Jared Kushner’s attempt to recoup the cost of his Harvard MBA by founding a hedge fund has turned into a debacle. The scandalous downfall of Kushner’s venture, called KENDRA, is an excellent case study for anyone in the investment industry. Kendra was founded in 2011 with $20 million from family friends and other investors. Mr. Kushner left his job as CEO of his father’s real estate company to run the fund full time with his brother Josh as chief risk officer and another brother, Joshua, as general counsel. The firm raised $50 million from high-end investors (the “ accredited investors ” necessary to avoid SEC regulations). The partners invested in what they believed were undervalued companies operating in industries with positive long-term trends–and sold shares at a hefty discount for both these reasons. Investors who bought in at that early stage locked in their price: During its three-year life span, KENDRA purchased almost 50 smaller companies and posted an average annual return of almost 20%. Read on to learn why you should not follow Jared Kushner’s example when it comes to your career as an investment professional…
Reasons for KENDRA’s Failure
Kendra’s precipitous demise was due primarily to two factors: First, the company took on too much leverage. The investment strategy called for buying companies with a high debt-to-equity ratio and then restructuring the finances to improve their ability to repay the debt. This entailed making significant upfront payments to the sellers, which the fund could not afford. Kushner and his partners resorted to complex arrangements such as equity participations and mezzanine loans to make the deals work. Jared Kushner was no stranger to high-risk strategies and debt. As CEO of his father’s real estate company, he had nearly bankrupted the family business by making risky investments with inadequate financing. KENDRA’s second major mistake was managing investor funds in a way that created conflicts of interest. They paid almost 90% of their investors’ money back as promised, but only after using a significant portion of the funds to repay their own debt. Because the Kushner brothers owed their investors almost $80 million and had only $13 million in cash left in the fund, they had to find other ways to pay back their debts. KENDRA’s “voluntary liquidation” closed the fund to new investors, who could not expect to receive back the full amount they had invested. The fund’s managers repaid the original investors and themselves by selling the companies they had purchased.
Conflicts of Interest
The conflicts of interest arose where the interests of the fund executives and the investors they had promised to repay did not align. For example, KENDRA executives selected the companies they purchased based on the interests of the fund’s original investors. They paid a higher price for companies whose assets they could use to repay their investors more quickly. Investors who provided money later in the fund, however, shared in the overall profits of the fund based on the earlier investors’ higher returns. KENDRA’s management also created a conflict of interest between their fiduciary duty to their investors and their own personal financial interests. The brothers took out high-interest loans from their investors. When KENDRA repaid its investors, the Kushner brothers’ personal debt was also repaid, but the interest rates on the original loans were so high that the brothers were almost certainly enriched by this transaction.
Mismanagement of Investor Funds
To repay those debts, Kushner and his partners mismanaged investor funds. They purchased companies that appeared undervalued but then paid too much for them. In one case, they bought a company for $800 million but wrote down the value of the acquisition at $300 million. In another, they paid $80 million for a company that had just recorded $5 million in revenue. KENDRA also lost millions by attempting to acquire companies that did not meet the fund’s investment criteria. The firm purchased an insurance company on the verge of collapse, a Brazilian construction company that had improperly recorded expenses, and a company whose owners failed to repay their loans. KENDRA also lost money by not managing the risk of its large debt positions. The fund borrowed money from its investors at high interest rates and used the proceeds to fund its acquisitions. Instead of carefully monitoring its debt levels, KENDRA took on additional risk in an attempt to boost its investments.
KENDRA was an ambitious attempt to bring the high-risk, high-reward strategy of private equity investing to the retail market. The fund’s managers, however, were too inexperienced and too greedy to succeed in this endeavor. KENDRA’s managers were inexperienced because they had no track record as fund managers. They had been trained in real estate acquisition and restructuring at the senior levels at their family’s company, not in managing the high-risk investments in smaller companies that comprise the typical private equity portfolio. KENDRA’s managers were greedy because they did not stop after successfully repaying their investors. They borrowed more money at high interest rates and took on riskier positions in an attempt to increase their returns. KENDRA offers an excellent example of the perils of investing in other people’s companies. If you do choose to invest in emerging companies, you should understand that the owners are responsible for managing the businesses and that the shares are illiquid.