The Great Robinhood Slowdown
When FINRA fined Robinhood (NASDAQ:HOOD) $70 million last June, investors might have understandably shrugged. The dollar amount represented only 0.2% of HOOD’s market value.
Yet fast forward three months, and everything about Robinhood has changed. Gone are the aggressive marketing, free stocks and app-based fireworks that made the day-trading platform so addictive.
Instead, HOOD’s app now looks more like the ones it was meant to replace. The slick fireworks and animations? Swapped out for old-fashioned buttons. And as for its crypto offerings? HOOD still offers the same number it has since 2019: seven.
In other words, FINRA has turned Robinhood from innovator to follower in less time than it takes to ripen Swiss cheese.
A Shrinking Return Potential
However, not everyone is convinced that Robinhood has turned to spoiled milk. Cathie Wood’s ARK Innovation ETF (NYSEARCA:ARKK) has consistently bought HOOD on the dips — the fund now owns 4.75 million shares of the firm. And Wall Street analysts are similarly bullish: their $57 average target price suggests a 40% upside.
But why should Moonshot investors go through all that trouble for a 40% return? By the time Robinhood navigates Payment for Order Flow (PFOF) legislation, crypto regulations and other issues surrounding its growth, smaller startups would have returned 10x… 100x… 500x or more. It’s easier to provide massive returns (relatively speaking) if you’re starting off small.
In today’s Big Read, we’ll take a look at a company doing exactly that in the financial services industry. What’s more, it’s a company where you can get in on the ground floor.
Crowdfunding Takes Hold
In 2016, Title III of the JOBS Act went live.
“Regulation CF,” as it became known, blew the doors open for crowdfunding — allowing private companies to raise money from hundreds of non-accredited investors. It’s one of the few areas of finance where regulators have removed regulatory hurdles rather than added them.
Since then, plenty of sleek crowdfunding sites have sprung up, offering great investments mixed along with some terrible ones too. It’s a Wild West of finance where both platforms and investors need to do their research.
And the biggest crowdfunding sites out there is currently looking for investors:
Investors, Start Your Engines!
Founded by entrepreneur Howard Marks in 2014, StartEngine has rocketed past older competitors to claim the No. 1 crowdfunding spot. In Q2 2021, the platform raised almost twice as much as WeFunder.
Perhaps success was predictable. Mr. Marks co-founded the billion-dollar gaming company Activision Blizzard (NASDAQ:ATVI), where he still sits as chairman. He also started Acclaim games, an online gaming company he sold to the Walt Disney Company (NYSE:DIS) in 2010.
And when it comes to investing in startups, the founding team matters.
“The team behind a business concept can be more important than the idea itself,” according to a USC study on startups tracked by AngelList. Experienced investors typically use “the quality of the founding team… as a reliable indication.”
Mr. Marks’ timing, however, was also serendipitous. Regulation CF came into effect just two years after StartEngine was founded, paving the way for timely growth.
Rocketing to the Moon
Today StartEngine is using its platform to raise money for itself. And it’s a Moonshot that investors shouldn’t miss.
- Value. The company’s $786 million valuation leaves plenty of room for returns.
- Funding Stage. It’s rare to find a company at a Series D stage seeking crowdfunding money (a by-product of StartEngine being a crowdfunding site). These later funding rounds offer investors an ideal mix of stability and upside.
- Growth. The company tripled revenues in 2020 and saw another 15% growth in Q2 2021 alone. The industry is expected to grow at double digits through 2025.
The startup has also wisely chosen investor Kevin O’Leary, aka “Mr. Wonderful,” as its strategic advisor and paid spokesperson. It’s a natural fit: the host of CNBC’s Shark Tank has a long history of buying private companies, and his made-for-TV personality lends a much-needed hand to this lesser-known area of finance. Ask someone what Republic is, and most people would sooner think of the waste management company than the crowdfunding one. (Ultra-conservative investors might still see them as one and the same).
That’s why, when it comes to crowdfunding sites, it’s so important to invest in the No. 1 company. These sites run on a positive feedback loop; more investors on crowdfunding sites incentivizes more companies to list, and so on. And much like ride-hailing companies like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT), the top companies will tend to gain market share and win.
Don’t Fall For Dirty Crowdfunding Tricks
Private investing however, is fraught with risks. Most startup founders know that investors seek proven operators.
So they game the system.
Theranos’ founder Elizabeth Holmes did this to a terrifyingly masterful degree. At one point, her startup counted Henry Kissinger, James Mattis and George Shultz on its board — powerful politicians with virtually zero experience running medical device companies.
A similar pattern is now forming in Beanstox, a robo-advisor that seeks to compete against Betterment and Wealthfront.
The Beanstox Paradox
Much like StartEngine, Beanstox counts investor Kevin O’Leary as an advisor and investor. And also like the former, Beanstox is raising money through crowdfunding.
What’s less clear is why a passive investing platform should have a famed active investor as its chairman at all.
It’s much like having casino entrepreneur Steve Wynn run your weekly Gamblers Anonymous meeting. It might draw a crowd, but chances are good you’ll be on the next bus to Atlantic City or Las Vegas right afterwards.
Yet money continues to flow into startups like Beanstox.
By highlighting their all-star team, Beanstox hides that only one of their top four executives works at Beanstox full-time (Worse, COO Carrie Farnsworth has only been employed for four months).
Active Investors on Autopilot?
Experienced investors will immediately sense red flags. Why spend so much time talking about the founding team when you already have a product in-market to show?
The answer quickly becomes apparent after reading user reviews.
“About as scummy as it gets,” wrote one irate user. “They sold my account to a different company,” complained another.
These poor app reviews make Beanstox look suspicious at best (Perhaps Beanstox sold off accounts to third-party DriveWealth because they lacked certain capabilities in-house?) At worst, it’s a company that’s cutting corners to compete in the ultra-competitive world of low-cost index-based investing.
Beanstox’s business case also looks weak. Passive investing platforms rely on gaining massive scale to offset overheads. When your three-year-old app still only has 1,400 users, it’s hard to imagine you’ll ever get to the million customers you need to justify any reasonable valuation.
Perhaps Beanstox can still succeed. COO Farnsworth and this funding round could be the bump the company needs to win. But investors are buying in from scratch. Without a convincing product, Beanstox looks more like a seed investment worth somewhere between $5 million and $8 million, rather than a Series A firm with a $27 million price tag.
Why Skeptical Investors Win at Private Investing
In 2017, 18-year-old brokerage company Folio Investing launched a mobile app. It’s goal was to “help investors create diversified portfolios to help minimize the risks associated with investing.”
The app however, came with a whole slew of bugs and performance problems.
“The platform is not user friendly,” wrote one user. “It provides no real time updates. Trades are not executed right away,”
Fees were also high, especially for a robo-advisor.
“This is a pretty sorry excuse for a brokerage account,” observed another customer. “Minimum monthly maintenance fee adding up to $60 minimum annually to simply hold any stock.”
Unsurprisingly, the company eventually shut down. As of December 2020, Folio Investments no longer provides self-direct investments; its customers have been transferred to a rival firm.
Skeptical investors understand that it’s only business. In a world where 90% of all startups fail within five years, they need to say “no” to any mediocre company far more often than they say “yes.”
And when you have companies like StartEngine powering ahead? It’s surprising that laggard firms like Beanstox can raise any money at all.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.