Every investment decision requires proper research, so it comes as no surprise that many prospective investors seek additional information to get a deeper understanding of a potential alternative investment opportunity. There are a few questions investors can ask themselves as they develop their own personal due diligence strategy for asset-based lending investments.
When evaluating an asset-based lending opportunity, you can start by answering these five questions to help get comfortable with an investment. If you are satisfied with the answers, you are well on your way to determining whether it’s right for your portfolio.
Always try to understand what would happen if the investment defaulted, and what measures are in place to protect your principal balance. In a lawsuit funding opportunity, what happens if an obligor has an unforeseen collapse, or if an unusually high amount of cases fail to be settled? If the investment is a real estate opportunity, is the LTV (loan-to-value ratio) sufficient to cover the loan? What is the underlying collateral, and how is it structured? Figure out the different scenarios that could leave you behind, the likelihood of that happening, and make sure you’re comfortable taking and articulating those risks.
What was the underwriting process for this asset, and can you trust it? If you’re investing in a real estate investing opportunity, is the value based on a third party appraisal? Or is it based on similar properties in the neighborhood, and does it come from a reliable underwriting team? Make sure that the asset appraisal comes from a known and trusted source.
Investors should have a solid understanding of the borrower, the originator, and their respective track records. Look at the obligor’s credit rating, their historical losses, and management history to determine the trustworthiness of borrowers and originators. Ask yourself – Does the borrower have a proven history of repaying investors in full and on schedule?
Besides looking at the originator and borrower, investors should know who is investing alongside them, such as an institutional or accredited investor. In many YieldStreet investment opportunities, YieldStreet’s participation is only a portion of the gross investment and our investors are included alongside other institutional groups. This can be beneficial because it shows us that other third party investors have shown their confidence in the investment by performing their own due diligence and participating alongside YieldStreet. It also gives us peace of mind knowing that participants and the originator have a vested interest in the opportunity, and will thus work to ensure a successful outcome. Getting a good scope of who else is in the opportunity besides you – from the originator and borrower to other investors – will give you a further understanding of the opportunity’s quality.
Understanding the payment schedule and structure before investing in an opportunity will help prevent any surprises when the loan is in repayment. Are you comfortable with event-based payouts, which can be less predictable, or are you looking for a scheduled monthly payment? It’s important to familiarize yourself with how amortizing loans generate cash flows, and how investors get payouts from our event-based litigation finance opportunities. Make sure that the payment structure fits your cash flow and investment needs.
Once you’ve determined the structure of the offering and the potential risks, take a look at the associated yield or return on invested capital – does it make sense given the risk you’re taking on? A typical investor’s mindset is that a higher return means higher risk, but that may not always be the case with asset-based lending. Dig deep on the risk/return profile of the opportunity and make sure that it makes sense for your needs and your comfortable after calculating return on investment.
While these questions may not cover all the investor due diligence necessary before investing in an opportunity, they can provide a guideline to help newer investors get started on forming their own process. Armed with these questions, download an investment memorandum and do a practice run of reading through it to determine your level of comfort with the opportunity. If you think you are up to the task of digging deeper on an opportunity, check out what to look for in the memorandum for a litigation or real estate investing opportunity. Over time, you can build out your own personal due diligence process of what aspects are most important to you and learn to understand any asset-based investment.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.