By Andy Gordon on May 2, 2014 Dear Early Investor,
Do I have a deal for you!
I'd like to offer you a chance to invest in... me.
You'd get 20% of any future money I make from anything I do.
I have big plans. Broadcasting. Books. Reality TV. Maybe a biopic movie down the road.
All you have to do is loan me a million bucks right now.
In return, I'll give you shares. Let's say $10 a share, okay?
Just to keep things on the up and up, you won't be dealing directly with me. I'm letting an independent company handle everything. My shares will be trading on its private trading platform.
How about it? Interested? No?
Investing in the Future Earning Power of Stars Sounds Like a Great Idea
Then how about investing in the future earning power of a star NFL player?
Even I have to admit that sounds a lot better than investing in me. Actually, I have no plans to IPO myself. Reality TV is safe.
But, if you want, you can invest in professional athletes.
It seems pretty neat at first glance. You'd be lending to millionaire athletes at the top of their profession. Someone like Vernon Davis. He plays tight end for the San Francisco Giants. Makes good money too. His current contract has two more years to go and will pay him $10.2 million.
A company called Fantex is giving Davis a $4 million loan. Fantex is issuing 400,000 shares at $10 apiece to raise the money. In return, Fantex gets 10% of Davis' future earnings that (in theory) will be passed on to shareholders in the form of a dividend.
Blazing the trail for Davis was Arian Foster, a running back for the Houston Texans. Fantex lent him $10 million late last year. In the second year of a five-year deal, he'll be making up to $23.5 million through 2016 (though not all of it is guaranteed).
He's been a great back for Houston. But he'll be in his sixth year come this fall, considered old by NFL standards. Many running backs are on the back end of their career by then. The Boston Globe explains, "It's a physical toll, playing running back. Many assume, because of the nature of the job, that a running back's prime is not nearly as long as someone who takes far fewer hits."
The Many Ways This Deal Could Go South
So, should you invest in these types of deals?
Not in your life. The devil is in the details. Consider... - About 75% of the income Fantex expects from Arian Foster is tied to future contracts that do not exist, like playing contracts and future endorsements.
- Fantex itself has generated little cash. And it has substantial expenses. The company admits, "We have little operational history and limited assets and resources, have never generated any revenues."
- If Fantex goes under, you'd get reimbursed from the remaining assets of the company. But only after payment of debt and liabilities. Even before this happens...
- The company's board of directors may at any time convert its Foster shares into common stock, for example, in response to some "special or extraordinary circumstances," as pointed out in Fantex's S-1 filing. The company cites a potential restructuring, reorganization or change of control as qualifying events.
- And the board can do it at any price it determines to be "fair" (a subjective and arbitrary calculation at best).
- Nor is Fantex under any obligation to pass Foster's earnings on to shareholders. In fact, the company says its "capital structure may decrease dividend payment."
- The board doesn't provide any guarantee that the tracking shares will in fact accurately track the earnings performance of the Foster brand. Why?
- Tracking shares only partially reflect the economic performance of Foster's earnings. How "brands" do is also affected by Fantex's common stock performance, for better or for worse.
- A "for worse" case: The Foster and other tracking shares are subject to the risk associated with an investment in Fantex as a whole.
- Failure is not an option, at least not for the company's overall income-generation performance. The brands doing well are required to make up for the income that the non-performing brands were expected to provide.
- Fantex will be acquiring interests in additional athletes/celebrities in the future. That means the performance of Foster shares will depend on the unknown success of future athlete IPOs.
Bottom Line?
If Foster fails, so does your investment. If Fantex fails, you also get little and perhaps nothing from your investment.
Say you bought 100 shares or 1% of the 1 million Foster shares. You should get dividend payments amounting to 1% of the 20% that Fantex skims off Davis' earnings.
But, as you see, Fantex can deploy a number of exceptions not to pass Foster's earnings on to you. Suppose Fantex needs that money to pay bills rather than to pay shareholders? Taking care of Fantex's 100 million shares at the expense of the one million Foster shares is a no-brainer.
In making such an investment, you'd be taking on two big risks.
The first: Foster's earnings enter into a slow or sharp decline in the next few years. After all, 78% of NFL players, 60% of NBA players and a very large percentage of MLB players (four times that of the average U.S. citizen) file bankruptcy within five years of retirement (says Wyatt Investment Research).
The second: Fantex itself goes under or, not quite as bad, uses the earnings of Foster to shore up its financial position, instead of giving the money to you. Even if Foster goes on to make tens of millions of dollars more, you might see very little of it.
The silver lining to all this?
The company itself freely admits all of these risks. Either in its prospectus or S-1 form. You don't need me to point them out. You could have found out for yourself that this investment stinks.
Yet I have no doubt that many people will love the idea of investing in millionaire athletes and won't bother to read the fine print. Don't be one of them.
I always follow this rule and you should too. It's never let me down: The more exciting a deal sounds, the more research you need to do.
Fantex is a lesson on how not to structure investments in "personal IPOs." Until some other company comes up with a much less risky way to do them, you should keep your distance.    
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