Desperate people do desperate things

My life is filled with so many memories.

Many of them are good – amazing even, like the birth of my children and now my grandchildren as well. But I have plenty of darker recollections as well, including my mess of a business partnership back in the 1990s.

I was a commercial real estate (CRE) developer at the time, and we were developing two large shopping-center projects together. One was a grocery-anchored center with a total development cost of around $10 million. The other was a Walmart-anchored mixed-use project valued at approximately $50 million.

I had personally made sure they were properly and even conservatively capitalized. So they almost certainly would have worked out if my partner wasn’t developing a large hotel and conference center project on the side.

From the beginning, something about that situation bothered me. Or maybe I should say there was a lot that didn’t seem right, including how it lacked sufficient equity.

Large hotel developments are operationally intensive, highly leveraged, and extremely vulnerable to delays, cost overruns, and changing market conditions. As such, they can quickly become financial black holes if anything goes wrong.

I knew my partner – let’s call him Dave – didn’t have enough capital to successfully complete this one. And as the project unfolded, it continued to consume money at an alarming rate, leaving him desperate for liquidity.

So desperate that he turned to me for help…

Without actually asking my permission.

You see, both his hotel and our shared shopping centers utilized the same construction manager. And so he began “transferring” costs between the projects, as it were.

That saga was how I learned an intensely valuable lesson about risk. And I learned it in about as painful a way as possible.

I first noticed problems on my side of the fence when the Walmart development began costing more than originally projected. When I asked about these escalating bills, “Dave” – who handled all the actual finances – told me that construction costs had escalated.

That actually happens often enough with development projects. Unexpected expenses just have a way of popping up.

Even so, something felt off.

By the time the Walmart project was almost done, its change orders exceeded $500,000. And when my concerns were once again swept to the side, I decided to do my own investigation…

Only to find that the invoices and supporting documentation simply didn’t match up.

Since I knew Dave could do math just as well as I could, I came to the logical conclusion: He was intentionally screwing me over. Moreover, I learned, he didn’t have the money to pay the contractor without (actually approved) help from me.

In order to keep the Walmart project moving forward, I agreed to co-sign on what can only be described as a usury loan from a lender known as Instant Cash. It carried a 4% monthly interest rate, which amounted to nearly 48% annualized.

We rationalized that “deal” because we thought we’d be paying it off in a mere month or so. After all, Walmart was supposed to release payment shortly after site delivery, and we’d then put those proceeds toward our debt.

That was my plan, anyway. And who knows. It might have been Dave’s, too. Except that he was still making really bad decisions on the side that he couldn’t pay off on his own.

So while we did use that Instant Cash financing to pay off the contractor, he then used Walmart’s payment to satisfy one of his other obligations. Our debt therefore remained outstanding, racking up month after month of interest.

And it only got worse from there.

As I would come to find out all too soon, Instant Cash had illegally secured several of Dave’s and my shared assets as collateral for the loan.

Dave had signed off on that agreement.

I had not.

One of the assets in question just so happened to be a prized shopping center in Spartanburg, South Carolina. It was one I’d spent years building and stabilizing, with more than $5 million of my own equity tied up in it.

That property was one of the crown jewels of my portfolio. And I took a lot of pride in it.

Yet as everything came to light, I realized there was no way around it. The shopping center had to go into foreclosure.

Devastating though the decision was, there was nothing I could do to stop the pain of losing my hard-earned equity.

I paid the price of trusting the wrong person: an experience I’m never going to forget. Nor do I don’t want to.

It’s not that I’m bitter and want to hold a grudge. Truly. I’ve long-since forgiven Dave. However, the whole rotten experience taught me a lot about how to avoid similar pain in the future.

Because of his “poor business practices,” I got to see an invaluable example of leverage, governance, liquidity, and human behavior gone bad. That changed how I think about risk.

And that, in turn, made me a stronger, smarter investor with more significant profit potential.

To this day, whenever I analyze a company – including its assets, history, and balance sheet – I make sure to consider its management team as well. Trust me: None of the other details matter much if they’re left in the hands of unscrupulous, unwise, or otherwise unattractive management.

I can’t stress this point enough. A company can have the most amazing products or services. And it can have piles of cash to burn as well.

But I won’t invest in any of it unless I can trust the people in charge.

You should think twice before you do as well.

If I can sum up my own personal experience through all that misery, here’s the sentence I would use: Desperate people do desperate things.

Or, to put it another way, people do dumb things when they’re under financial stress. Ramp up that strain enough, and they might even turn to unethical or outright illegal behavior.

People begin rationalizing decisions they would never otherwise make. Short-term survival overtakes long-term judgment. Boundaries become blurred. And priorities shift.

So, put simply, never give your money to someone who gives any indication that they might get desperate. Telltale signs of a mismanaged company include:

It’s easy to get blinded by the possibilities. I know I was. That’s why I partnered with “Dave” in the first place.

He had more money than I did. He was more successful than I was. And I wanted to speed up my own profit timeline.

Today, after going through what I went through, I would rather align myself with a slower-growing business run by disciplined, shareholder-oriented management. Because that focus tends to build wealth that actually lasts.

Happy SWAN investing,

Brad Thomas
Editor, The Wide Moat Daily

The markets may be up, but that doesn’t mean every single stock is. In fact, there are 10 previous market “darlings” that now trade at a steep discount.

Cell tower giants… specialized real estate… tech consulting firms… These out-of-favor companies may span the sectors, but they all beg the same question.

Are they bargains or value traps?

That’s what Nick Ward and I discussed in last week’s Wide Moat Show, with some interesting conclusions all around.

Catch the full episode right here.