Buying equity in people
The idea of buying equity in individuals rather than companies has occasionally been the subject of dystopian satire. And when Michael Lewis wrote in 2007 about a nascent attempt to set up a market in sports stars, he was far too early: Protrade closed in 2009, never having come close to achieving its dreams. (There are lots of echoes there of HSX, but that’s a different story.)
More recently, however, the idea’s been trickling back. In October 2009, entrepreneur and part-time professional poker player Rafe Furst invested $300,000 in a person he called “Marge”, in return for 3% of her future lifetime revenues. Rafe’s partner in this investment was another poker pro, Phil Gordon, and in a way it’s unsurprising that the deal came out of the poker world, where rich individuals regularly “stake” players in return for a share of their winnings.
Furst provided a three page Personal Investment Contract for anybody else who was interested in doing the same thing, but a couple of years later, in August 2011, he revealed that “Marge” was in fact his brother-in-law Jon Gunn. Now if you want to help out a family member, and you know they don’t have the money to repay a very large loan, and you have faith that they’ll make a fair amount of money in the future, and you have a very strong relationship with them, then this kind of a contract might be an interesting way to go. But I’m skeptical: such arrangements very rarely go as intended, and usually end in tears.
Still, other people heard Furst’s story and tried to do much the same thing. Saul Garlick and Jon Gosier set up a website asking for the Marge deal: $300,000 for 3% of lifetime earnings. Their friend Kjerstin Erickson doubled up, asking $600,000 for a 6% stake in himself. (Evidently, the present value of a 20-something entrepreneur is generally understood to be $10 million.)
Now, however, a mysterious website has appeared, called Upstart, offering “capital in return for a small portion of your future income”, and claiming to be “backed by Kleiner Perkins, NEA, and Google Ventures”. The site’s slogan is “The Startup is You”.
In a world where venture capitalists increasingly invest in a startup’s management team rather than in its business model or underlying idea, this makes sense. Find the entrepreneur and invest in the individual directly, thereby guaranteeing that you’ll have a stake in their success if and when they finally hit it rich on their fifth or sixth attempt.
But given the long and sordid history of VC-backed entrepreneurs, I would never advise anybody to take Upstart’s money. The legal advice alone that you would need to protect yourself would probably consume most of what you raised. And there are lots of practical reasons why accepting this kind of funding is a bad idea, too. For one thing, at least if Furst’s document, is any guide, you have to pay out not only on your income, but also on all of your other capital gains, even any inheritance you might get from family members. For another thing, you have to pay out a percentage of your gross pre-tax income, but you have to make that payment out of your post-tax income. And most importantly, it’s far from clear which if any expenses can be discounted. Let’s say you’re a self-employed entrepreneur who runs a business which makes a profit of $100,000 on gross revenues of $1,000,000. Do you have to pay out on the $1,000,000 or just on the $100,000?
Equally, I wouldn’t advise anybody to go down the buying-equity-in-people road, either. It just doesn’t smell right: there’s a whiff of indentured servitude about it, and it makes the concept of the rentier, living off someone else’s hard work, all too real. The investor is also essentially levying a tax on the individual, and I can absolutely see a successful legal defense saying that only the government has the right to levy taxes. More generally, I can’t imagine that the contract would ever be particularly enforceable. There’s nothing in Furst’s contract saying what happens if the individual simply refuses to pay any more money to the investor, but if the investor tried to sue, I wouldn’t fancy their chances in court.
This is an idea, it seems to me, which many people have thought about, and a brave few have tried, but which has never really gotten off the ground, for very good reason. If you want to invest, invest in a corporation. If you want to raise equity capital, then create a limited-liability corporation, and get people to invest in that. Corporations exist for good reason. Circumventing them by investing directly in people is an idea whose time will never come.