor has had dozens of successful DSTs over a decade or longer track record, or dozens of non-traded REITs, or dozens of this or dozens of that, they’re very well-known, and they’ve had conservative underwriting for multiple market cycles, let’s say. Do they get, I don’t wanna say a free pass, but is there more trust when reviewing that kind of an offering, or is it kind of, like, guilty until proven innocent, where you almost have, I don’t wanna say a hostile, but you kind of just view every offering in a neutral way, and, you know, kind of, like, prove it type of mindset?
Brad: Yeah, sponsor-level analysis, program-level analysis, both of them are very, very important processes, that need to be, I guess, prioritized and taken seriously. You know, even with the highest-capitalized sponsors out there, you know, things turn on a dime. I mean, look at our economy. Look how many cycles that, you know, we’ve went through. And, you know, even highly-capitalized, experienced sponsors can face times of distress. I mean, we saw that with COVID, where certain real estate sectors, you know, clearly outperformed others, just due to supply and demand considerations, as well as, you know, inflationary considerations. So, yeah, you need to be, like, doing both. And it’s two distinct functions. With the sponsor review, you know, you’re going in and you’re doing an investigation to determine whether this is a sponsor that’s operationally and financially capable of managing a program to a successful conclusion. On the other side, with the product review, it’s more about product fairness. Is this offering fair to the investors, given, you know, the risks and given the quality of the assets and the return potential?
Andy: So, that’s interesting. So, you’re doing the due diligence on both levels, with the product and with the sponsor. When you’ve diligenced a sponsor, and you’ve kind of determined, okay, they have the capability and experience to operate, to manage this offering, is that, like, a one-time, kind of a pass-fail, or is that something that you kind of have to review annually, or with each offering? You know, like, because that could change, right? Because you might have one management team in place that you diligence, and you say, “This is a strong management team,” but then management teams are gonna change over time. So, yeah, how do you kind of approach that over time?
Brad: Yeah. Varies from sponsor to sponsor, but I would say the shelf life of a sponsor-level review, I mean, it’s typically about two to four years. But, that said, even when we’re doing, like, our product reviews, we’ll certainly go in and we’ll relook at the financial statements. We’ll keep looking at the performance, you know, and how that might have differed over the years. And we’ll update those sections of our due diligence within the confines of the product review. Again, the shelf life of a sponsor review is typically two to three years, but maybe, you know, in some cases where there’s substantial changes in the sponsor’s operations, or their fortunes, or prospects for success, they may wanna undertake, you know, more frequent sponsor-level due diligence, maybe every 12 or 18 months. It just kind of depends on the company, what they’re doing and what’s happening.
Andy: I appreciate that transparency, Brad. That’s kind of helpful to know, you know, as an advisor, investor, to kind of know how often these things are reviewed. So, moving on to some sectors, and I guess, the process, you mentioned, you know, three big sectors that Mick Law covers, or diligence, as I should say, energy and real estate, as well as private debt and private equity. I wanna talk about how those are different, but first, let’s talk about how they’re the same. How does the due diligence process work, you know, kind of in the abstract, regardless of what sector we’re reviewing? Is there, like, a general framework that you all use?
Brad: Oh, yeah. You know, there are subtle differences, you know, when we’re looking at a real estate versus an oil and gas deal, but there are some commonalities, some common themes within our process that resonate, you know, across all sectors. Like, in each case, we wanna look at what the risk is, the risk of execution failure, because that’s gonna be different from sponsor to sponsor. We’re gonna look at the reward. We’re gonna look at the quality of the asset and, you know, under realistic, conservative conditions, you know, what type of a return, what range of return is possible? Does the offering terms match the risk that’s being taken by the investors?
We’re gonna look at the material risks of the offering, whether those are properly disclosed in the PPM and the prospectus. And then we also wanna know whether or not the investors are being fairly treated, in terms of their access to financial information, and also just their voting rights. Those five things, you know, we do that, regardless whether it’s a real estate offering or an oil and gas offering. We also apply what we’d like to refer to as the alignment of interest test. This is a formula, a test that, actually, Brian Mick came up with several years ago, when he started the firm. It’s a pretty simple test, but I think it’s applicable to any due diligence engagement. You’re asking, who’s putting money in? Who’s taking money out? Is the sponsor compensation performance-based? You look at all three of those, and that really gives you an idea of whether the interests of the investors are aligned with the sponsor and the issuer.
Andy: Understood. Yeah, that’s an interesting… I mean, that’s an important test. Well, some of these things, I guess, that you were talking through are, I guess, are a legal question, right? There are a question of how the offering is structured, like, we, mentioning voting rights or investor rights and so on and so forth. But when you mentioned, like, is the offering fair to investors their risk-reward profile, it seems to me like that also requires a little bit of financial analysis or investment analysis, you know, not just purely legal analysis. So, when you all are diligencing an offering and you’re kind of determining is this, you know, a fair offering for investors, you know, are you analyzing the offering from, like, a financial or investment point of view, aside from, like, the pure legal?
Brad: Oh, yeah. Asset quality, that’s critically important. We use independent, like, appraisers and independent reservoir engineers to help determine, you know, the quality of the assets and the return potential of the assets. You know, we do take the sponsor’s pro forma as a foundational piece of information. I mean, we give that some weight, but we certainly don’t completely rely upon that. You know, we’re gonna take a look at that pro forma, and we’re gonna take an independent, you know, look at it, and we’re gonna come up with our own underwriting, our own pro forma. We’re gonna take a look at the cost, the revenue…
Andy: I’m sorry to interrupt. So, you all actually make a complete pro forma? You underwrite the whole fund or offering completely independently?
Brad: We do. We consider the revenues, the costs that are likely to be incurred during the operational period. We’ll take a look at the sponsor compensation and the load. You gotta factor that as well, because there have been a lot of times where the sponsor will give us its pro forma, but it won’t be on a load-adjusted basis. It’ll just…
Andy: Gross performance. So, I guess I should ask, how much, or maybe, what’s the range of deviation, typical range from the pro forma that a sponsor provides to you, and then the pro forma that you independently come up with? Like, what’s the typical…? Like, do they typically are, you know, they’re 90% in, you know, like… Maybe there’s probably no one-size-fits-all answer. Like, there’s probably, you know, the occasional offering that’s, like, way, way, you know, way different. But what would be typical? What’s a typical…
Brad: I mean, in some cases, where you’ve got companies that have been in the business a long time, that really understand their areas of operational focus, you know, our deviation will be, like, 5%, maybe 10%. There’s always some deviation, because we don’t always agree with the sponsor on all economic assumptions. But yeah, with your better sponsors, that are really balanced operationally and that really understand, you know, where they’re operating, you know, there will be very limited differences. On the other hand, yeah, there are… I mean, we’ve had situations where, yeah, the sponsor thinks that it’s got a platform of assets that can deliver a 20% IRR, where we think, you know, it’s a losing asset that’s not gonna turn anything. So, yeah, it can be a lot… It can be very different, in some cases. But yeah, in others, you know, the sponsors just kind of differ in terms of, you know, how close they are to our pro formas.
Andy: Understood, right? I mean, and they’re all… Sponsors, I guess, have a little bit, they all have their own differences and their own underwriting. And, I mean, they all kind of claim to be conservative, but probably some sponsors are more conservative than others. So, that’s…
Brad: Yeah. The big problem you gotta watch out for in that regard, like, where we get, I think, in the cases where we really, really get diametrically different with the sponsor are those cases where maybe the sponsor, they’re cherry-picking the best, like, outcomes, you know, within their area of operations. The better sponsors, on the other hand, they tend to use the average, be more conservative, kind of use the middle-of-the-road type assumptions.
Andy: Understood. Okay. So, that’s a great kind of general framework for due diligence. But now, drilling into these three specific sectors of, or, I guess, four, energy, real estate, private equity, private debt, how does the due diligence approach differ? You know, how much of it is sector-dependent, right, that, you know, is dependent on doing due diligence in energy, or doing due diligence in private equity?
Brad: Oh. How much of it is sector-dependent?
Andy: Yeah. How does it change, I guess, when your diligencing, you know, an energy offering, I guess, versus…
Brad: Oh, sure. Well, just, it’s the type of consulting that we use is different with respect…like, oil and gas, we use reservoir engineers and geologists to help us, you know, understand the field, the reservoirs in the field, the operating conditions, and the probable outcomes in terms of oil and gas production. On the real estate side, we’re using appraisers, people with certified appraisal credentials or CCIM designations to go in and to look at the markets and to analyze the real estate assets.
Andy: I guess, big picture, is there, like, a cost or man-hour…? Like, does it take more time, on average, to diligence an energy offering than a real estate offering, for instance? I mean, because you mentioned energy. I’m thinking about all these different experts you gotta hire, versus real estate, you send an appraiser, you know. I don’t know. So, are they all kind of the same animal, or are some of them are, you know.
Brad: I think real estate asset underwriting’s a little quicker than it is, like, for oil and gas with real estate. Yeah, with respect to our turnaround, like, on DSTs and 1031 products. Yeah, we’ll get the information, and we can generally turn that type of a project around in five, seven days, whereas with oil and gas, it’s a little bit longer process, start to finish. Tends to be, like, four, five weeks.
Andy: Well, five to seven days. I mean, well, I guess maybe it’s needed because DSTs have been, you know, opening and closing so quickly, but…
Brad: It’s tough, but…
Andy: I’m having a vision of, like, attorneys, like, on TV shows, that are at the office till midnight, you know, burning the midnight oil.
Brad: Yeah. We’re fortunate in that regard. We’ve got consultants that have worked really in all, that have had experience looking at assets in most major metropolitan cities, as well as the tertiary, important key tertiary markets. So, yeah, they’ve got considerable coverage, plus, we use a lot of different databases to be able to ferret out the market fundamentals on a micro scale.
Andy: Okay. Got it. So, it’s an efficient process, and obviously, you all diligence a lot of offerings, so that makes sense. Well, let’s shift and talk a little bit about the current landscape. Obviously, it’s been a wild ride in the past few years, both in the alternatives industry, but just broadly speaking in the global geopolitical landscape. What are the major headwinds, you know, that you think are the most important ones that investors are facing right now, especially that intersect, I suppose, with due diligence, and how advisors and investors should be evaluating these products?
Brad: Yeah, let’s talk about real estate first. A lot to think about here. Stating the obvious, it costs more to conduct business today. Most notably, borrowing costs have gone way, way up. You know, go back two years ago, a year ago, prime rate was 3.25%, I think, for a couple years. And then, just couple months ago, yeah, we saw a pretty significant… Well, we’ve gradually seen pretty significant spikes. Prime lending rate’s 7.5% today, so that’s a 450-basis-point uptick in the cost of capital, from a debt perspective. You gotta couple that with inflation, which is at 6.5% now. I think it was 7% for most of last year. It becomes very difficult to drive NOI and to pay the distributions. And we’re seeing evidence of that, like, in a lot of these DST products that we’re looking at. You know, looking at Mountain Dell’s, Q4 ’22, report, average year one cash-on-cash returns across all 1031 products was, like, 3.99%. You know, that’s pretty low if you, you know, go back four or five years ago, when these products were paying about 5%, 6%, 6.5%. So, yeah, we’ve seen yields shrink. Maybe not so much in some sectors, of, you got senior housing is still paying 5.63%. Hospitality is over, a little bit over 5%.
Andy: Well, let me ask you this, Brad. When a yield shrinks, or, you know, compresses in a particular sector like that, in a product sector, alternative sector, does it change how you diligence in the sense that, you know, you might be an average or even above-average product in a sector that is just struggling because of those factors? So, do you kind of… I guess what I’m asking is do you diligence of product, like, kind of with that absolute, really zoomed-out view, or do you kind of look at its peers? Like, so, if DSTs are all yielding less, for instance, in a particular time period, does the due diligence approach, is it more comparing them to each other, or do you kind of compare them against the entire investment landscape?
Brad: We have to look at it from I think the entire investment landscape. We need to look at the peer group, because that’s important from a Reg BI perspective, you know, comparative analysis. So, yeah, we’re gonna be looking at, you know, what the peer group is delivering in terms of yield that, you know, we’re also gonna take a comprehensive underwriting analysis, that not only considers whether this is an asset that can cover that marketed yield, but can also return capital in seven to eight or nine years, because that’s the goal and the exit plan of these DSTs, is to buy, hold for six to maybe eight, nine years, and then return capital, or possibly a little bit more than a return of capital.
Andy: Yeah, and don’t get me wrong. I was just using that as a theoretical example. I have nothing against DST… A lot of great DST products, including ones launching this year. So, let me ask you this. With all this, you know, work that you do with due diligence, is it, you know, just, I guess, on a personal level, is there any aspect of this work that you find rewarding? You know, fun, so to speak? Any aspect of the job that, you know, makes… “I can’t wait to due diligence that deal because of X, Y, or Z?”
Brad: I like the site visit work that we do. It’s an important part of the process. It’s I think underappreciated, but very, very important, if you want to get really a good feel of, you know, what the pulse and heartbeat is of a company, you know, how the staff morale is, how management’s morale is, and whether or not they’re all on the same page in terms of mission and goals, you know, the site visit’s gonna help you ferret that out. I like to do the, like, interviews with bankers, and contract vendors too, and suppliers. I think that’s important. You can get a lot of information by just picking up the phone and talking to, you know, key suppliers, key vendors, and even, you know, bank officers. How they feel about the sponsor. Whether they, you know, are comfortable with the relationship.
Andy: How about that, Andy? Does Andy pay his bills on time, you know?
Brad: You’d be surprised, though. You know, you think that, you know, the sponsor, they give you references, you know, that they think, you know, are gonna talk good about them. You’d be surprised. Once in a while, you’ll get a vendor or a banker that will open up a little bit, and they’ll voice some concerns.
Andy: Sometimes, you know, Brad, I guess, more relevant maybe in your line of field, although I am a podcast host, but, you get interesting people talking. You just get people talking. You never know what they’re gonna say, right? It’s almost like the key is just to get them talking.
Brad: Oh, yeah. Yeah. I think the interviews are important part of the process. Underappreciated, again. There’s a lot of things that you can pick up in these interviews, especially if you do a lot of them.
Andy: Yeah. Understood. Okay. So, returning to, you know, the standpoint of the financial advisor, whether broker-dealer or fiduciary, RIA, we all learn from mistakes, right? No matter what line of work you’re in, whether you’re an advisor, or sponsor, or investor, we all make mistakes. We all learn from mistakes. In terms of due diligence, in terms of evaluating alternative investments, what are the mistakes that you see advisors make?
Brad: Oh, sure. And we learned this about 12 years ago when we had a couple blow-ups. Provident, Med Cap. You know, first and foremost, you can’t pay yield on a non-yielding business. You know, the business plan that’s being touted, it might, you know, sound real sexy and cool, but you really need to take a look at the assets, and, you know, whether they can deliver a yield that can support a distribution payment, or a trend of distribution payments, you know. You’re gonna want, on the oil and gas side, this is important. You’re gonna wanna know whether or not the sponsor is highly dependent on outsourced services, especially, like, in areas like geology and drilling. I mean, just empirical knowledge shows us that the sponsors, the oil and gas sponsors that are vertically integrated, that are not promoters, that are actually going out and, like, supervising their own field operations, that are actually doing it, perform much better than the ones that outsource it, the ones that really are just serving a role as a promoter. Just, a misunderstanding of the sponsor’s prior performance, you know, that’s come up from time to time.
You know, having a sponsor with good outcomes is great, but is it relevant? Prior performance. I mean, were those successful outcomes in strategies that are being followed today, in fields that are being, like, explored today, or within a real estate sector that the sponsor is deploying capital into today? So, like, having relevant performance is very important. And then, transparency. Is there a culture of accountability or unaccountability? Are investors being provided access to audits, and even, like, quarterly financials? I think that’s important. Do they get appraisals, reserve reports, that maybe explain, you know, the quality of the assets and, you know, how much, like, upside those assets have? And then voting rights, you know. That’s important as well.
Andy: You know, all of this, I guess, to me, if I’m sitting in the advisor seat, sounds very time-intensive, but I guess that’s really the benefit of Mick Law and what you all do, right, is being a trusted…
Brad: Yeah, the one major difference between us and, like, a public underwriter, we don’t put a hard valuation on the company and put a price on the security, but we do a lot of those other things. You know, we’re going out, we’re doing the background checks, we’re looking at the quality of the assets, we’re looking at the quality and the relevance of the sponsor’s prior performance. We’ll also look at the balance in all key areas of operations. You know, investor relations, marketing, finance, accounting, field operations, property management. You know, we look at all of those areas, and whether there’s ballots in those areas. Yeah, again, we also look at IT resources. We’re also gonna look at financial statements, so the sponsor’s [inaudible 00:35:00] because we want a sponsor that’s gonna be around for the long term, somebody that’s gonna be able to manage these properties, you know, to a successful outcome in 15 to 20 years, and to, you know, make a determination on that. Yeah, you really need to dig hard into the liquidity, you know, what their current resources are, as well as their net capitalization, and ability to stay operational long-term.
Andy: That makes sense. So, then, kind of flipping that last question, you know, those are some of the mistakes that advisors have made historically, that other advisors and investors can learn from. Are there any common threads, I should say, among RIAs and advisors who are doing a good job with due diligence, who are doing a good job with, you know, evaluating these kinds of products? Are there any common threads or best practices that you could point to?
Brad: Sure. You know, we talked a little bit about the mistakes that are being made. You know, the advisors that are doing better, of course, you know, it’s just the opposite with them. They’re performing due diligence, and they’re doing it on a regular and ongoing basis. It’s very important to really update that sponsor-level due diligence, and really kind of have your eyes on what’s going on with the sponsor operation [crosstalk 00:36:20.567]…
Andy: You know, you mentioned ongoing due diligence. I’m just thinking, if I’m an RIA, I don’t really have time to do ongoing due diligence, you know, of a sponsor necessarily. Is it more that they’re kind of outsourcing that, they’re partnering with you? It’s just that they’re reviewing that information regularly, they’re communicating…
Brad: Yeah. They certainly use us in the process, to supplement their product knowledge. I think first and foremost, oh, yeah. The advisors that don’t get into trouble and that do it right, they know the product. And they use our due diligence reports to get to know the product, because product education, very, very important. It’s also very important to know differences between competing products. That’s another area where our services can be critically important. Also, just knowing the client, and treating the client fairly. That’s also important. Maybe that’s not so much something that we can help with, but just, it is something that will keep you out of trouble.
Andy: Yeah, no. I think that’s exactly right. I mean, there’s, I guess there’s multiple ways to get into trouble. And one of which is just placing the client into an investment that is not appropriate for them in the first place, right? That’s why we have…
Brad: Oh, yeah. Yeah, you’d be surprised. I mean, there’s some pretty significant… Yeah, you’d be surprised what can come up from time to time.
Andy: I’m sure I would. Well, Brad, I can’t thank you enough for, you know, giving us a little bit of an inside look at the due diligence process. You know, I know Mick Law has a very, very reputable big name in the alternative investment, you know, sector. You mentioned alternative investment is a smaller industry than traditional investments. But I would say the alts industry has grown up. I mean, we’re…
Brad: Oh, yeah.
Andy: We’re pretty big now, you know, especially in the last couple years.
Brad: Oh, yeah.
Andy: So, you know, really appreciate all the leadership, you know, that your company provides in this field, and your coming on and sharing your insights with us today. So, that being said, where can our audience of advisors go to learn more about Mick Law and the services that you offer?
Brad: I’d say advisors that want to just learn about the alternative investment process and the opportunities, you know, there’s a lot of industry conferences out there where you can get very educated on these different, like, alt strategies. There’s ADISA. There’s TNDTA. And then, another thing that’s been going on, another trend, among the third-party providers, is the fact that they all hold their own conferences. I mean, we do two conferences a year. Our May conference has an energy focus, whereas our October conference has a real estate focus. I also know that Buttonwood and FactRight…
Andy: Well, Brad, did my invite get lost in the mail, or… I don’t think I got my invite to the May show yet? No, I’m just…
Brad: You are invited. Consider yourself invited to the May.
Brad: It’ll be in Dallas.
Andy: Oh, even better. We love Dallas. That’s where my partner Jimmy lives. So…
Brad: Yeah, what we’ll do, we’ll invite about 14 energy companies to come and give 25-minute presentations, and then we’ll layer in maybe four or five educational [inaudible 00:39:32] where we talk about just due diligence best practices, and maybe giving the advisors and broker-dealers there some guidance on how to better screen and evaluate the products.
Andy: Absolutely. Well, I’ll be sure to add to our show notes here links to your all website, the Mick Law website, and maybe I can also find a link to those upcoming conferences, for any RIAs or wealth managers who are interested in attending. Just as a reminder, our show notes are always available at altsdb.com/podcast. Brad, thanks so much for joining the show today and sharing your insights with us.
Brad: Thank you.