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Phil Champagne, Managing Partner, Wren Investment Group, LLC Phil's 12 years of experience in commercial and single family investment along with his passion for macro-economics, positions him well to guide the investor through each step of the acquisition, re-position & asset exit phases of... More
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  • The 5 Types Of Investment For Your Money 0 comments
    Jul 9, 2013 5:53 AM | about stocks: ETF

    By Phil Champagne, Managing Partner at Wren Investment Group, LLC

    Have you ever heard of that statistics that says that after a few years, most lottery winners - even if millionaires - end up back where they were before? This is where the importance of cash flow over cash comes. It is Cash flow that is king, not cash. Given the choice between a single payment of $1,000,000 now as opposed to a secured $150,000/year every year, indexed for inflation, what would you choose? That's a 15% return indexed for inflation. You should be picking the $1M if and only if you are certain that you can invest this $1M at a higher return than 15% at a similar risk or better.

    Once in a while, you will have someone who ends up with an influx of money and needs to invest it. Say someone sold his house and downsizes to a smaller one, or they cashed out some stock options from a company, or inherited the money. This person suddenly find himself in the need to put this money to work. Keeping it under the mattress doesn't work considering that it would lose its value and would not bring any steady stream of cash flow, year after year.

    When it comes to investing, the large majority of the public knows about just the following:

    1. Opening a stock brokerage account and invest in publicly traded stocks or Mutual funds, Exchange Traded Funds (NYSEMKT:ETF) or commodities. (Blue chips dividend paying stocks or speculative or a combination).
    2. Investing in annuity or bonds, whether they are government bonds or corporate bonds. Depending on the perceived risk, they may have a higher or lower yield (the interest you are being paid for lending money). The advantage of this type is the return is definite and specific, well as long as the borrower does not default. The disadvantage is the return is not adjusted for price inflation.
    3. Real Estate Investment, typically by buying a house or duplex, fourplex. In a few cases, a property management company is hired to take care of the management of the property. Of course in this category should be considered the case of one wealthy investor purchasing by himself a large commercial real estate as well. (We could also include in this category the case where one invest in his own startup/new business, but this article wants to focus on passive investment).
    4. Speculative and wealth preserver: buying raw land in the hope of selling it at a higher price, buying gold and silver, buying art work, etc. Although this type is somewhat known by the public, a small fraction of investors are invested in this.

    But a 5th way also exist which is not well known, or at the very least perceived to be available only to the very wealthy.

    => 5. Private investment. For example startup companies in their pre-IPO phase, before they are public. It can also be in real estate as well, either for funding a short term real estate construction project or funding the acquisition of a commercial property to be held for the long term. Any type of private investment where one group provides the funds and another group brings the expertise and run the operation would be included in this category.

    For private offering of investment, the entrepreneur need to follow one of the rules provided by the SEC on how to fund their project. One such rule is Rule 506 of Regulation D. Take a particular look at the first 2 bullet points below in bold. (From http://www.sec.gov/answers/rule506.htm):

    Companies using the Rule 506 exemption can raise an unlimited amount of money. A company can be assured it is within the Section 4(2) exemption by satisfying the following standards:

    • The company cannot use general solicitation or advertising to market the securities;
    • The company may sell its securities to an unlimited number of "accredited investors" and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated-that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
    • Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that are generally the same as those used in registered offerings. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well;
    • The company must be available to answer questions by prospective purchasers;
    • Financial statement requirements are the same as for Rule 505; and
    • Purchasers receive "restricted" securities, meaning that the securities cannot be sold for at least a year without registering them.

    The Jumpstart Our Business Startups Act of 2012 (JOBS Act) required the SEC to amend Rule 506 of Regulation D to permit general solicitation and advertising in private placements as long as all purchasers are accredited investors. However this has still not been done yet as there is a current debate about how to adjust Rule 506. If this change is implemented, it could alter significantly the way capital is raised by start-ups, existing operating businesses and private funds, making it quite easier, although still restricted to accredited investors.

    Per S.E.C rules, accredited investors means they meet one of the following rules:

    1. Assets of at least $1 million (not including the value of the primary residence)
    2. Annual income exceeding $200,000 in each of the last two years or joint income with a spouse exceeding $300,000 for the last two years.

    We wrote earlier about the SEC rules in a prior article. Essentially, what is required today is a prior relationship between the sellers of the securities and the investors. Those laws and regulations have been established back in 1933 with the goal of protecting the public from "bad actors" (think Charles Ponzi). The consequence however is that it made it more difficult for investors to learn about private investment, particularly non-accredited investors.

    The most important one that all sellers of security must consider is that private offering requires a prior relationship with any investors. In addition, it is a good idea to keep a record, a paper trail of this conversation by asking the investor to fill such a form.

    For non-accredited investors, notice the SEC rule that this person be a "sophisticated" investor - that is "have sufficient knowledge and experience in financial business matters to make them capable of evaluating the merits and risks of the prospective investment". Now that's something very open to interpretation and not very much quantifiable. No matter what the regulators are trying to prevent by elaborate rules and regulations, there is always a danger for a rascal to take advantage of them. Meanwhile they limit the general public to learn about opportunities with private investment. These laws however are convenient for Wall Street as they give a preferential treatment to stocks traded on major exchanges where they can recoup a commission fee as opposed to a private investment where Wall Street is left out of the picture. Law firms involved in crafting the more elaborate S.E.C paperwork are happy as well since it increases their business. As for investing in stocks, the investors does not have to be accredited, nor does he/she has to be "sophisticated". However, the majority of those shareholders do not have any contact with the CEOs and board of directors of a publicly traded companies. They should indeed be "sophisticated" enough when investing in stocks to know how to read the financial statement published quarterly by those publicly traded companies. A last resort is to invest in blue chip stocks, well established companies with dividend paying stocks, but even that is not completely safe from fraud, think Enron.

    The risk level also varies in private investment, just as it does in public companies. Some offering are for a position in a company investing in a class A property in a very good and stable area with somewhat good returns while other offering might be targeting a higher return with a class B or class C property. On the extreme, it could be a young start-up company with no assured success but if it does, a potentially amazing return - think Amazon.com (NASDAQ:AMZN) for example.

    On the other hand, regarding the SEC rule, the part we do like is this one:

    • The company must be available to answer questions by prospective purchasers;

    We believe that helping understand the quarterly reports and answer any questions before AND after acquisition should be essential for anyone selling private and public securities.

    To learn more, see http://wreninvestment.com/investors/ or contact us

    Disclosure: I am long PSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I am long real estate

    Themes: income-investing-strategy Stocks: ETF
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