Reading a Private Deal Memo Backward
Contents
Trevor L Taylor, the Miami private investor who founded Fortius Capital, draws on a background in systematic models, where the assumptions buried at the bottom of a spreadsheet drive every figure printed above them. A private deal memo works the same way. Most memos open with a vision, move to the market, introduce the team, present projections, and only near the end reach the exit assumptions, the fee schedule and the risk factors. That order puts the most persuasive pages where a reader’s attention is freshest and the least comfortable pages where the reader is tired and half convinced. Reading the memo backward reverses that effect. What follows is the reverse order, written as the questions each section must answer.
Start at the exit
How does the money come back, and when? Look for the specific mechanism: a sale of the asset, a refinance, a merger or a schedule of distributions. Then look for the assumed timing. A memo that projects a sale in year five at a stated multiple of earnings is making two predictions at once, one about the business and one about the market years from now.
Professionals price deals from the exit backward. In a survey of 79 private equity investors, Paul Gompers, Steven Kaplan and Vladimir Mukharlyamov found that they rely mainly on the internal rate of return and on multiples of invested capital1 when judging a deal, both of which depend heavily on the assumed exit. Exit assumptions can also fail for reasons outside the deal. The New York Times described how a credit freeze left banks holding buyout loans committed at terms the market no longer offered2, a reminder that financing available today may not be available at the planned refinance or sale.
Who decides when to exit? In most private structures the sponsor controls timing. That can be reasonable, but it means the investor’s liquidity depends on the sponsor’s incentives.
Then the fees and the waterfall
What does the sponsor earn if the deal is merely average? Fees in private deals come in layers: acquisition, asset management, financing and disposition fees, plus a share of profits above a preferred return. CNBC’s explainer describes carried interest as the managers’ share of a fund’s profits, typically 20 percent of the total3, paid in addition to the other fees a fund collects.
Those layers add up. Ludovic Phalippou estimated that private equity funds have returned about the same as public equity indices since at least 20064, while collecting an estimated $230 billion in performance fees. A reader should add up what the sponsor collects in a scenario where the investment simply returns capital plus a little inflation. If that number is large, the sponsor is well paid for an outcome that leaves investors flat.
Where does the profit split change? The waterfall sets who gets paid in what order, and the point where the sponsor’s share rises is the point where its incentives are strongest. The Institutional Limited Partners Association makes alignment of interests between limited and general partners5 the center of its published principles, with emphasis on transparency and governance.
Then the risk factors
Which risks belong to this deal alone? Risk sections are often padded with boilerplate. Skip the generic paragraphs and look for the few that could only describe this asset: a single tenant, a zoning approval still pending, a construction budget with thin contingency, a loan that must be refinanced before a fixed date. Those paragraphs are the real memo.
Refinancing risk deserves particular attention. The Federal Reserve’s financial stability report noted that commercial property prices had stabilized while warning that distressed sales could follow if borrowers cannot refinance their mortgages6.
What is missing? Compare the listed risks with what is known about the asset class. Institutional Investor traced a run of retail bankruptcies among companies owned by buyout firms7, including Toys R Us and Payless. A memo for a heavily borrowed retailer that says little about debt service is telling the reader something by omission.
Then the projections
What has to be true for the base case to happen? Rewrite the base case as plain statements. Rents rise this much each year. Vacancy stays below this level. The loan is refinanced at this rate. Construction finishes by this month. Each line is a bet, and the projection depends on all of them succeeding together.
Rules outside the deal can move the numbers too. The New York Times explained how a change in tax law limited the deduction for interest paid on debt8, which had long made heavily borrowed deals more attractive. Projections built on old assumptions about financing costs can look very different after such a change.
How sensitive is the result? Good memos include a sensitivity table. If one is missing, build a rough one: move each major assumption against the deal by a reasonable amount, one at a time, and watch the outcome. The assumption that moves the result most is the one to understand best.
Then the team
Has this team done this exact thing before? Experience in real estate is not the same as building ground up multifamily in one submarket. Look for direct precedent at similar scale, and for how earlier projects actually finished rather than how they were projected.
Professional investors put people near the top of the list. A survey of 885 venture capitalists found that they rate the management team as more important than product or technology9 when choosing companies. A memo should also state how much of the sponsor’s own capital is at risk alongside investors, because a sponsor paid mainly through fees behaves differently from one with meaningful money in the deal.
Finish with the vision
Only now read the opening pages. By this point the reader knows what the deal needs in order to work, what it costs, and how the money comes back. The vision either fits those facts or it does not. Often it still reads well, which is perfectly acceptable. A strong story attached to sound terms can be a good deal. A strong story attached to weak terms is one of the most common ways capable people lose money in private markets.
Reading backward is a way of separating what a deal is from how it is presented. Persuasion works on attention, and attention fades. Meeting the hard pages first means carrying their answers into the story instead of carrying the story into them. The whole method fits on one line: exit, then fees, then risks, then numbers, then people, then the dream.
