Why this matters
Income-focused investors love clarity—known coupons, set maturities, scheduled payments. But clarity isn’t the same as certainty. Your best defense is a repeatable, checklist-style approach that spots risk early and confirms you’re comfortable with the trade-offs.
This guide is general education. Always review the documents for your specific note offering; those govern terms, rights, fees (if any), and risk factors.
The 7 Questions Framework
1) What economic engine powers my interest payments?
Identify the real source of cash flow behind the note.
Ask: What activity or receivable generates the money that pays my coupon?
Look for: Concrete, recurring cash flows; historical performance; stress cases.
Why it matters: The stronger and more predictable the engine, the higher the confidence in scheduled payments.
2) How is underwriting performed—and by whom?
Underwriting converts raw data into risk-adjusted decisions.
Ask: What data are reviewed (financials, bank statements, performance history)? Who does the analysis?
Look for: Documented criteria, credit policy, third-party verification, concentration limits.
Why it matters: Consistent underwriting and risk controls help reduce surprises.
3) Where do I sit in the payment waterfall?
Position in the capital stack shapes your risk/return.
Ask: Is this senior, subordinated, or otherwise? Are there any payment priorities or reserves?
Look for: Clear language on priority, reserves/escrows, and events of default.
Why it matters: Senior/priority positions typically get paid before junior claims.
4) What are the exact terms, covenants, and triggers?
Your rights live in the documents.
Ask: Coupon, compounding (if any), frequency, maturity date, grace periods, and financial/operational covenants.
Look for: Defined remedies for late/non-payment, reporting requirements, and any extension or renewal mechanics.
Also confirm: When interest accrual begins. In most offerings, accrual is tied to the Effective Date defined in the documents (not to when funds clear).
Why it matters: Well-defined covenants and remedies can improve recoveries and reduce ambiguity.
5) Who services the payments and how do I receive them?
Execution is an operational risk you should understand.
Ask: Who calculates interest, sends statements, and distributes payments? What systems are used?
Look for: Payment calendars, statement cadence, reconciliation controls, auditability.
Why it matters: Smooth servicing = fewer administrative delays and clearer visibility.
6) What’s my liquidity reality and timeline discipline?
Know how long your capital is tied up—and plan around it.
Ask: Is there any early liquidity mechanism? If not, what’s the practical holding period?
Look for: Maturity date, notice requirements, cutoffs/funding windows, and reinvestment options (if any).
Why it matters: Notes are commitment instruments. Align with your cash needs and consider a ladder.
7) What could go wrong—and how is it mitigated?
Pre-mortem thinking improves decisions.
Ask: Top 3–5 risk scenarios (market, concentration, operational). What controls and buffers exist?
Look for: Reserves, diversification policies, counterparty checks, contingency plans.
Why it matters: Knowing the downside—and the mitigants—helps you size allocations appropriately.
Turning answers into an investment decision
Build a simple risk snapshot
Create a one-pager for each offering you’re evaluating:
- Economic engine: __________
- Underwriting overview: __________
- Payment priority/waterfall: __________
- Terms & covenants (rate, maturity, triggers): __________
- Servicer & reporting: __________
- Liquidity/timeline: __________
- Key risks + mitigants: __________
- Personal fit (goal, horizon, allocation size): __________
Compare apples to apples
When multiple notes are available, line them up on:
- Coupon vs term: Is the extra yield worth the extra duration?
- Payment frequency: Monthly vs quarterly to match income needs.
- Priority/covenants: Stronger terms may justify a lower coupon.
- Operational clarity: Clean servicing and reporting reduce friction.
Laddering to manage risk and cash flow
A note ladder staggers maturities (e.g., 12/24/36 months) so you have periodic principal returning for reinvestment or expenses.
Why it helps:
- Reduces timing risk if rates change
- Creates rolling liquidity
- Eases reinvestment decisions over time
Next step: Review current maturities and coupons on /investments and map them to your ladder rungs.
A hypothetical illustration (purely educational)
- Allocation: $300,000 split across three notes
- Rungs: 12, 24, 36 months
- Payment frequency: Monthly
Outcome (illustrative only): You receive monthly interest from all three, and every 12 months a principal tranche returns, letting you rebalance or reinvest based on market conditions and goals.
Your actual results depend on each offering’s documents, timing, accrual basis, and any compounding/reinvestment mechanics.
Common red flags (slow down if you see these)
- Vague use of proceeds or unclear economic engine.
- No documented underwriting policy or unexplained exceptions.
- Unclear payment waterfall or missing reserve language.
- Thin reporting (no schedules, no statement cadence).
- Deadline pressure without time to review documents.
Quick due-diligence checklist
☐ Read the offering documents end-to-end
☐ Confirm accredited investor status & onboarding requirements
☐ Note coupon, frequency, maturity, and cutoffs
☐ Understand priority/waterfall and covenants/triggers
☐ Review servicing, statements, and payout mechanics
☐ Align liquidity timeline to your needs (consider a ladder)
☐ Size allocation relative to your risk tolerance and diversification plan
FAQs
Are higher coupons always better?
Not necessarily. Higher yield can mean higher risk, longer duration, or lower priority. Balance coupon with terms, covenants, and position in the stack.
How often do notes pay?
Payment frequency varies by offering (often monthly). The exact schedule appears in the offering documents and payment calendar.
Can I get out early if I need cash?
Notes are generally not designed for daily liquidity. Plan to hold through maturity unless the offering documents specify otherwise.
How should I size my allocation?
Many investors size based on risk tolerance, time horizon, and the role of the note within a broader income strategy. Diversification across maturities can help.
What documents are most important?
Subscription documents, offering materials, payment schedules, and any servicing/administration descriptions. These govern the investment.
Compliance & disclosures
For accredited investors only. This blog is for informational purposes and is not investment, legal, or tax advice. All investments involve risk, including loss of principal. Actual terms—including coupon, payment frequency, accrual conventions, minimums, fees (if any), and maturity—are governed solely by each offering’s documents. Review all materials carefully before investing.
