Performing Due Diligence Before You Invest & The Due Diligence Top 10 List
Mat Sorensen

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April 23, 2013

Before you invest your hard earned savings or your self directed IRA into a “non-traditional” business or real estate investment of another you need to ask some hard questions to the person or business receiving your money. Here are some tips to keep you out of legal trouble and to help you avoid bad investments or structures.

  1. If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
  2. If you aren’t given adequate documents outlining what has been explained to you verbally or what has been put into a presentation then don’t invest.
  3. If you’re told that you can get a commission for bringing others to invest into the same company and if you don’t have a license to receive such commissions then don’t invest. If the investment sponsor is willing to violate the law to pay an un-licensed person to raise money from others then what’s stopping them from misappropriating your money you invested? It is only the law preventing them, which they’ve proved they will disregard.
  4. If you are loaning money for a real estate venture, then demand a deed of trust or mortgage on title to the property protecting your investment. Also, make sure that you get a copy of the title report or commitment showing what position your loan is being placed into when the deed of trust or mortgage is recorded. Many savvy investors (and what all banks do) create lending instructions to the title company closing the real estate transaction and tell the title company to only use the funds being loaned when the borrower signs the note/loan documents, when the title company verifies the priority of the deed of trust you are getting (1st position, 2nd, etc.), and whether all other defects to title have been cleared (and if not cleared, disclosure of what they are).
  5. If you’re investing into a PPM or private offering you should receive lots of documents outlining the investment, the use of funds, the background of those managing the company, and also documents regarding your rights as an investor (e.g. offering memorandum and LLC operating agreement or LP limited partnership agreement). Also, check to see if the PPM or private offering was properly filed with the SEC by going to SEC.gov and checking the company name in the SEC database. If no filing record exists for the PPM or private offering with the SEC then the person raising the funds has possibly disregarded the law. As stated earlier, if someone is willing to disregard the law to get your money what is stopping them from disregarding the law to not pay you back (it’s just the law)?
  6. Investigate the background of the person you are entrusting your money with. When you are investing with others you need to think like the bank and do what the bank does. What is this person’s credit worthiness? What is their employment or prior business experience? What is their business or investment plan? What are the terms of the investment? Is there a realistic rate of return that fairly recognizes the risk being taken?
  7. If you are pressured that this opportunity will pass if you don’t invest now, then let the opportunity pass. Most scams use this technique and most legitimate investments never have this funding crisis.
  8. Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents already it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting you. Sometimes, unfortunately, the devil is in the details and many investments have clauses that can significantly impact your ability to get your money back out or that give the company raising the money the ability to pay whatever compensation to themselves they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
  9. Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else they can help you find issues to consider and questions you should be asking.
  10. Be comfortable saying no and only invest what you are willing to lose. Non-traditional investments have made many millionaires over the years but they have also caused lots of financial ruin. Just keep the risk in perspective and don’t “bet the farm” in one deal.

Don’t be scared about investing into non-traditional investments. Just remember though that you may need to get out of your comfort zone by asking lots of questions, by demanding additional documentation, or by simply saying no. Remember, you are the best person to protect yourself.  So do it.

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