Whenever I speak at an event, I often include the story of how I lost a big chunk of money in a bad investment. I share this as a learning experience.  The lessons I came away with helped shape Hughes Private Capital’s approach to investing, including stress-testing the heck out of our investment models.  I feel passionate when it comes to educating the public about investments, and what better way to do that than with my own history?  In this three-part series, I’ll tell you about a big investment I made, what went horribly wrong, and the invaluable lessons I learned.

Losing money is painful, and it’s a feeling I wouldn’t wish on anyone.  That’s why protecting our investors’ principal is our #1 consideration when structuring an investment.

Back in 2002, as I was reading through Fortune magazine, I came across an ad for an investment opportunity in something called “CORFs”: Comprehensive Outpatient Rehabilitation Facilities.  Investors could license their own facility and would be taught how to open and manage them.  Normally, I wouldn’t have paid attention to an ad like that, but I had recently sold my first business and was looking for my next move.

I tore out the ad and put it on my desk, where it sat for weeks.  I finally picked up the phone, called the number, and was connected to a person who actually grew up here in Reno.  He no longer lived here, but his parents did, and they belonged to the same country club as my dad, so I already felt like we had a connection.  I listened to the concept and learned how this business was already operating successfully with hundreds of facilities across the country.  They were not franchises but were instead purchased through a licensing agreement.

The guy I spoke with invited me to an upcoming event in Phoenix, the company’s headquarters, to learn more.  After performing some due diligence, I decided to attend.  I brought my assistant’s daughter with me because she had experience with these types of facilities.

During the one-day event, we heard from: the CEO (who was a medical doctor); the president (who had done this before with another company and who claimed to have sold it at a high multiple to a public company); a man who handled the real estate portion (he helped licensees find a location and analyze its viability); and many others within the organization.

Most importantly to me, we heard from the CFO who reviewed what he claimed were conservative averages of profit and loss statements and balance sheets from the many facilities in operation.  The CFO’s financial reporting matched what seemed to be the theme throughout the event: that there were more than 200 facilities around the U.S. already operating successfully.

During the event, I spoke with the CEO and told him I was from Reno.  He said, “I know Reno very well. A few doctors up there are begging us to open a couple facilities and they definitely have the business to fill them.”  He mentioned some local hospitals by name and spoke as if he really did know Reno.

I struck up conversations and exchanged contact information with others like me who were also interested in the opportunity. After the event, I began communicating on a regular basis with a guy named John.  We agreed to do our due diligence together, which took a few months’ time.

One of the first red flags was that the company refused to provide a list of names and contact information for the 200+ operators, saying that it was “private.”  I didn’t like that at all and tried multiple times to get that information.  They finally offered to put us in touch with seven operators who were willing to talk to us and answer our questions.  John and I called each one separately and grilled them with questions.  Even though we weren’t able to speak with additional operators, we felt a little more comfortable that we were able to speak with at least seven of them.

Two of the operators we spoke with were based in Dallas.  They ran two facilities and were preparing to open a third. I arranged to fly to Dallas to meet with them and tour their facilities.  I took the profit and loss statement and the balance sheet from the event with me and went through the documents line item by line item.  They told me that not only were those financials accurate, but that their facilities had been exceeding the numbers.  Then they threw me a curve ball, which you will understand later: they said that, in opening their third facility, they would neither go through the CORF organization nor would they pay for another license through them.  This wasn’t illegal, and maybe it wasn’t wrong, but still — why wouldn’t you just follow the same procedure as the first two facilities to speed up the process, especially if it was as lucrative as they claimed?  (Keep in mind that, in speaking with the Dallas operators, I felt confident I was meeting with peers who would be honest with me about what I needed to know, good or bad.)  In spite of the fact that I didn’t quite understand why the Dallas operators wouldn’t go through CORFs to open their third facility, enough of the pieces were in place that, when I left Dallas, I was ready to invest.

After speaking with the CEO who had said how badly Reno needed these facilities, I made the decision to purchase two licenses.  I also secured the first right of refusal for another one in Reno and one in Carson City.  The cost was $169,000 for the first one and the bargain price of $81,000 for the second.  How could I pass up the bargain on the second one when Reno needed it so badly and was supposed to be able to support a total of three facilities?

Off went my check for $250,000!  I celebrated in Tahoe with my wife and four kids, and we looked forward to being successful CORF owners.  I remember it like it was yesterday.  John, by the way, had also sent in a check for one facility.  We were just waiting to be contacted about starting our training back in Phoenix.

As you might guess, things did not go as planned.  Want to know what happened?  Read part 2 and part 3