The Long Arithmetic: Issue 14

A reader lost a good deal of money in private deals he was legally qualified to be in.

He is a physician, in the middle of a job change. What he wanted was for someone inside this business to say out loud that for a person without the hours or the training, a plain index fund might have been enough all along. He was not asking for a better tip. He is probably right, and very few of us will say it to him.

Here is the part that stays with me. Under the SEC's rule, an individual qualifies to invest in private deals by clearing one of two financial tests. Net worth over $1 million excluding the primary residence, or income over $200,000 on your own ($300,000 with a spouse) in each of the past two years. Clear either one and you are accredited, and from there the deals come to you and the deciding is yours. He clears both. So what qualified him is a balance sheet and a paycheck. One of those is currently in motion. His ability to judge a private deal has not moved an inch in either direction.

The rule was measuring his money the whole time. Some of what he lost was probably the year rather than the judgment. The rule never tested either one.

As rules go it is defensible. Somebody has to draw a line, and "can this person absorb the loss" is at least an honest one. (Those thresholds have sat roughly unchanged since the early 1980s, so inflation has been widening the door for forty years.) My problem is what happens to the rule on the way to you. By the time it reaches your inbox it has been translated into something warmer. You are sophisticated now. You have access. You have outgrown the index fund.

I have been on the selling side of that translation. I have structured private deals and read hundreds of private placement memoranda from the sponsor's desk, close enough to see how little daylight there is, on paper, between a careful deal and a flimsy one. The quieter version rarely gets said out loud: the law checked your balance sheet, and a balance sheet has never read a rent roll.

This is what I see. A private deal asks you for two things and mentions one. It asks for capital, which you have, since that is what got you the invitation. And it asks for labor, which appears nowhere in the projected return.

Consider what the work is, laid end to end, for one deal. There is the document. I have written about which few sections carry the real terms, so I will not repeat it. An afternoon if you know where to look, a lost weekend if you do not.

Then the part the document cannot do for you. Rebuilding the sponsor's assumptions in your own spreadsheet to see which one the return leans on. Learning enough about that submarket to know whether the rent growth is a forecast or a wish. Finding references the sponsor did not hand you. Asking questions that have no clean answer, then listening to how the answer is held.

Then the deal closes and the job keeps going. You are in this five to seven years, longer when the exit gets pushed. Quarterly reports to read rather than file. A capital call that arrives at a moment you did not choose. A K-1 that shows up in September on extension, after you have already had to guess at your own return. All of it unpaid, unscheduled, and invisible to everyone but you.

Now multiply. One private deal is a part-time job. Ten deals held for diversification are ten jobs. The capital divided. The labor did not.

Two things cut those hours, and I want to be fair about both. The first is repetition. The tenth memorandum takes a fraction of the time the first one did, because you go straight to the sections that carry the terms and you already know which questions produce a useful answer. The curve is real and steepest at the start. The second is AI. A lot of people now run these documents through a model, and for the mechanical part (pulling the fee structure out of ninety pages, listing what the projection assumes, flagging where two sections disagree) it compresses the reading considerably. I would take that help. What neither one does for you is the judging. A tool can tell you the return leans on a three percent rent growth assumption. Whether three percent is honest in that submarket is still an hour you spend yourself.

Some people love this job. I do it, I find it genuinely interesting, and the ones who are good at it would probably do it for free. The trouble starts when someone is handed the job without being told a job was included.

A client of mine spent weeks on a single sponsor. He is an accomplished IT professional with a demanding job, so this happened on evenings and weekends, in hours that were supposed to belong to something else. He read everything. He checked the history. He talked to people.

At the very end, he asked the sponsor a plain question. Had they ever lost money, or had any problems. The answer was no. Never, on either count. He said no to the deal.

I have written before about why that answer is a warning, so I will not re-argue it. What I want you to notice is where it appeared. The memorandum did not hold it. The track record did not hold it. The data room was complete, the references were fine, and the deciding fact sat in none of them. It came out of a question he asked out loud, late in a process that had already taken weeks.

That is the thing about this job. It never tells you in advance which hour is the one that matters, so you cannot buy only that hour. You do all of them to be standing there for that one. He could have stopped at week two with a clean file and a good feeling, wired the money, and every box would have been ticked.

His accreditation gave him none of that. The rule had declared him qualified before he read a page. What kept him out of a bad deal was hours. (If you have ever walked away late in a process like that, I would be glad to hear what tipped it. I read every reply myself.)

Key points:

So the useful questions before the next deal are about the job attached to it, more than the deal itself.

Consider how many of these you have already done. The first deal and the eighth are not the same job, and that difference is the whole argument for staying in this. So track it, roughly. If deal eight takes as long as deal two, you have been repeating a motion rather than building a skill.

Consider how many hours you actually have, and whether they are the kind that can hold a spreadsheet at ten at night. Consider whether you can do this for every deal you hold, not just the exciting one in front of you. And consider what those hours are coming out of, because they are coming out of something.

If the honest answers point away from the job, there are two decent moves and one bad one. You can hire the judgment, through an advisor or a fund whose whole purpose is doing this work for you, and pay for it knowingly. Rented judgment costs money and is less reliable than the pitch admits, and it is still a real option. Or you can own the boring portfolio and stop apologizing for it, which is roughly what the physician was waiting to hear someone say.

The bad move is the third one. Take the job, do a third of it, and let the size of the wire stand in for the work you skipped.

Accredited means you can afford to lose it. That is all it has ever meant. The word never asks the second question, which is whether you can afford the work that would keep you from losing it.

So the next time a private deal is offered as the thing you have finally outgrown the index fund for, consider asking what the job costs before what the deal returns. How many hours, for how many years, across how many deals, out of a week already spoken for. If the honest answer is that you do not have them, the arithmetic has just done its job.

Reply and tell me the last private deal you said yes to, and roughly how many hours you actually spent on it before you wired. The real count, including the weeks you told yourself you would get to it and did not. I read every reply myself, and I will tell you what I see across them.

Disclaimer: This is not financial advice. This material is for educational purposes only and not financial, legal, or investment advice. Private investments may be risky. Do your own research and consult licensed professionals before acting on anything specific to your situation.

Until Monday.

Alina