Economy out of daily life (1)

We know that debtors have higher priority than shareholders in bankruptcy cases. Sometimes, due diligence is important to understand what situations we are in before investing.

Joe borrows $100K to start his real estate business. The business starts well and he thinks he can expand it. So he talks to Jane to see if she is interested. Jane indeed is looking for investment opportunities. So she put in $100K to become a shareholder, essentially. They don't have a corporate form. Joe still owes $100K to his debtor. Now the company has value of $200K. The RE market turns down quickly later on. When Joe realizes that the company's value is well below $100K, he files bankruptcy. But he seems not lose anything except his credit: his debtor gets part of investment. Jane, on the other hand, does lose $100K. Joe, after a few years of silence, restarts another business.

This is the case repeatedly happen in investment world: fund managers fold their funds and return remain funds to investors. After a couple years, they would open other funds. Who really get hurts are investors. Therefore, on investors' side, they need to understand the risk. On fund managers' side, they also need to have ability to undertake this risk of withdrawing. John Paulson, the star fund manager, is undergoing a similar situation.

A recent news says that John's funds had almost 50% lost in 2011. Speculations from rivals that he needs to face redemption drives some of his holdings down hugely (his holdings are in public reports). As a sophisticated investor, his funds' major investors are in his company. So it is unlikely he needs to sell everything. But do investors want to stick with him?