Equity investing in superstar individuals (not their companies, them)

http://emergentfool.com/2009/10/30/investing-in-superstars/

by rafefurst • 17 years ago

60 47 17 years ago

ckjohnston• 17 years ago

i've always thought this would be an interesting idea. it's neat to see someone doing it. if u think about it, the YC program operates under a similar concept (people are more impt than the idea).

rms• 17 years ago

This has been discussed here before. I can't believe someone actually did it.

icey• 17 years ago

It makes a lot more sense when you realize that Rafe Furst and Phil Gordon are poker players. Poker players are amongst the most creative "investors" I've ever seen. They love playing around with interesting odds to see how it turns out.

If Matt Maroon gets in to this thread, I'm sure he has some interesting war stories about poker guys getting big stacks of money into bizarre schemes.

marketer• 17 years ago

This is really weird. It sounds like indentured servitude.

http://en.wikipedia.org/wiki/Indentured_servant

ricaurte• 17 years ago

That was the first thing that came to my mind. If someone owns the rights to your future labor, then don't they own a % of you, since you're treating yourself like an LLC?

tptacek• 17 years ago

The beneficiary isn't required to work. They're simply required to pay N% of their income and gains if they do.

patrickas• 17 years ago

Really! How so?

From that wikipedia page: " An indentured servant is a laborer under contract to an employer for a fixed period of time,[...], in exchange for their transportation, food, clothing, lodging and other necessities. "

Here you are paying a fixed sum of money that they can use for whatever they want (instead of the minimum necessities like food and clothing) and you are not the employer, the person can work on anything they like as long as they pay back the dividend.

I don't see what makes the two cases similar. In one case you pay the minimum so they work for you. In the other you pay some amount so they can work whatever they want but you get a percentage of that.

hyperbovine• 17 years ago

Well, so does the alternative. (Read the post)

enki2• 17 years ago

i'd totally go for this

dstorrs• 17 years ago

A variant on this that I've seen proposed is: find a (medical student | apprentice plumber | law student | etc) that you think is talented and honest. Pay his/her way through school and provide enough money to get them comfortably set up. They now owe you free service for the rest of their career in that field.

btilly3• 17 years ago

The problem is that the amount of that student's future work you can reasonably consume is far less than the cost of their education.

lg• 17 years ago

Well, this could be a good strategy for patent trolls.

lolcraft• 17 years ago

So, you've basically proposed slavery, then?

abalashov• 17 years ago

Yes, unless there are some hard (and reasonable) limits to the extent of free service defined.

pchristensen• 17 years ago

Wow. Creepy, seems illegal, and quite possibly disruptively brilliant. Nervously keeping tabs on this concept.

carpdiem• 17 years ago

I think indentured servitude is the wrong way to look at this. The key difference is that the investors don't dictate that you need to achieve a certain level of returns, or that you pursue a certain line of work. Instead you're still free to do whatever you want.

Since these contracts don't impinge on personal freedom, they should be legal. And I dare say that any number of highly motivated and intelligent people would jump at an opportunity like this (myself included), especially with the buy-out clause.

HistoryInAction• 17 years ago

I disagree re: indentured servitude. This reminds me of Renaissance sponsorship of artists and musicians, such as Leonardo DaVinci. Why not take something that was proven to work and update it for the modern world?

I'd also look at something like Intellectual Ventures, except on a longer term, where smart people are paid to attend the sessions to generate as many new, useful ideas as possible.

abossy• 17 years ago

If I am reading that correctly, "Marge" must make an average of $250k each year for their investors to merely break even. That seems like a lot, but obviously they must really believe she'll strike it rich somewhere along the way. Seems like a good deal for her, and an incentive to take off for the Bahamas for a while. I wonder how old she is, and whether that's an important factor for investors to consider.

simon_2• 17 years ago

It seems like there would be serious problems in the enforcement of a contract like this. I don't see any reporting requirements imposed on the entrepreneur, and it's pretty unclear what a court would do in the event of a default on the entrepreneur's part.

btilly3• 17 years ago

This would really make sense for students. A lot of kids go through universities and wind up scared about their college debt. On average their expected improvement in future returns is more than enough to make up for it. But individually people are running a scary risk. If you can solve that and spread risk across many people, it should average out in your favor.

If you have enough money to do this and seek to invest, I would highly recommend going after academically successful but poor kids. They are the ones who are most likely to drop out of university or go to a community college instead because student debt is too scary for them. That is because their belief about likely future income is based on people they know, which is far out of whack with what educated people can make. But their life choices are likely to leave them at what they expect.

At a practical level this means that you have room to structure the deal so you get better average returns than a loan, they are better off after accepting your deal than they would be if they don't go to university, and they are better off than they would have been if they earn what they think reasonable. Everyone wins.

anonjon3• 17 years ago

Creepy, but I think we can make it more creepy:

If you do this investment and the person takes out a life insurance policy on themselves, and they die, do you get 3% of the life insurance policy?

Although, I dunno, isn't this what having children is for?

You pay upkeep on them until maturity and when you are old and senile they pay to put you in a home and have you fed applesauce or whatever.

Femur• 17 years ago

One could stipulate that the person you have a contract on would be required to carry term life insurance made payable to the fiduciary.

btilly3• 17 years ago

Reality has gotten there first. In a number of states (Texas being famous among them) companies can take out life insurance policies on their workers. A company with such "dead peasant" policies now has an incentive to provide bad working conditions and poor health care support because that goes straight to the bottom line!

http://deadpeasantinsurance.com/which-employers-bought-polic... has a list of companies that did this.

eru• 17 years ago

> because that goes straight to the bottom line!

Not if the insurance company has a say in this. They will raise premiums for bad working conditions.

jhancock• 17 years ago

I'm guessing that a personal bankruptcy may get you out of this debt.

coderholic• 17 years ago

Even if it did, the article says "The Personal Investment Contract (PIC) can be calibrated for just about any situation where the investor believes the person they are investing in is (a) a true superstar, and (b) completely trustworthy."

If someone was willing to pay me $300K cash so that I could work on my passions rather than having to work a day job I'd be more than happy to give them a return on their investment, rather than looking for ways to get out of my obligations to them.

enki2• 17 years ago

My reasons for accepting such an offer would be the nonlinear utility of money (my chances at making more money would significantly increase with the initial freedom to work on projects fulltime), and the equity equation (http://www.paulgraham.com/equity.html).

After twittering about this, someone (possibly half-joking) offered to invest $60 USD in me under similiar conditions. Transaction costs and overhead however make these small investments really unattractive.

Is it completely crazy to propose a website that allowed me to combine lots of small PICs, and handling the overhead, to get my life as a project financed?

shimon• 17 years ago

It's not crazy, but in the US, it would require that you register the securities (possibly each person?) with the SEC, or only take investment from accredited investors (http://www.sec.gov/answers/accred.htm). This could well increase the overhead enough to make the project infeasible.

jfager• 17 years ago

http://www.kickstarter.com/

frig5• 17 years ago

Lessin's comments are the only smart ones.

At an abstract level there's some appeal to this notion.

At a practical level not so much, though, and that's even before you get into the nitty-gritty mechanics (like tax law here lol).

The adverse selection risk is huge, unless you go for very young people. What this means is that for people who're already "established" and/or have a track record:

- if they have a worthwhile idea they won't have trouble getting better, cheaper funding than this

- ergo if they're asking you for this kind of funding:

-- they either blew through their previous earnings and don't have a concrete idea to pursue next (NOT GOOD!)

-- or they aren't actually that "established" / lack a track record, and therefore are actually exactly the kind of people you don't want to invest in like this

...so pretty much investing in people proven-successful won't be happening.

We can roll back and consider younger people -- those too young to have any great success to there name yet -- and now there's some possibility here: catching brilliant people on the way up and giving them a further hand up.

Your problem here is that:

- you're competing with student loans as a choice of funding; for a student to pick your investment over a student loan it has to be a better offer. For any student that anticipates serious success you'll have a hard time being a better offer in terms of net payout; student loans are painful b/c their payback is frontloaded into the postgraduation years, which are at the point of the lowest lifetime earnings potential...but in net amount 3% of lifetime earnings will be much greater than the total amount of student loan payments.

- most of the really talented individuals won't even need your money, as there's an unbelievable wealth of grants and scholarships and fellowships for the truly exceptional in all walks of life (science, music, athletics, etc.) that they pretty much don't need funding until after they graduate. After graduation they might take you up on the offer but as time passes they become ever-more-likely to be able to raise cheaper funding for whatever they desire

...so even going after the young'ins leaves you unlikely to be attracting the people you'd want to invest in.

Which means good luck: even if you had the money together if you extend the offer at a price that'll leave you likely to turn a profit it's unlikely to be compelling to anyone you'd want to invest in.

And if that doesn't dissuade you think about the tax law implications: given how easy it would be to do an end-run around inheritance + gift-tax law with this type of "investment" -- and that that this end-run route isn't being taken 24/7, etc. -- I can guarantee you the recipient of this "investment" is going to be taxed on it as income (or at even worse rates, perhaps)...which means the math for the recipient is even worse:

- your investee now has to decide if, say, 125k or so (about what'll be left out of a 250k investment after taxes) is worth 3% a year

...which further contributes to the adverse selection issue as you're only really offering half as much as you think you are.

simon_2• 17 years ago

If it was structured correctly, you wouldn't take a tax haircut on the 250k. (You don't pay taxes on the proceeds when you get a loan, e.g.)

frig5• 17 years ago

You might think so, but there's not an existing legal framework for receiving equity investment as an individual.

If it were that easy people would already be getting around gift tax and estate tax by investing $millions in their kids in exchange for .01% of future annual income, initial payments deferred 15 years (and transferring as part of the estate) and and so on.

DavidSJ2• 17 years ago

- most of the really talented individuals won't even need your money, as there's an unbelievable wealth of grants and scholarships and fellowships for the truly exceptional in all walks of life (science, music, athletics, etc.) that they pretty much don't need funding until after they graduate. After graduation they might take you up on the offer but as time passes they become ever-more-likely to be able to raise cheaper funding for whatever they desire

You're making the assumption that the person would choose to use the money on schooling. Student loans come with that terrible string attached. This investment would not.

frig5• 17 years ago

This is a valid point, and a helpful one also.

Keep in mind that I'm already ruling out people with substantial established track records of prior accomplishment, leaving you with:

- people mid 30s or older without any kind of track record to speak of (UNLIKELY TO BE A GOOD INVESTMENT!)

- kids in the 18-25 y/o bracket, eg old enough to sign a contract but not-yet with a track record

So if we have someone 18-25 with a tangible track record (eg: successful software / website / invention / artistic performance record / etc.) they're out of the picture; we're left with 18-25 y/o's with promise but nothing else.

In most fields it's not impossible to pull off a huge success without the training acquired in at least an undergraduate program but it's very unlikely in most scientific fields (and if you were the type who could do it you'd probably also already have enough of a tangible track record that you'd not really be part of the group we're considering atm anyways).

EG: you're almost certainly not going to do anything significant in biology or medicine or chemistry or engineering or materials science or semiconductors or optoelectronics (and even football and basketball) without the training usually acquired as an undergrad (let alone in grad school).

So yeah: the money not being tied to college would have its appeal but putting on the investor's hat for a second someone without a plan for acquiring that level of training looks like a bad bet unless there are further mitigating factors.

Which is why I think the assumption is still mostly warranted, even if it shouldn't be taken for granted (as it was in my previous response).

But, what is helpful is this points in the direction of selecting candidates who would benefit from this program: musicians and other artists.

In many musical + artistic genres a couple hundred upfront in exchange for a cut of lifetime earnings is much better than the deal they typically get now. There's not necessarily a ton of fledgling artists out there who'd actually be good investments but it's a niche where the offer may make a fair amount of sense from both sides.

Essentially you should be asking: what potentially-highly-remunerative "career paths" are (a) open to people in their early-mid 20s and (b) such that star talents exist and (c) such that star talents would find this type of investing a better option than their existing funding options.

ispivey• 17 years ago

Unlike a student loan, I could simply refuse to pay back the 3%. In the relatively unlikely case a court held the contract valid, I could shed it in bankruptcy.

The downside case is much better with the "3% equity in a person" investment than a student loan.

frig5• 17 years ago

You're right, I didn't want to broach enforceability issues but you're right.

If true it'd only further contribute to the adverse selection effect: the ability to easily shuck the obligation will do more to draw out people you don't want to invest in than to ring in superstars who otherwise might say no.

johnnybgoode• 17 years ago

Interestingly, some of you find this disturbing. Out of curiosity, if we work backwards from the percentage of annual income taken, what percentage of you does the government own?

DannoHung• 17 years ago

Indentured servitude much?

anonjon3• 17 years ago

Perhaps I can explain the disturbtion?

My taxes to the government are more of an exchange of services. My government gives me roads to drive on, schools to send my kids to, police, fire department, parks, regulation of various industries, labor laws, military protection from hostile governments (among other things including the potential betterment and presumed increased safety of society).

To wit, my taxes are my end of a tacit social contract that I have made with my government. Because it is a social contract, the purpose of it is not profit, but instead the betterment of mankind in general.

When you compare the benefit received by paying taxes to the benefit of a lump sum payment (which could be had just as easily in the form of a loan), you realize how little you are getting from this investment plan.

But I think that my specific revulsion comes from having read plenty of literature (Shakespearian and pre) and knowing that usury is a sin.

ggruschow2• 17 years ago

False analogies.

Taxes are forced on us, not chosen. They do support some betterment of mankind, but the inefficiency is bad for mankind. Taxes are an order of magnitude higher, and the individual benefits are usually far less.

Loans are paid back plus interest on a fixed schedule. These aren't. Most investees will profit from the transaction even without TVOM.

Don't like lump sums? Just convert it to guaranteed monthly income for life by buying an annuity. Rates are low right now due to the economy, but you'll still get ~$2k/mo for a $400k lump sum.. and you can get things like inflation adjustment too.

"You'll never be poor" is usually worth more than "a few percent of your income" plus the right to buy it back.

bhousel• 17 years ago

It really doesn't seem all that different from sports contracts with elite athletes.

The main difference between is the open-ended nature of this contract. 3% for the rest of your life? Honestly, I don't think "Marge" is a very good negotiator. But that's why athletes have agents.

hooande• 17 years ago

I think this is how most equity investing works anyway. You get the feeling that one or more of the founders are "superstars" and decide to back them, not the idea or product that they pitched you with.

The lifetime contract is an interesting spin. Kind of reminds me of a classical artist having a patron. It's a great deal from the perspective of the individual...3% is always a trivial amount of your income. I do worry about it from the investment perspective...it seems way too easy to let personal biases and an individual's charisma get in the way of making rational investment decisions. While most investments are made on the basis of "I really like this person", it probably isn't the best criteria.

kalvin• 17 years ago

A good friend and I are in the process of agreeing to something vaguely similar. We each get x% of the others' proceeds if we're a founder at a company that has an exit. So it increases our chances of seeing a payout and decreases that payout by x% (but x is small.) Ideally we'd have a couple more good friends-who-are-equally-likely-to-be-founders join in, and we'd really have a good pool...

Equity investing in superstar individuals (not their companies, them)

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