A Russian Proverb Explains Investor Approaches to Risk Management By Joseph Feldman, President, Joseph Feldman Associates1 The Russian proverb—“Trust, but verify” (in Russian pronounced doveryai, no proveryai)—provides a helpful framework for understanding how rather differently various equity and debt investors assess and manage risk. This proverb was made famous in North America when Ronald Reagan used it to describe his strategy for dealing with the Soviet Union during the missile reduction talks of the 1980s. For each investor type shown below, their consideration of risk reflects a mix of both “verify” and “trust.” Among the examples of “verify” are control provisions, financial covenants and collateral (including reputational capital in the case of friends/family investors). Risk assessments based on “trust” reflect knowledge by the investor of the particular industry, business and team. The roles and relative importance of “trust” and “verify” are most divergent when comparing friends/ family investors with secured debt lenders: • “Trust” predominates over “verify” for friends/family investing in a start-up, with high reliance on their familiarity with the founder (“she’s so passionate about this new business idea”) and the founder’s own investment (“he’s committing all of his limited savings”). There may be little potential for collateral or contractual assurances, rather only the founder’s reputation (and perhaps family harmony) may be at stake. • Alternatively, commercial banks and other secured lenders invest substantially on the basis of “verify”, with far less emphasis on “trust.” The uncertainty and risk of a business plan, financial projections, or detailed understanding of competitive dynamics, are less crucial when a loan is backed by personal guarantees and collateral (e.g., cash, land, securities). Private equity and venture capital investors invest with considerations of both “trust” and “verify”: • Through expertise in particular industries, health (or not) of companies, growth models, and management team assessments, the inherent uncertainty of these “trust” factors can be mitigated… and an assessment of risk more confidently made. • Nevertheless, through negotiated control of strategic decisions and board appointments, a measure of “verify” remains an important aspect of an investment decision. Joseph Feldman is President of Joseph Feldman Associates, a Chicago-based corporate development consulting firm founded in 2003. Joseph Feldman Associates provides acquisition and other strategic transaction consulting for growing companies and their investors. 1 A sister publication of the popular newsletter, The Corporate Counsel, Deal Lawyers is a bi-monthly newsletter for M&A practitioners to keep them abreast of the latest developments and analyze deal practices. Founding Publisher: Jesse M.

Brill. Formerly an attorney with the Securities and Exchange Commission and a leading authority on executive compensation practices, Mr. Brill is also the Founding Publisher of The Corporate Counsel and Chair of the National Association of Stock Plan Professionals. Editor: Broc Romanek, former SEC attorney and Editor of DealLawyers.com and TheCorporateCounsel.net. Broc can be reached at broc@naspp.com. DealLawyers.com • P.O.

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