MNvest: Beware of This New Minnesota Investment Opportunity

| August 22, 2016
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MNvest! It's here! The legislation creating equity crowdsourcing has arrived, Minnesota, and the concept sounds appealing:

The democratization of investment". It’s about time! Did you know that for the last 80+ years, only the richest among us have had the really good investment opportunities; the ground floor opportunities? And that it was Congress who made it so? That is until MNvest came swooping in to take these opportunities from the rich and give them to the rest of us. Democracy!

It’s so…Robin Hood, right?

Not. So. Fast.

There is no debating the fact that MNvest is here to stay. Having recently become the law of the land, the question you should be asking yourself is this: Should I invest my money through MNvest? In two words: probably not.

Why not? Well, it’s complicated, but basically, it’s for these three reasons:

  • It is designed to benefit the companies trying to raise money, not you, the investor.
  • The investor protections that Uncle Sam put into place in 1933 have been removed.
  • You are at great risk of losing part, or all, of your investment.

I’m not saying some people aren’t going to win big. Inevitably there will be some winners, but playing long odds isn’t exactly a promising investment strategy. As a financial advisor, I assess risk vs. reward and look at probabilities of success and failure every day. Minimize risk, maximize return. MNvest threatens just the opposite.

What is MNvest?

Technically, it’s legislation legalizing equity crowdfunding for the masses. It’s like Kickstarter, with an extra kick. With Kickstarter, someone comes up with a great idea for a new gadget, they post their idea on Kickstarter with a sweet video, you like the idea, and you give them money to make the new gadget. In return, you get something, like the gadget, or the gadget at a discounted price.

MNvest is similar. Someone comes up with a great idea for a new company, they post a cool video about their company on a MNvest portal, you like the idea, and you give them money. In return, you might get the gadget they’re making, but here’s the kick: you now OWN a piece of that company and its future success.

Online crowdfunding started to take shape when IndieGoGo and Kickstarter launched in 2008 & 2009, respectively. So why did it take a full 7 years before equity crowdfunding got started?  Blame Uncle Sam for this one.

Why does the Securities Act of 1933 matter to me? A brief and boring history lesson.

In 1929, the stock market collapsed in a big way, ushering in the Great Depression. In the aftermath of the crash & in the middle of the Depression, Congress enacted the Truth in Securities Act (a.k.a. Securities Act of 1933) as a means to protect investors from fraud and deceit. After the Act was passed, if a company wanted to raise money from investors, that company now had to register with the Securities and Exchange Commission (SEC) which involved disclosing copious amounts of financial data and material facts about the company. Seems reasonable, right? Yes, and no.

The process of getting registered is a pain. A huge and expensive pain. So much so that most companies can’t afford to become registered and therefore can’t raise money like their larger competitors. Doesn’t seem quite fair, does it? Don’t fret, there’s a loophole! There are certain criteria (like size), that if met by a company, allows them to be exempted from the registration requirement, allowing them to raise capital from investors.

But there’s a catch. There’s always a catch.

The whole point to the ’33 Act was to protect the average investor. If there were businesses out there that didn’t need to register, how was that protecting mom and pop investors from deceit and fraud? It didn’t. And the congressmen knew it. So they provided the exemptions to small businesses, but in being exempted, these small businesses couldn’t go out and blanket the world with solicitations and advertisements to invest in the company. They could only solicit to folks who could afford to lose their investment.  And who are these noble people who are willing and able to lose their shirts in unregistered companies?  Accredited investors.

Essentially, the congressmen had to find a group of people who 1) could afford to lose money and 2) ought to know a bad investment when they see it.

Are you an accredited investor?

There is no exam, no secret society, and no dues to pay to be an accredited investor. It’s the most basic criteria for entrance into any group I’ve ever seen:

  • You make greater than 200k/yr (300k for couples)

                                        OR

  • You’re worth $1 million (sorry, this excludes your home)

Again – there’s no assumption of business acumen or intelligence here. Simply, that you could afford to lose money on an investment more so than the average mom and pop just trying to get by. 

So that’s why accredited investors exist. They exist to protect 97% of the population from deceit and fraud in investments while still allowing those unregistered companies a way to raise capital when they need it.

Why does MNvest exist and what does it have to do with accredited investors?

It’s all about positioning and perspective.

If a person’s perspective comes from looking at the historical context, having accredited investors is good because that means that the vast majority of us can invest in companies that are registered with the SEC.

However, try this perspective: You have an awesome idea for a company to build this widget that everyone is going to need. You come from modest means, don’t have any millionaire friends, and the bank won’t lend to you because the company and the widget are only an idea at this point. You see Kickstarter and think: that’s a GREAT idea, I’ll raise capital from investors through crowdfunding and give them a little piece of the company in return! Guess what? You’re stuck. You are legally prohibited from advertising to or soliciting to anyone but accredited investors. This ticks you off because you have a transformative idea and see the internet as the perfect way to raise capital for an idea that’s going to change the world. So what do you do? You organize with other entrepreneurs and small business owners. You lobby legislators. You tell the public that the provisions in the ’33 Act that are designed to protect them really aren’t that important. And you convince mom and pop that accredited investors have been scooping up the best investments all along and it’s about time they get a piece of that pie. And it works, and MNvest is born.

Oversimplification of the advent of MNvest? Perhaps. But here’s the point: MNvest has largely thrown out the protections of the ’33 Act. It makes it much easier for entrepreneurs to raise capital at the expense of investors’ safety.

What are some of the potential issues with MNvest?

They are too numerous to point out here, but here are a few that should matter to you:

  • One of the main protections touted by MNvest proponents is that non-accredited investors (97% of the population) may only invest up to $10,000 into any given company listed on a MNvest portal. Great, so mom and pop can only lose up to $10k? Nope. While there is a $10k limit on any one company, there is currently no limit on the number of companies an individual can invest in. So if you’re like an average 60-year old with just over 100k in retirement savings, you can invest your entire nest egg in 10 start-ups through MNvest.
  • Accredited investors are not subject to the $10,000 cap. If MNvest truly was trying to level the playing field for the average investor, then its proponents would have applied the $10k cap to everyone. However, as it stands currently, if a promising company wanted to raise $500,000 via MNvest, an accredited investor can swoop in and take most, if not all, of the offering. Conceivably, the very best offerings on MNvest portals will go to accredited investors, leaving the leftovers for the rest of us.
  • You are very likely going to lose on your investment. According to Harvard professor Shikhar Ghosh, 30-40% of startups fail completely. If failure is defined in terms of failure to see the projected return on investment, then the failure rate is 70-80%. Any investment that has a 30-80% chance of failure is speculative at best, which is likely to be far too risky for the average investor.
  • You want to raise $2 million? Well, MNvest legislation requires that you fork over audited financials to investors. However, have no fear if audited financials is too onerous a requirement: you can still raise up to $1 million without any audited financials whatsoever. That’s right, you can raise a million bucks without an accountant checking and verifying your numbers.
  • There is no guarantee of liquidity through MNvest. In order to sell your stake in any company – either public or private - there must be someone willing to buy your shares. The MNvest legislation does not require issuers to guarantee any level of liquidity. So while your investment may show a 4000% return, if you can’t get your money out, what’s it really worth?

Bottom line: Is MNvest right for me?

If you can afford to lose your entire investment and understand the low probability of realizing any kind of return, then investing a miniscule amount of your portfolio might be appropriate for you.  But please, before you invest, do what many accredited investors do before they invest in a startup: consult your financial professionals for their advice on the matter.

About the author:Paul Wilson, a 15-year financial services industry veteran, is a Financial Advisor at SDW Investment Advisors, a Minneapolis-based Fee-Only Registered Investment Advisor. Paul writes and speaks on issues related to the high-net worth community as well as a wide range of financial planning topics, with a focus on investor advocacy.  You can follow him on Twitter @Wilson_Advisor or on LinkedIn.

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