Decoding Private Investments: Private Equity, Venture Capital, and Real Estate

March 7, 2024

In this episode of the FIN-LYT by EWA, Matt Blocki, Jamison Smith, and Ben Ruttenberg discuss various types of private investments and their complexities. The realm of private investing has become increasingly accessible to high-net-worth individuals, and it is critically important to do proper due diligence and understand the nuances of these investments. Matt, Jamison, and Ben dissect the three main categories of private investments: private equity, venture capital, and more localized, mom-and-pop private deals, adding a fourth dimension with real estate syndicates. They provide a comprehensive breakdown of each category, highlighting the differences in strategies, the level of due diligence required, and the varying degrees of regulatory oversight. Venture capital and private equity are contrasted through their investment stages, the nature of the companies they target, and their ultimate goals. practicalities and pitfalls of engaging in private investments. In addition, they discuss the importance of a disciplined approach including critically assessing investor motivations and the potential impact on broader financial plans. This episode is a resource for anyone looking to navigate the complex landscape of private investing with confidence and caution. It will guide you through the risks, rewards, and realities of this challenging yet potentially rewarding aspect of wealth management.

Episode Transcript

Welcome to EWA’s Finlit podcast. EWA is a fee only RAA based out of Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you. And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everyone to this week’s Finlit podcast. Today I’m joined by Ben Ruttenberg and Jameson Smith. Really looking forward to this podcast. We have a lot of questions come in with private investments, a lot know high net worth clients get pitched all kinds of things at all times of day, it seems like.


And so we’re constantly doing due diligence on the behalf of our clients to vet out these deals and as such we’ve have some really good perspective on what’s worked and what’s not worked. But a lot of times with these private investments, it could be a guessing game. So speaking of guessing games, I wanted to pick your brains. Who do you think this week is going to be? The second round of the NFL playoff? So who do you guys like? Jameson, we’ll start with you. Who do you think is going to win the Super bowl?


So this is definitely going to air after maybe even after the Super bowl. So I think in the AFC, I think the Chiefs are just like they’re coming alive. I think the AFC is wide open. They have playoff experience. I like them to go to the Super Bowl. I think Baltimore is the best team, but I don’t know that they haven’t shown they can win the playoffs. Chiefs and then, I mean, 49 ers have just been dominant.


I think that’ll be who’s going to take it. 49 ers go with the Chiefs.


I think they’re going to do it. I don’t know. I’m a huge Patrick Mahomes fan though, so I’m totally biased.


But yeah, if he stays healthy there, he can beat anyone. Ben, how about you?


I’ve been all in on the Niners all season. I think they’re the best team. I understand the Ravens beat him in the regular season, but I’ve got a lot of faith in Kyle Shanahan, in Christian McCaffrey, Debo Samuel, Nick Boso. There’s just too much talent on that team and I like the way it broke out for them in the NFC. Dallas and Philly are out. I think they have an easy path. So willing to be know we’ll see when this airs, but I got the Niners definitely coming out of the NFC and probably winning the zoo rule.


Who you like in the AFC?


Probably Baltimore. I think their defense has been really good, especially in the second half of the regular season. I feel like they’re getting. I like, obviously it’s hard to bet against Patrick Mahomes, like you said, but I think they’ve got a much tougher test with Buffalo in the divisional round. I think that’s going to be a war, and I think Baltimore will take care of business against Houston. So I think it’s going to be a great Super bowl. If it is Niners and Ravens, you’re.


Going to get Stroud.


I know CJ’s my guy. He’s had an amazing rookie year. Very happy for CJ. But I think they’re playing a different animal in Baltimore.


Who do you like? Well, I have so many things I want to say to Ben right now. I’m going to limit it to just a, you know, the, can’t they just win just like, you know, won the whole thing? They beat Ohio State. I hate to say it. I think Harbaugh, the other Harbaugh, the better Harbaugh, because he already beat his brother in a Super bowl, is going to take it this year with Lamar behind the wheel.


We were talking yesterday, has Lamar Jackson won a playoff game ever?


He’s one in three, I think.


One in three.


One and three. Yeah, I know they lost when they were a one seed to the Titans. They were a big favorite and they lost last year.


The Titans upset everyone on the playoffs.


Though last year they did not play. I remember. I think they lost to the Chargers one year. But, yeah, I mean, he could use a couple of wins, that’s for sure.


All right, I guess this could be a sports podcast. How knowledgeable you guys are. Hopefully you’re as knowledgeable as sports, as your private investments. We’ll see. Anyway, so thanks for those prediction, guys. So, Jameson, tell us first, we have this broken down. I would say there’s really, in general, there’s like three types of private investments. There’s private equity investments, which is a lot of people think they’re doing private equity and they’re not. Private equity is like basically these big mega firms, rich firms that have a lot of money that basically own everything. And most people don’t know they own everything that’s not public. Then there’s the venture capital world, and then there’s just kind of the, we’ll call it like the mom and pop private deals, where it’s like a friend or family member starting a company from scratch.


So those would be the three categories. You guys have any other categories you’d add to that?


I would just categorize all these as alternatives. So anything that’s not like on a publicly traded market, I think that’s a good description of the three main.


The three main opportunities.


I would say maybe real estate. There’s a lot of real estate syndicates, deals that fall under that category.


Maybe four. Private equity. There’s venture capital, there’s like the mom and pop, just private deals. And then there’s the real estate stuff.


And these would all be categorized as, like you said, alternative investments. So outside of your retirement assets or outside of your non qualified brokerage assets, this is a totally separate category. And we’ll get into why that’s important.


In a second before we dive into specifics. I guess the big difference is, like a publicly traded company on the stock markets, regulated SEC, there’s a ton of regulation. A lot of times these are, there could be regulation, but a lot of times there’s much less regulation. So that’s one of the main differences, is it’s literally totally private.


Yeah, absolutely. So who wants to take private equity?


Sure. Yeah. Private equity, basically, like you said before, massive companies, it involves investing in private companies or companies not publicly traded on any sort of stock exchange. And some examples of really large private equity firms would be like Apollo Global Management LlC, they have $150,000,000,000 valuation. Caesars Entertainment Group, they’ve invested in. Norwegian cruise line they’ve invested in. Their strategy is to buy most quick.


Side note, norwegian cruise line someone signed me up for as a prank, signed me up for a thing, I blocked the number. I still get like, you know how that voicemail show up on your blocked list every day? I still get it from a year straight. I get a call, tried to try to sign up for norwegian cruise lines. I’m guessing that’s probably one of their most profitable investments because they’re funded by.


A company that has $150,000,000,000 valuation. Someone had their coffee that morning when they figured that out. But their private equity firm, their strategy is mostly to buy mature companies that are already established and their goal is to streamline operations to ultimately increase revenues. So generally speaking, private equity firms will buy 100% ownership of the companies that they invest. Usually can be in any industry, which we’ll get into the differences between vc and private equity in a second. But usually when you buy such an established company, there is an expected positive return because you’re buying an established company, and you’re looking to just streamline operations and try to make things efficient moving.


Forward, and then flip it. So basically, private equity companies, generally speaking, they’re looking for, like, three to five year exits where they’re double three xing, maybe even four xing, ten xing their investment, and they’re flipping it. So private equity companies with billions, like you mentioned, Apollo, $150,000,000,000 valuation right now. Blackstone, 146,000,000,000 in private assets. These companies aren’t messing around, so they’re not going to go to you and say, hey, we want 50k minimum investment come in, and it’s just unavailable. Unless you have, like, hey, here’s 100 million I’ll throw into the deal. This is just going to be off limits. A lot of people think they’re doing private equity. You’re not.


Private equity groups are preserved for the super top 1% of the top 1%, or you’re a partner in a private equity, and typically, you’re putting your own money in to fund deals along with debt, typically. And then if it goes well, you’re making a lot of money.


Just real quick on that. 25% of all private equity deals are between 25 million and 100 million. So we’re talking about, like you said, super high net worth. People might be thinking they’re doing private equity when they’re doing other types of.


Investing, which we’ll get into. But real quick on the private equity, there has been a movement, again, because a lot of private equity, unfortunately, they’ll make companies go grow. And then the exit sometimes is to ipo, and then all the people that are in it big want their money out. So then it almost becomes like a pump and dump scheme, where then it goes public. All the middle class people say, oh, I want in. That’s like super, like, Instacart. I want to buy the shares. Well, the easy money has already been made. And then all the rich people exit, take their two x, four x ten x profits, and then the share prices crash. And that’s why we did a podcast on this recently.


But it’s, like, over, I don’t know, like, two thirds of ipos in the last couple of years have been. You’ve lost money. Historically, that hasn’t been the case. Ipos are basically a way to get wealth transfer from poor people to rich people at this point. So be really CArEFul when an IPo occurs, it’s probably not what you think it is. So, James, anything to add on the private equity side before we pass the ball to YoU for venture capital.


No, I would say their main goal, like a private equity firm, it’s pretty cutthroat. That’s a tough word. They care about profitability. They want to be profitable. That’s what they’re looking to do.


They’re extremely good at their jobs. We have some clients of private equity. They do very well. And from what I understand from the clients that we work with, I’ve never heard of them doing a bad deal. So they’re doing not guaranteed deals, but deals that are highly in their favor that they’re going to be able to flip for a huge profit. In forex, basically, private equities is like, get out of the way kind of deal. What they’re doing are, these are Ivy League, Harvard, Princeton, like, the elite of those schools are going in to work at private equity.


Smart guys, really smart guys and girls that usually have a lot of third parties, too, with a lot of due diligence. So this involves a lot of management consultants, a lot of lawyers, a lot of auditors. There’s just a lot of parties in figuring out which deals to make and processing the deals as they come. We’ll get into other types of investing that there may not be as much due diligence or as many kind of heads at the table trying to figure out how best to do this.


And one more thing I’m going to say is that private equity has stormed into the RAA space. And in my humble opinion, it’s created a lot of conflicts of interest because a lot of advisors have exited big broker dealers. Because of all the conflicts of interest that existed. I want to wear one hat for clients and now assume that a private equity company comes in with their only goal is profits. Imagine now the pressure on that rea to produce profits if they accepted. A lot of times I’ve seen, like, I’ve had some friends sell, like, 20% stake. So a lot of times, private equity deals, like, they take over the whole company. Sometimes it’s a minority stake, but I have seen it can do really good from a growth perspective. It can also produce conflicts of interest.


So we’ve been approached several times that politely have declined as the goal here is best service for clients, have a company that exists long term, and eliminate conflicts of interest. So that’s been the route we’ve taken thus far. So, had real life experience in that, which is pretty cool, but. Jameson, venture capital, what is it? What are some examples, et Cetera?


So venture capital is, I guess, essentially like the opposite end of the spectrum. They’re looking for small startups. This is really popular in the tech mean. I’m like a huge nerd. I love learning about this stuff. But I think of that show about Uber. What else? There’s the show about Elizabeth Holmes. It’s on Hulu that talks about this stuff.


That show about Uber is pretty good. What’s that called? It’s on Netflix.


Super pump.


Is there another season going to come out?


I don’t know.


Because it kind of left at a pretty big cliffhanger.


Yeah, that’s a great show. And then what’s the bad blood? Is that the. Her whole thing was great. Anyway, any movie show about a startup, they’re just going to be some sort of venture capital firm.


Usually that’s real life, though. Uber wasn’t venture capital based.


Any big tech company that’s blown up in the last 20 years has been backed, mostly has been backed by a venture capital firm. Because basically what happens, you have a lot of these. Like, if went and started a tech company and our goal was to get like a billion dollar valuation, they may be like, hey, you guys are young. We need somebody that’s done this before, has experience, that’s exited companies, and they’ll bring them in, they’ll fund it and then kind of oversee everything. And it’s kind of like. It’s like a meme you would see, but it’s almost like having a parent on a young startup founder.


That’s like a chaperone.


Yeah, basically is like what it is. Anyway, so similar private equity, their main goal is to take startups with high potential and then get them to grow IPO, exit, something like that. And a lot of times these are like. Or at least from what I know about venture capital funds and firms, they’re more of like, they’re cool if like one in 20 hits, because that one that hits is going to be like 100 x.


The return, it makes up all the losses.


Yeah. So it’s like. It’s almost like gambling, whereas, like, private equity, it’s more of like, hey, we know this is going to work and it may not hit as big, but they want more wins.


I guess that’s why if you approach a private equity company and say, hey, I want to put 100,000 in, they’re going to laugh at you. But a venture capital company would say, probably take it. Yeah, we’re going to put it in these two deals that are far long shots.


Yeah. Like you said, james, the private equity, these are established companies that are looking to make profits. VC is, hey, there’s a new AI tool, there’s a new biotech tool, new clean technology tool, like new niches, new industries, new ideas. That’s primarily what’s funding these new VC deals. Whereas private equity is the total opposite. It’s super established, super high barriers of entry, total opposite ends of the spectrum, like you said.


And so, like popular common firms like Sequoia Capital is a big one. They backed Google, Apple, a lot of tech companies, and Horowitz. I actually, that book, the hard thing about hard things we’ve talked about, that’s Mark Andreessen or, no, sorry, Ben Horowitz wrote that. Mark Andreessen wrote something else. But basically they were in a lot of these guys. They’ll start a tech company, they’ll sell it, and then they move over to venture capital. Like Peter Thiel has a venture capital firm. And that’s really the goal.


The famous guy that put all that in the Roth.


In the Roth, the PayPal stock, $5.


Billion in the Roth.


I think it’s PayPal.


Or is that right? 5 billion or something like that.


Something crazy. Yeah, man. Yeah.


And he’s basically who caused the Silicon Valley bank to collapse through Twitter or an ex tweet or whatever. Was that Twitter back then?




Interesting character.


Yeah. Really smart guy, but, yeah. So that’s basically it. Been anything to. I know you did a lot of research on this thing to add.


Yeah, I would say, like I said, the private equity is usually between 25 and 100 million. Like, most of those deals fall in that range. Vcs spend generally 10 million or less. Startups are usually very unpredictable. And then there’s also very little due diligence required, if any, as like a VC investment can be made because someone believes in the firm founder’s idea. And that’s basically all the green light that they need to actually start giving money. There’s not a lot of auditor, lawyer, consultant work like a private equity deal would be. VC is like, hey, that sounds like a good idea. Like, yeah, sure, take it.


That’s a good point. And I’ve read Peter Thiel’s book. I’ve read, like I said, the hard thing, but hard things. And I’ve heard a lot of these guys talk. They literally will say, we want a founder that just like, we like who they are as a person. We think they’re determined, and whatever that person touches will be successful. So to your point, there is not a lot of due diligence. There could be not a lot of color, black and white facts. It’s just like, hey, you seem like you have character traits of a successful person. We’re going to bet on you. Which obviously could have huge upside or could fail miserably.


Yeah, no question. Well, let’s talk about the differences then. So you hit on some of those, the amounts. Ben, what are some other ways to distinguish between private equity and venture capital?


Yeah, outside of what we’ve already mentioned, I think a couple of the big differentiating points between private equity and VC. Number one, private equity generally use both equity and debt to invest, whereas most VC investments use just equity. There’s usually not a lot of debt involved in any sort of venture capital. And just on both sides, like VC firms generally will invest small amounts into a seed stage. Like if a company hasn’t gotten off the ground yet, you’ll see smaller investments, whereas if they’re in more of an expansion phase, you’ll see larger sums invested. So a big differentiating point is that when these investors actually do invest and they obtain equity, just depends on how much voice they actually get in the company’s decisions.


So a lot of times, like VC firms will want someone’s funding, they’ll want to gather funding, but they don’t necessarily want them to have a say in the company’s future or have a say in ideas. So that could be a differentiating point in private equity and VC, where VC you could have investors start getting equity and a voice in a company’s decisions, whereas private equity is mostly just funding.


Perfect. Okay, let’s go into the third category. So just like private investments. So private investment could be a, I mean literally anything. Like, I’ve seen it all from a, hey, we want ten people to invest, we’re going to buy car washes and that’s kind of like a real estate syndicate. We’re going to give you an 8% guarantee and you’re going to get 20% of the profits or just something simple. So I mean, everything like this, we’ve analyzed, we’ve seen parking lots, shopping plazas, literally anything. Yeah, malls. We’re going to go in and we’re going to put in franchises, any amounts of stuff. I want to focus real quick on the real estate stuff. I think this is really interesting.


Every real estate investment I’ve seen typically guarantees like a high interest rate and then some kind of fee and then some kind of profit share on the back end. I recently, I did this chart because one that I was looking at was like a 16% simple interest. So it’s like, okay, that’s pretty high, right? But if you look at the stock market, historically, it compounds at nine SP 500 compounds at over ten. Yeah, but that’s like the last 100 years. But let’s back a percentage off one and a half percent off, et cetera. So if you look at five years, if you had $100,000, you put into an investment 9% versus 16%. The 16% wins over five years by 23,000.


Simple interest.


Simple interest. But then if you look at 30 years out, the simple interest, even though it’s 16 versus a nine, it’s $893,000 behind.


What’s the initial investment?


So 100,000, if it’s compound at 9%, would grow to 1.47,100,000. If you get simple interest for 30 years, would grow to 580,000.


Can you explain the difference? Just like in you’re talking to your golden retrievers, Sammy and Chloe. Like, what’s different between simple and compound?


Yeah. So compounded, you’re putting, let’s say the simple interest, you’re getting 1616 every year. That’s not getting reinvested, just on the 100. And then compound will be you’re getting nine, but the nine is getting reinvested. So now you’re getting nine on 109. Then the next year you’re getting nine on 118. And it keeps compounding and compounding, and there’s a hockey stick with compounding interest that just explodes, like after 1020 years. So that’s one thing, piece of advice. We’ll go right into advice now, but a lot of times it’s kind of like index. Sometimes private investments can look as good as indexed annuities, which we know are like the worst creation and financial planning ever. Probably anything indexed, like indexed annuities, indexed life insurance, et cetera. It’s like, oh, stock market returns and no downside risk.


What the reality is like, no, you’re going to end up getting less than you would get in a CD in a bank long term, and the policy expenses are going to make you implode early. But anyway, so we actually did a podcast just on that, on the annuity, so we can reference that. But let’s go through piece of advice. If clients are looking at private investments, how do we advise, how do we recommend the due diligence, et cetera? So let’s just go around until we run out of piece of advice. But James, what would your first piece of advice be?


I would say really do your homework and ask the right questions because like you said, they look shiny and cool and great. But then when you pop the hood open, there’s a lot of hidden fees. There’s a lot of just a million things that aren’t necessarily disclosed. So I would say ask the right questions and do your homework.


Yeah. So out of all, we generally recommend against private investments, but unfortunately, they’re really cool to talk about, and it’s kind of like that sexy part of investing. So sometimes we’ll be in meetings where we’ll talk about now or just about the private part of the balance sheet. So I actually did just a data set on our clients. Now, granted, we have, what, about 400 households at this point? And so only 10% of them have done private investments, like a little bit less than 10%. So I’m just rounding up just to make sure we’re not misquoting here. And out of the 10% that have done them, there’s been about under 300 deals that our clients have done in private. There’s been several clients that have done the majority of those.


But then in further looking at out of those deals, ones that are at least three years or more mature, like you made the investment and three years have gone by, less than 10% of those to date. Now, not saying they’re not going to hit, have hit. And so a lot of those investments, we’ve had a couple of things in common. There was big promises up front, but in the reality, what’s happened is with interest rates going up, the companies are going back to the investors asking for more money because debt payments are coming due. And now instead of having a 3% interest rate, they have 7%. So as a small company, if you have gotten funded privately and you’re a high risk, most likely a bank is not going to give you a good interest rate.


If you say, hey, we need a couple of million dollars to survive until our company gets sold, it’s just not going to happen. So a lot of these come with capital calls, and you need to look at the agreement. Like, if I invest 100k in three years, are you going to come back to me for another 100k? Or if I don’t give you that capital call, are you going to dilute my shares drastically? So all questions, all things you have to look at contractually before you make the investment.


Yeah, I think about that. Like, if you’re doing like a trip to Vegas or you’re doing a trip to the casino, popular strategy to make sure you don’t run out of money is take out money before you go and then tell yourself, hey, I’m not taking out anything. What if I go down this, I’m done. That’s that very responsible way to. Yeah.


Or you do that, Matt.


No. Why are you laughing at me? I just don’t carry a debit card around me, so then I’m not tempted.


Think about that. In relation to the private equity deal, though. Say, hey, I’m putting in x in this period. That’s it. If they call me for more, am I going to put in more? If they call me in a year and they’re struggling and they need x to fix this problem that I didn’t know existed a year ago, am I going to put in more? Am I not going to put in more? Having those boundaries in place before you make the investment is so important because we’ve seen this kind of spiral where it starts out as an x investment, it turns into a y investment, it turns into a z investment, and we’re going to have some kind of guardrails in place for how much of our net worth we want to stay in private equity.


And that’s the quickest way that this can get kind of out of control.


Yes. Oh, go ahead, James.


I was saying, what guardrails do we recommend?


Yeah. Lesson. So, first of all, make sure our financial planning is on track. Period. No correlation, no need to have a big private investment, hit or not hit. Assuming it’s on track and you have excess funds, make sure it’s no more than 10% of your balance sheet at any point. So if your balance sheet is 20 million and your plans on track with ten, even though you think, oh, that extra ten, I can just play with never more than 10% of the total. So no more than 2 million in that example, should be in these kind of private investments. Because what can happen is if you put all ten and then this ten, you kind of become a house.


To put this, that ten kind of masters you where now it requires your time, it requires your attention, all these board updates, and then, oh, we need capital calls. Well, now you’re pulling from your good ten. That’s a financial planning ten to support the risky ten. So 10% or less of the total balance sheet. And that’s assuming the financial plan is already on track. And then extreme due diligence. In reality, you should only be doing, like, one out of 20 deals that come across your plate because there’s a lot of bad deals. Every pitch is going to be amazing, but in the reality, the likelihood of someone coming to you with this bright idea and then be able to execute it start to finish, I think statistically it’s like, what, less than 5% of businesses of, like, startup from scratch businesses actually make it?


Yeah, like most fail.


Yeah. Like most financial advisors that can go to a big broker dealer, 3% of them make it. And that’s kind of like a startup business. And they have a playbook to follow. If you follow this playbook, you’re guaranteed successful. It’s still only 3%.


The only ones that succeed are the ones that are sane enough, that think they can compete. Insane enough, I guess, or however you.


Want to look at it, I guess the venture capital people have it right. They pick the right people. And that’s totally different than private equity, because private equity is like going after companies that have already shown big success that can just improve stuff. But again, that’s why private equity is not available to individual investors. Even if you’re a credit investor, typically you’re not going to have enough money to get involved with, like a private equity firm. Okay, what else? What other piece of advice do we have?


Yeah, I would say I was bringing this back to sports, but I was just watching a 30 for 30 recently called Broke, which is a documentary.


Good one.


It’s a really good one. It’s about how athletes go broke. There’s a lot of good lessons around taxes, and it circles back to private equity here, because a lot of athletes are almost preyed upon in terms of, hey, it’s very public, their net worth. Like, people know that they have money. Their contracts are easily googled and readily available to see, and so they get pitched all the time. And oftentimes they have family members or best friends that say, hey, I got this great idea. All I need is your money. And they know that you have it. So learning how to say no, and especially when it comes to friends and family, in regards to these deals, that’s so important. For all the reasons we said, not all of these will be successful.


And then in regards to how to keep your total net worth under, keep your net worth and your private equity deals, make sure that’s in balance. Learning how to say no, even if it’s a friend and family, understand that your financial plan needs to come first in regards to that.


And fortunately, I’m going to say a couple of things with that psychology in our brains. We’re completely opposite to all this, because humans, by nature, we’re in the most nonviolent world we’ve ever lived in. We have less poverty than in history, technology advancements. We have more people going into middle class from poverty. And so there’s all these good factors, and still people aren’t as happy as they were. So we’re sending this book out from Morgan Housel same as ever. One of the big points we make is like one of the happiest points was like after a period of the Great Depression, then it was kind of boom, just like everyone was happy because that perspective, well, now we don’t have the perspective. We just want more and more and more.


And so humans by nature are just so competitive that if they can think I can get an upper hand on my friends and family and make this invest, could change my life if it ten x’s, that’s like literally a wolf of Wall street. Like, people were buying penny stocks, which were like the worst investment, worse than any investment you could ever make because of the pitches being so great, of like you could pay off your mortgage. So just realize to have to know yourself, it’s so hard to stay disciplined and keep that perspective in place. But it’s so easy to say, yeah, I want to do this. This could change my life if it happens, when more likely it could really hurt you if you put too much in.


And then the second thing I’m going to say is a lot of these private equities. Morgan Housel, in that book, he talks about, in some recent podcast interviews, he talks about this concept of social debt. So back to athletes. He said, athletes don’t go broke because they spend too much. They go broke because of their fifth cousin buying them a house. And so they grow up in poverty, and then they buy their mom a house and their cousin, and then it’s like their fifth cousin or whoever is like, I need to buy him a decent house. They just can’t afford to do all that. And I’ve seen that play out in private equity deals. I’m sorry, not private equities, private deals, where it’s kind of like, okay, here’s my friend. He’s a founder, I’m going to fund him, and then suddenly it’s next year.


He needs a little bit more next year. And so you kind of feel your friend knows how successful you are, how much income generally you make. You’re good standing, and now suddenly you feel the pressure to fund that debt when it’s not on you. But it’s very similar to what athletes go through with their family and friends. These private investments. If you’re dealing with friends and family, it can kind of turn into that social debt aspect a little bit. And we’ve seen that unfortunately happen in real life. Not to a devastating point. But it’s like, to a point of, like, wow, if we didn’t have these investments, we could have, like, double the net worth right now. Okay, well, let’s assume that you’ve made a private equity investment and it’s gone. We think it’s going really good.


Like, okay, in a year or two, this may be one of the ten that actually hits it big. So, from a financial planning standpoint now, what are some things that we could do? What are some tactics we could do to plan efficiently for taxes or whatnot?


This would be harder to do, but like you said at the very beginning, we’ve seen these owned inside of a Roth IRA. So you could buy it with, like, an IRA and then convert it to Roth, or buy it inside of the Roth IRA. So if you have the ability to do that, you could avoid a lot of taxes. That’s one.


Yes. If you have, like, 100,000 you put into investment. We have a couple of clients have done this. You set up a self directed IRA that way, if it’s a ten x, or if the 100,000 turns into a million on the back end, that’s all tax free. It’s all in the Roth, and you get to kind of invest it regularly after it hits, versus if you put 100 in, just with cash grows to a million, then you’re paying capital 23.8%. If you’re a high income earner of that 900 is going to go right to taxes. That’s as, like, low hanging fruit. If it’s a high conviction, if it’s a risky investment, if you put in a Roth IRA, you’re wasting precious Roth money on something that could go to zero. So that’s a really. You could look like a genius if it’s done right.


Or you could be like, oh, that hurt. If it goes bad. Yeah, that’s a good one. What else?


I say a trust, irrevocable trust. So use that $100,000 investment. Again, I’m not going to get into the details of. Let’s just say you’re able to get that into a trust through gifting. And you do that 100,000 now is out of your estate. If you’re ever the estate exemption, and you use up your estate credit, that’s taxed at 40%. However, if that 100,000 is now out of the estate and it hits to a million, now that million is entirely out of the estate, while you just use the gifting exemption of the 100,000 and could avoid that 40% tax. So irrevocable trust will be another way.


And that’s typically one that comes with a low with no repercussions. Let’s say you’re a married couple and you have three kids. So one spouse, it’s 18,000 per kid that you don’t even need to report. So three times 18 would be what? And then you have a spouse that can do 50, that’s times two, that’s 108. So you could put that 100,000 in without using any of your lifetime gift exemption. If it was a joint investment that you and your spouse made. And that way, if it hits awesome, if that 100,000 grows to a million, that’s out of your estate. If it’s in a spousal life access trust, technically you can still use the money through your spouse as the trustee, et cetera. But then also if it doesn’t hit, and you weren’t using that exemption anyways, no harm, no foul, probably already have.


The trust in place anyway.


That’s one we love. Because if it does hit, awesome. If it doesn’t hit, we didn’t get hurt at all. If it was a small enough investment to not utilize gifting exemption, even if it was a big enough investment to utilize gifting exemption, this is like an 80% probability it’s going to hit in two years. That’s still a great time to move it in there at a low valuation, let it pop inside the trust, and then all that appreciation is now out of your estate forever for kids.


If that’s your goal, that’s probably the best way. But we’ve also seen people just put it in kids names directly, similar type thing, than if it hits, the kid has the money.


Yeah, especially if your kid is under over 18 and responsible trust probably makes.


Some extra protection mechanisms, but for sure, one way or the other will get the same outcome.


Okay, awesome. Well, any closing thoughts on private investments? Ben, throw the ball to you first.




I would just say, just to recap everything we talked about, know what you’re getting yourself into, understand the difference between is this a VC investments? It’s just like my friend has an idea, how much am I going to be putting in upfront? Is there going to be any more additional calls? And then be aware, like, do I actually believe in this idea or is this a family or friend that’s soliciting me?


Absolutely. Jameson, what about you?


Yeah, I’d say do your homework and then make investment. Know we talk about on three things. Number one, what’s the rate of return? Obviously the rate of return here could be good. Number two, what’s the time? Your time commitment, how much of your time is it going to take? And number three is stress or peace of mind. So usually use those three things as a decision making framework for investments.


Yeah, my advice would be all what you guys said, and I would ask yourself a lot of questions, is it passive or active? Oh, it’s passive. Is it really passive? Go deeper. Well, from our experience, the passive investments turn into now that founder wants you on like a board meeting update call every quarter. Now they’re soliciting you for more money, now they’re soliciting you if you know any friends that want money. And now it’s kind of like you’re orchestrating almost not a full time job. That’s not passive. Passive means you put it in and three years from now you say, hey, good news, here’s three extra money back. That’s passive. Passive is not constant communication and updates and letters and asks. That’s not passive at all. So you have to ask yourself, is this passive or active?


Typically, if you have the money to invest in a private equity firm, you probably don’t have the time to be active in your private investments. You’re making your money on your day job or your business or whatever it is. So protect your time at all costs. That’s number one. Then number two again we talked about is the capital calls. This is a one time contribution. Am I be expected to bankroll this company until it fails or succeeds? And number three is just ask yourself, why am I making this investment? And go seven layers deep. I think it’s a good investment. Well, why is that? And typically you’ll arrive to, okay, this is a no brainer. Or you arrive at like, this is just stupid gambling. I want to feel good. I want to talk about it. You know what?


I can achieve this by just diversified investing and be just as I may miss that happiness or that dopamine hit of talking about cool stuff with my friends, but I’m going to protect my time and my peace of mind and my financial resource I’ve worked so hard to create. So those are my closing thoughts. But as always, thanks everyone for joining and look forward to catching you next week. Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast and please share with any friends or family members that would also find this beneficial. Thank you very much.

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