Why Accredited Investors Get More Access to Private Deals, How to Evaluate Pot Stocks

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Q: Why does the government give accredited investors more access to private deals? That doesn’t seem fair. I don’t need protection. I need investment opportunities.

A: I’m with you. It’s regressive, elitist and unfair, but it’s not the worst news in the world. I’ll tell you exactly what I mean in just a minute.

The government’s current stance stems from the 1929 stock market crash that brought on the Great Depression. It was a horrific, devastating blow to investors large and small. Family lore has a great uncle of mine jumping out of a window to his death because he lost everything in the “Great Crash.” He was a Wall Street investor, mind you.

In the 1920s, being a Wall Street investor didn’t necessarily make you smarter than other investors (it still doesn’t). But, if you were lucky, it did give you access to all the get-rich-quick schemes and chicanery of that wild decade.

The government stood aside. After all, times were good. People were getting rich. And the rich were getting richer.

Then the inevitable happened. And it came to a crashing halt in late October 1929. In 1933, the government passed laws to “fix” the problem and make certain security offerings available only to “accredited investors.”

This is what you’re up against…

Unless you make $200,000 ($300,000 per couple) OR have a $1 million net worth, not including your primary residence, you don’t get access to startups raising under Regulation D, rules 505 or 506. And many more companies raise under Regulation D exemption rules – in which companies can skip registering with the SEC but have access only to accredited investors – than under crowdfunding rules.

These restrictions are predicated on the antiquated assumption that an accredited investor’s wealth is proof that they’re able to protect their own interests. The corollary: No wealth, no proof, no eligibility.

But the restrictions have no grounding in reality. The Securities Act of 1933 was the result of a financial crisis caused by the rich whose ranks were harmed more than any other socioeconomic group. The wealthy were both perpetrator and victim. The only shred of a valid argument is that somebody with a million bucks in the bank can withstand losing $200,000 better than somebody with $100,000 in the bank can. The idea is one’s mortgage payment may be at risk for the latter but not the former. The argument is simplistic to a fault.

Will things change? They almost did last year. A “JOBS Act 3.0” bill expanding accredited investor criteria was approved in the House but died in the Senate. In the meantime, the SEC is revisiting the definition of accredited investor. (The last update was in 2011.) It will at some point be seeking comments to explore if the definition is “appropriately tailored to address both investment opportunity and investor protection concerns.”

The SEC has been down this “study, comments, revise” road before without taking any concrete steps, so I’m keeping a lid on my expectations.

But it’s not all grim news. The real and exciting silver lining is that the quantity and quality of crowdfunding deals have improved every year. We’re seeing more great deals than ever on our favorite sites (Wefunder, SeedInvest, MicroVentures, Republic, Netcapital and others). We used to have slow periods when there was a dearth of decent deals. No longer.

I’m not holding my breath for a more expansive JOBS Act to pass. But I’m also not all that frustrated with the status quo. Not as long as I can recommend high-quality deals to our members.

In the meantime, I fully expect the SEC to proceed at its own deliberate pace with little sense of urgency.

+ Early Investing Co-Founder Andy Gordon

Q: How is investing in cannabis stocks different than investing in other sectors? What am I supposed to be looking for in the earnings reports that came out this week?

A: The cannabis industry is in a very rare and unique position today. First of all, we’ve never seen a $200 billion black market go legit like this.

Secondly, I believe the medical side of cannabis will be at least as big as the recreational side. We know cannabis can effectively treat pain, inflammation, seizure disorders, anxiety and insomnia. But because cannabis has been illegal for so long, critically important medical research has been neglected.

The legalization movement is sweeping the world, and I believe it’s too late for the establishment to stop it. So the good news is that there’s rapid growth baked into this market for the next few decades.

However, cannabis investors should realize going in that it’s going to take time for this market to mature and grow. In fact, if you look at any cannabis company and try to value it like a normal stock, it’s not going to look very attractive. All the growth is ahead of this industry.

So in many ways, evaluating cannabis stocks is like evaluating startups. You have to judge a company’s future growth potential, which is largely a subjective exercise.

I do that by looking at the company’s progress so far. What did the company originally set out to do? How successful has it been at hitting goals? Has it acquired companies? If so, how have these investments done? How big is its potential share of the market?

I’m looking for the strongest brands with the best management teams, so I spend a lot of time evaluating these two criteria. If you’re interested in a particular stock, sign up for the company’s newsletter, follow it on social media and read its press releases. Search social media for its brand names and see what people are saying. If the CEO is interviewed on TV, watch it! See how confident they are and what their growth plan is.

And while it’s important to keep an eye on earnings and to see strong revenue growth, you can tell only so much about a cannabis company from its financial statements. I would argue that how the company is investing today matters as much as, if not more than, current revenue.

The most important question should be: Which sector of the market is this company going to dominate? Distribution, medical, grow tech, recreational? Vaping, dabbing, edibles, beverages? Hemp?

These are all going to be very large markets. The hard part is finding the ultimate winners. But because of the potential rewards, it’s a very worthy goal.

+ Early Investing Co-Founder Adam Sharp

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