Does the early bird always catch the worm?

Have you ever observed someone who is always busy? He comes into the office early and leaves late, but he never seems to deliver projects on time?  It’s likely that psychologists have a name for this “syndrome.”

When you’re considering whether a management team deserves your investment, however, this may be a material factor in deciding against committing capital.

Carofin’s affiliate, Carolina Financial Securities, once raised capital for a hard-working management team in a company that used to buy large, expensive engines to repair and resell.  We were familiar with this type of business, having raised capital for companies in a related industry.  This one represented a classic business model and met all the usual requirements. It held all the necessary professional certifications. It followed industry practices and accepted regulatory oversight. All its warehouses carried adequate insurance. Without question, its client roster was first-class.

Still, here’s another facet to understand when analyzing a potential investment. Other business models can rely on diverse income streams from many products or services, etc. In this case, the company had only one source of revenue: selling engines for a profit. Think of it this way: you work for, say, IBM. You’re paid in cash and stock, and you buy more stock in your 401(K).  The stock loses 50% of its value and, to save money, IBM fires employees by the thousands. Now you’ve lost your single source of income (and your retirement account is looking peaked).

The same is true of a single asset company model.  As an investor, you’re relying on one income source. If something goes wrong, you might watch that investment sink, joining others in the “deep six” of your portfolio.

In this case, something within the operations didn’t jive. Management was working hard. We would get calls early and late to discuss the company’s status. But we were missing what, ultimately, derailed the company.

Because of the risky nature of this business model, we hired an expert. She conducted an extensive background search and analyzed whether this company had a viable business.  The final report indicated that the company didn’t have a systematized process flow. It hadn’t buttoned up its operations. This was what was causing management to work so hard. They were putting quick fixes on an imperfect system.

On a comparative basis, however, it operated like many other industry participants.  After careful consideration, we made the decision to move forward. It was our belief that the company should be able to perform well enough under its current obligations. The investment, though still high risk, warranted the high projected return.

But, here’s the rub.  Over time, management began to shift resources to an affiliated company. As a result, the primary business began to suffer.  Rather than institute and follow a tight process, they began to make decisions based upon expediency. In the end, they became overextended. They couldn’t manage the company efficiently.

Anyone who has built a business will recognize the strain that entrepreneurs face. In this case, management stepped over the line. To keep the business afloat, they broke covenants we had in place in the loan agreement.  So, we took appropriate action to recover investors’ funds.  In the end, investors got their money back, but only after an exhaustive review of management’s actions.

Our illustration of the early bird who can’t deliver only tells part of the story.  Running a business is risky. So is investing in one. To minimize risks, we recommend:

  • Invest small amounts in many private placements;
  • Limit the percent these high-risk investments constitute of your total portfolio;
  • Be an engaged investor who follows a careful portfolio management process AND conducts due diligence.

The reward often will be worth the risk.





In the interest of accessibility, here are some terms that any investor should be familiary with.