There is a reason why Warren Buffett is the world’s most prolific investor: He invests in good people. It’s because he knows that a plan is only as good as the people who will execute it.
Investors are generally proficient at asking great questions about specific investments, but poor at asking great questions about the people managing, promoting and developing the investments.
With that in mind, here are five questions to ask anyone who wants you to invest, whether in a business, real estate project or any other investment venture:
1. Are you personally invested in the project?
If you want to gauge how serious someone is about an investment, ask them if they have put their money where their mouth is. In other words, how much have they invested? How much have their friends and family invested?
What you’re trying to gauge is how badly it will hurt this person if the investment doesn’t work out as expected. If their commitment to the project would cause serious financial, emotional and other hardships if it failed, you can be pretty sure they will exert every effort to make sure the project goes well. This is extremely important if your role as an investor is passive—you want them to be highly motivated.
2. Can I see a copy of your credit report?
Asking someone for their credit report may seem like a big request, but so is asking for $50,000. There is a reason banks use credit reports religiously: they are an objective view of someone’s financial history.
That’s not to say that there are not legitimate reasons someone’s credit report may be tainted. In general, however, credit reports are a good indication of an individual’s financial responsibility (at least historically). Would you really want to give $50,000 to someone with two bankruptcies and a 590 credit score? If they can’t manage their own cash flow, how can you expect them to manage the cash flow and/or expenses of an investment project?
Credit reports reveal a wealth of information about an individual, including:
- Assets. What does this person own in their name? In other words, what do they risk legally losing if they mislead investors?
- Problems. If they had problems in their youth, how did they handle it? Did they immediately file bankruptcy or did they come up with a way to make good on their obligations?
- Leverage. Are they overleveraged? If the investment runs into problems, do they have the financial wherewithal to provide additional capital?
3. How many other projects like this have you done?
If the individual has a lot of experience, there should be a wealth of comparables to review and references with whom you can talk. However, most experienced investors don’t spend a lot of time raising funds from people to whom they are not already extremely well connected.
More often than not, you’ll be talking with someone who either is a first-timer or has limited experience. It’s okay to bet on a first-timer, but you should be compensated accordingly. In addition, you should look for individuals who acknowledge the value of experience and who engage consultants with experience to aid in the project (especially the planning stages, where the assumptions which drive the expected returns are made).
4. What could cause me to lose all or most of my money?
This question may seem abrasive, but it is revealing. What you are really looking for is how well this individual understands the risk factors associated with the project. If they don’t recognize the risk factors, it is virtually guaranteed they won’t be planning the project in a way that limits those risks.
When someone tells you there are zero risks, you should immediately turn 180 degrees and run. There are always risks; the question is merely one of likelihood. Make sure that the people you invest in have a good idea of what they are up against and a plan for how to manage the risks that could lose your money.
5. What and how are you being compensated from this project and/or my investment?
This question determines whether your goals are aligned. If the person asking you to invest gets paid a portion of the check you write, you’re dealing with a salesperson. If the person asking you to invest is a principal in the project, are they being paid for some of their efforts before the project is profitable or do they only get a benefit if and when the project is completed?
Knowing how someone makes their money is the key to understanding their underlying motivations and potential conflicts of interest. If you won’t be the one controlling the project, you want the person who is to be highly motivated and have goals aligned with yours.