E67: How to Evaluate a Term Sheet for Private Investments (3-Pillar Framework)

AIME Episode 67 Transcript

Sarah Florer (00:19.695)
Hi everyone, welcome to Alt Investing Made Easy. Don't be a speculator when you invest. You want to become an allocator. Your capital deserves more than hype, hope or headlines. It deserves a process.

Roland Wiederaenders (00:49.196)
Most private investors operate like speculators, reacting to deals, chasing returns, and making decisions based on pitch decks, personalities, or momentum.

Sarah Florer (01:01.807)
Professional allocators do the opposite. They follow frameworks, evaluate structure, and demand alignment, all to protect downside at all costs.

Roland Wiederaenders (01:11.896)
Are you ready to move beyond reacting to opportunities and start investing with true intention?

Sarah Florer (01:18.553)
Welcome to our Term Sheet Teardown series. Today we're talking about why you need to be an allocator and invest in a structure, not any specific asset.

Roland Wiederaenders (01:29.154)
Most private investments don't fail because the assets were bad. They fail because the structure was broken from the start. And the hard truth is, most investors never actually read the part of the deal that determines whether they're going to win or lose.

Sarah Florer (01:44.441)
And that's why today we want to talk to you about our Term Sheet Teardown ebook. This is an offer for subscribers only and we will tell you more about how to receive your copy at the end of the episode.

Roland Wiederaenders (01:56.664)
Well, Sarah, we're going to need to talk about what a term sheet is, aren't we?

Sarah Florer (02:01.367)
Yeah, we sure are because we really want to help people with a mental reset to shift from being deal focused into a structured focused approach when they look at potential investments. So Roland, what kind of term sheets are we talking about here?

Roland Wiederaenders (02:15.821)
specifically for financing deals. know, on Alt Investing Made Easy, we're talking about private securities deals in the world of commercial real estate, private equity for an investment in an operating company, investment in an investment fund, like a hedge fund or a private equity fund or a real estate fund. Oil and gas would be included in this, but these are really financing deals rather than acquisition deals, although the acquisition

Sarah Florer (02:37.819)
Mm-hmm.

Roland Wiederaenders (02:45.185)
deals also would have, we're going to be providing you with relevant information that would certainly apply to the acquisition deals. But again, we're talking about a term sheet here that you're looking at as an investor primarily, thinking about investing in a company. And we're really trying to give you a new framework, new ways to think about these term sheets.

Sarah Florer (03:09.915)
So to start off, mean, oftentimes what you get as a potential investor is you get marketed to and then you get a pitch deck. And pitch decks are marketing documents and some of them look very beautiful and they should do because it's a first impression that a sponsor is making for a deal. But they don't contain a level of detail that gives you any information about how you're protected or very, very many specific.

specifics at all. And it's something that the first thing to do likely for some investors is to ask for a term sheet so that they can understand or have a document that sets out a lot of information in a more concise way.

Roland Wiederaenders (03:50.37)
Yeah, for sure. know, one of the things we always do is we ask to review the pitch decks for our issuer clients and we want to make sure that they're not saying anything in there that could get them in trouble, providing any investment guarantees or making any misrepresentations about what they're doing and also making sure that they're providing all the material information about the investment opportunity. And part of that is including material terms, but yeah, your point is so well.

Sarah Florer (04:06.586)
Mm-hmm.

Roland Wiederaenders (04:20.301)
taken the pitch deck as a marketing presentation. And it should describe the terms of the deal, but really to get to the heart of the matter, like Sarah said, ask for a term sheet.

Sarah Florer (04:31.885)
Right, exactly, because you will get even further detail in your PPM and supporting documents for that. But at the same time, think sophisticated sponsors are going to be comfortable providing a term sheet that captures everything. And actually, part of the PPM should have a summary that can function somewhat like a term sheet. But in any event, once you have that information, we want to talk about

what a term sheet is, but also some of the issues that you need to look out for. And in our e-book, there's a framework that will help you analyze your term sheet so that you can apply the same structure over and over again to different deals that you might be looking at, different opportunities that you might have. And the reason we think this is important role in Riot is because it's very easy to get caught up in the excitement about certain kinds of projects.

Especially, think, real estate projects can have lot of emotions, like, looks like a cool apartment building, or those renderings are really interesting. I mean, there's something emotional that can be a hook-in for you, and that's human nature. But to make the shift into being an allocator, the way that professional allocators do this as a living, you have to avoid the emotional part and just have a logical framework that you use over and over again to analyze...

key terms and how they relate to each other.

Roland Wiederaenders (05:58.799)
And what we've adopted here, Sarah, starting out with this framework of the three pillars, why don't you tell us what those three pillars are?

Sarah Florer (06:09.691)
So, yes, the simple framework that we've organized here and present to you is that you need to analyze three different categories of information or deal terms. So the first pillar are the economics of the deal and in a minute we'll talk about what that means. The second pillar is the control. And then the third pillar are specific issues around downside protection. How is it?

total loss of your money, what are the protections against such an unhappy event, right? So, and I just want to make another note here that there is kind of an illusion. There are industry standard terms in some kinds of funds and you'll hear about carry and management fees having standard amounts, etc. But really, at the same time that you have

standard terms or industry standards, every deal has to make sense on its own terms. So if you're using an industry standard term of a 2 % fee, for example, but it doesn't make sense in the context of the deal at hand, that's something that the term sheet tear down analysis process can help uncover. And you never want to just rely on someone saying, you know, industry standard terms as if that makes sense in the deal that's

just in front of you. Roland, did you have anything you wanted to add to that before we move on and talk about the individual pillars?

Roland Wiederaenders (07:41.795)
Well, and the only other thing that I think is worth mentioning is that we describe several different asset classes here. We talk about different asset classes within the main class of alternative assets. I think risk ranges from some of the most esoteric trading strategies with hedge funds or some very speculative, I guess, oil and gas to...

Something that would be much more conservative perceived as very low risk, which is commercial real estate or multifamily. And so you do measure risk by reference to what it is that you're investing in the asset for sure, but that the analysis of risk shouldn't just stop with what the asset is. And that's what we're really trying to help people understand here is how to evaluate risk outside of

Sarah Florer (08:33.07)
Mm.

Roland Wiederaenders (08:39.202)
the asset, the specific asset risk, what's the structural risk behind the investment?

Sarah Florer (08:44.097)
Exactly. How do all the terms of the deal work together in the end?

Roland Wiederaenders (08:49.302)
Let's start out with the economics. And I think that's pretty straightforward. Sarah, do you want to start there?

Sarah Florer (08:56.761)
Right. And so when you think about the economics of a deal, it's obviously going to be talking about dollar figures or percentages, et cetera. But you need to ask yourself an underlying question, and that is, what am I getting paid really for taking the risk of putting my capital over here into this investment? And you have an opportunity risk, obviously, because you might have other opportunities that have less risk. So at the end of the day, you need to understand our, you know,

Are the terms fair and aligned and what are you really getting paid for putting your money into something? So Roland, what are the different kinds of economic terms that we typically need to encourage people to talk about and maybe even sometimes they can be negotiated when it comes to an investment?

Roland Wiederaenders (09:47.203)
Well, I think how the money goes in and how the money comes out is a probably good way to describe it. The way that it goes in is pretty simple really as an investor. You write a check, but you could have a capital contribution model or a capital commitment model. so making sure that you understand the distinction between those two and how you can make a commitment that is very much a binding obligation for you to fund an investment in the future. And don't think that

Sarah Florer (10:04.419)
Mm-hmm.

Roland Wiederaenders (10:16.77)
just because you don't have to pay the cash over now that you're, can get away with, you know, avoiding that obligation somehow in the future. So that's, that's an important consideration, but then also how is the money going to come back, come back to me? When will it come back to me? What should I expect to receive in return? And how am I going to be splitting the profits with the, the deal sponsor?

Sarah Florer (10:39.937)
Exactly. I mean, there's always, there's often, I guess, a preferred return, which is supposed to be something that you as an investor would get paid first, and it's usually percentage per year. Some not necessarily compounded, it can be cumulative, etc., etc. So this is one key term to look for. And I think you do normally see this in the preferred return will be prominent in the pitch deck.

Roland Wiederaenders (11:06.83)
For sure, and just to note that it's mostly, or what we're talking about primarily with the preferred return here is with the commercial real estate deal, right? Yeah.

Sarah Florer (11:16.747)
Exactly, yeah, of course, yes, of course. And that is important, Roland, because in the end, the different kind of investment is going to have different features that make sense because of the kinds of assets or the kind of investment that it is.

Roland Wiederaenders (11:33.239)
When the preferred return specifically though is good, it's good to know how that's structured as a fixed rate. And it's just noting the time value of money that you mentioned opportunity costs before. it's a nod to the fact that, hey, we've got your money and you could have been gone and bought a CD or something else, but instead you're investing with us and the clock is ticking.

Sarah Florer (11:55.887)
Mm-hmm.

Roland Wiederaenders (11:58.851)
The preferred return is a per annum charge on the money. It's a really good way to understand that the deal sponsor is trying to align their interests with the investor, that they're putting themselves on a clock. And then giving a nod to the priority of distributions for sure. We should give a preference to the investors.

Sarah Florer (12:18.459)
Exactly, however, mean, sometimes there's a preferred return that makes sense just on its own as the returns that someone is happy to get from an investment. But other times, that's just the beginning of the story of what you expect to earn from an investment. And that brings you to the profit splits. So how profits are divided after a pref rate is paid and...

Roland Wiederaenders (12:38.542)
That's right.

Sarah Florer (12:44.187)
Are there catch-up terms for a manager or a sponsor? In some cases, that makes a lot of sense. In other cases, it might be too much risk that an investor is taking. So that's something that you always have to look at. In addition to whether there's different hurdles and other features of a waterfall that can be involved in how ultimately the money from the deal is getting allocated between...

investors and the management or the sponsors of that investment.

Roland Wiederaenders (13:16.182)
And one thing to note is I counsel clients, Sarah, on backing into the investment returns in the sense of understanding that with respect to the different asset classes, there's probably going to be different expectations about the projected returns. And then once you can satisfy that, then

being conservative in your estimates and then seeing how much money you're going to be making from this because an investor will as a deal sponsor, the investor will be looking at that. And is that reasonable? And trying in all, all respects to try to be reasonable with the investors. And I think maybe that gets over to the next point, which is control.

Sarah Florer (13:49.722)
Mmm.

Sarah Florer (14:01.625)
Yeah, we'll get to that. Let's just quickly, just to make a note, because we want to, obviously people who choose to take the Term Sheet Tear Down ebook, you can see all these details there. But one thing just as a final point, Roland, is talking about the complete fee stack. So the way managers make some money is also through the fees, and that's completely legitimate. They are

doing a lot of work to manage the investment. But they are expenses to the deal prior to when there will be profits for distribution to a preferred return or other profit splits. So understanding the fees, the complete fees and how they fit and how they impact on the overall profitability of an investment is important too.

And also next to that was just also the general costs. Like there are going to be other costs involved in running the commercial real estate. They're always legal and accounting costs, et cetera. So those are all things that do need to be looked at as part of an analysis of a term sheet.

Roland Wiederaenders (14:55.805)
for sure.

Roland Wiederaenders (15:14.733)
For sure.

Sarah Florer (15:16.485)
So you ready to move on to pillar two? Let's talk about control, not to quote Janet Jackson.

Roland Wiederaenders (15:20.076)
Yeah. Yeah.

Roland Wiederaenders (15:25.922)
Yeah, I'll start out with this. generally, we like to represent issuers in these private securities deals. And it's a really simple reason, because we make more money off of that, typically. Representing investors is great, but the review of the investment documents generally can be done pretty quickly, unless we're doing a deep dive into the due diligence and really looking at

Sarah Florer (15:51.963)
Hmm.

Roland Wiederaenders (15:55.789)
just every nook and cranny, but as an issuer, we're for sure overseeing that. And what we generally try to do as attorneys on the issuer side is we try to give management as much control as is reasonably possible, but understanding that they're accountable to their investors. And so if they abuse that control, then the investors, of course, can get mad and, you know,

say that they're not taking actions in accordance with their obligations to the investors to act in accordance with the best interests of the company and all the investors, all the shareholders. wanting to really encourage people to give them that control, but make sure that they exercise the control in a real reasonable way.

Sarah Florer (16:45.525)
Exactly. and that's, there's, you an entire body of law that supports that built into fiduciary duties and, and just pure fraud, right? Not to mention, you know, the securities regulators who can also get involved when there are problems with people. But it is also still, I think, very helpful to just mention the different kinds of rights and control provisions that

If you are an investor looking through documentation, and especially if it's not making sense to hire an attorney to do that for yourself, that's part of why we've also created this is to try to help all the parties involved in these transactions because that ultimately helps the transactions flow more freely and be more stable. But in terms of the different rights, you'll see these are usually in the company agreement where the details really get

specific or the operating agreement depending on what state you're in. There'll be voting rights. Those are usually very limited. But you also might have reporting rights. You do some information on a regular basis and that's really important because that's an accountability question. You might have removal or replacement rights for management in certain extreme cases or if something, God forbid, happens to

the management team or a manager. And we actually talk about that often Roland with sponsors like what's your succession plan if something happens because investors need stability. You can have different veto powers on major decisions and limited cases I would say, but there are some basic times when the investors do get involved usually when things are.

not on a daily ongoing basis for just a normal investment under a normal flow. And then anything else you think, Roland, those are the major control provisions. And again, typically investors have very, very limited rights when it comes to control provisions.

Roland Wiederaenders (18:56.492)
Yeah. And on the flip side, there may be a more active investor that seeks out greater control. And so frequently, they're referred to as protective provisions that management can have general authority over all the affairs of the business except for these matters. So look for that in the term sheet, the accept, except for these matters, which must

be approved by majority of the shareholders or majority of the preferred stockholders or a specific percentage, or maybe the shareholders have a right to appoint one of the board members and that board member has to approve whatever the action is. Not the shareholder approval necessarily, but that specific board member. So really understanding what level of control you as an owner

Sarah Florer (19:35.13)
Yeah.

Roland Wiederaenders (19:55.545)
we'll be able to exercise over the management of the investment. you know, it's just, sometimes it's appropriate for you to have more control and sometimes it's appropriate to have basically zero control. And it just kind of depends on the deal really.

Sarah Florer (19:59.493)
Mm-hmm.

Sarah Florer (20:13.231)
It depends on the deal. then also we're going to get into that when we talk about Pillar 3, think. this is also part of as you increase it, as you apply a framework and understand more and more about the structures of deals, you'll understand where the control provisions usually sit and need to sit to make the deal actually work properly. Because over control in the hands of investors can actually have a detrimental effect.

on the investment as a whole if it causes things to not happen and quickly enough. So everything's a balance when it comes to control provisions and being educated about what to look for and understanding the why in a specific situation is important. So, shall we move on and let's talk about pillar three, downside protection. What happens when things go wrong?

Roland Wiederaenders (21:04.534)
Yeah. Yeah, yeah, exactly. And that's where it's good to consider the asset class for sure. Real estate at the end, even if you don't achieve your goal of rehabbing those units and increasing rents and increasing the valuation of the property, you still have the property ideally. You properly insure it and even a casualty, it still has some intrinsic value.

Sarah Florer (21:30.212)
Mm.

Roland Wiederaenders (21:30.518)
So structurally, looking at the asset type, if you have a software company and at the end of the day, you just have a bunch of code that only has value in the hands of that specific team and this specific application. And if you can't get the financing, it's really valueless at that point. Or hedge fund, could the risks of the trading strategies be so great that

Sarah Florer (21:51.471)
Mm-hmm.

Roland Wiederaenders (21:57.744)
you know, there's always a possibility that could go to zero, you know, the manager has to speak to that. So really you said it, what's, what is to guard against losing all the money in the worst case scenario.

Sarah Florer (22:12.459)
Exactly. I mean, that's one reason people like commercial real estate or real estate funds, because they seem to have a bit of intrinsic value built into them. But there are other things to look at, too. For example, I think this is a really important one or a good one, and that is asking the sponsor to co-invest or understanding if the sponsor has money on the investor side, let's say. So the sponsors put real money into the deal and isn't just

waiting to earn money from the work of capital that other people have put in. And I think with a lot of our clients, we see them more than willing and happy and wanting to join in, put in the same minimum amount or more as they're asking other investors to put in and on the same terms. So that money is where they earn the same way as an investor would earn with the same prep rate and that kind of thing.

When the sponsor has skin in the game as an investor, they don't want to lose their money either. So that's one great protection that you can look for.

Roland Wiederaenders (23:20.429)
Yeah, for sure. That is makes a motivated deal sponsor. I think anybody that has risk, their own skin in the game, like you said, has a lot more incentive to work hard to guard against that downside or to ensure the downside protection. So that's a really good point.

Sarah Florer (23:43.671)
You know, Roland, I don't know if you have another one, but I do have another favorite that's a downside protection. And the reason I like this is because we've had some clients who were used to be engineers and engineers are specialists in, I think, sensitivity analyses. And you know you've got a good sponsor when he gives you a spreadsheet that's tested about eight different scenarios of variations on interest rates and variations on different.

potential issues, for example, occupancy rates being at 70, 65, 85, 100, know, these kinds of stress tests and sensitivity assumptions, when you see, when someone presents to you, you know, the complicated spreadsheets that are involved in conducting these types of analyses, it's actually a very good indicator that they're thinking through the fact that...

you know, there's not just one perfect scenario where the investment will succeed that must happen so that people make some money, get make their money, make some money, or at least get their capital back.

Roland Wiederaenders (24:47.49)
Yeah, maybe it's just my personality, but I always really appreciate the managers that kind of go out of their way to show really what the worst case scenario would be, you know, and if they can show even in the worst case scenario that maybe my principal is still protected, then man, I feel a lot more confident in that investment.

Sarah Florer (25:07.885)
Mm-hmm. And I think those people tend to raise capital fairly quickly, I think, when you do see somebody who puts that kind of effort into the front end of presenting a deal.

Roland Wiederaenders (25:13.474)
Yeah, that.

Roland Wiederaenders (25:19.66)
Yeah, for sure. You want somebody that is going to present reality to you, not just a bunch of smoke and mirrors or rose colored glasses, I want somebody that is experienced and is telling me how things really are rather than what they're imagining they could be. Well, OK, we're coming up. We're like near...

Sarah Florer (25:30.614)
Exactly.

Sarah Florer (25:42.947)
Exactly.

Roland Wiederaenders (25:47.246)
26 minutes, so maybe we should get into telling people how they can get a copy of the term sheet tear down.

Sarah Florer (25:53.445)
That's a great idea. So yes, please. What you need to do to get a term sheet, tear down ebook for free, which is for subscribers, as we said, is first of all, turn your subscriptions into real investing edge. And if you're serious about this, can subscribe to the podcast and subscribe to the YouTube channel. So we have two asks for you. Subscribe to the podcast and subscribe to the YouTube channel.

Then you take a screenshot showing your subscriptions and email it to info at altinvestingmadeeasy.com with the subject line, term sheet teardown access. So this will also be set out in the show notes. Subscribe to the podcast, subscribe to the YouTube channel, send those two screenshots to info at altinvestingmadeeasy.com with the subject line, term sheet teardown access, and then.

We'll verify and send you a free copy of the Term Sheet Teardown PDF guide, which is the framework that we've started to talk about here. And actually, we'll also have further episodes, a few more, maybe as many as five in this series, to go through even further details about elements of the Term Sheet Teardown. Anything to add, Roland?

Roland Wiederaenders (27:09.826)
And Sarah, know, yeah, just to tell people why we're doing this, you know, we believe that the best investors are informed investors. And if you're willing to commit to learning by subscribing, we're willing to give you tools that actually protect capital. No upsell, no catch, just real value for serious allocators.

Sarah Florer (27:30.863)
So exactly, just to reiterate, you claim your free copy by subscribing to the podcast, subscribing to the YouTube channel, screenshot pre-fib both, and then email it to info at altinvestingmadeeasy.com, and then you'll receive your term sheet teardown. And we'll look forward to having you as a subscriber and hope to share very valuable content with you going forward.

Roland Wiederaenders (27:53.44)
OK, well, good deal. Thanks, Sarah. That was a good conversation.

Sarah Florer (27:56.891)
Wonderful as usual, Roland. And thanks to everyone for joining us today here on Alt Investing Made Easy. Please subscribe and like our channel.

Roland Wiederaenders (28:06.07)
And remember, take aim with your alternative investing strategies.

Roland Wiederaenders (28:14.41)
and you can say see you next time.

Sarah Florer (28:16.622)
see you next time.

Roland Wiederaenders (28:19.045)
Maybe give it a pause and then...

Sarah Florer (28:21.423)
See you next time.

Sarah Florer (28:25.328)
Actually, do we also want to add in?