photo of Spencer Dinwiddie (right) by Wikimedia Commons user Tdorante10
Spencer Dinwiddie’s $34 million, three-year contract with the Brooklyn Nets kicks in this season. In a move unprecedented for the NBA – though not in professional sports – Dinwiddie has decided to securitize at least part of that deal.
Dinwiddie intends to turn some portion of his contract into a “digital investment vehicle” according to The Athletic (which first broke this story). Dinwiddie, as the borrower, will give up some of his future income in return for an immediate lump sum payment. He can then invest the money he receives. If he can make more through investing than the amount he forgoes, Dinwiddie will come out ahead.
Securitizing his contract means that Dinwiddie is asking investors to issue him a loan that he will repay, with interest, using his NBA contract. As the New York Post put it, “he’s going to sell bonds in himself to get more money at his fingertips now.” This raises the question: Is Dinwiddie a good investment? Since NBA contracts are guaranteed, the main risk to investors is Dinwiddie violating the morals clause in his contract, which would invalidate it. In 1998 Frank Thomas, then a first baseman for the White Sox, tried to securitize his income. But the deal failed when financiers could not negate clauses that would have eliminated Thomas’ salary if, for example, he went on strike.
Dinwiddie plans to sell digital tokens tied to the value of some portion of his contract. He has expressed enthusiasm for cryptocurrencies, and especially bitcoin, in the past, so his decision to use blockchain-based digital securities for his debt offering is unsurprising.
Investors have had a chance to invest in professional athletes before, though not in NBA players. A company called Fantex struck deals with NFL players, MLB players and golfers, and allowed individual investors to buy and sell shares in entities that tracked those athletes’ earnings. Trade volume never took off, however, making the economics of the service unsustainable. Fantex shuttered its trading platform in 2017. Dinwiddie’s deal is different, in part, because he will not rely on a third-party service; he’s going to investors directly. According to The Athletic, Dinwiddie will start his own company to issue the digital tokens.
Dinwiddie is essentially betting that however he invests the lump sum, it will pay significantly more than what he would receive over the next three years by just collecting the corresponding portion of his salary. Dinwiddie will need to achieve a minimum hurdle rate just to break even, because he’ll owe interest to investors to compensate them for advancing him the money. To come out ahead, Dinwiddie’s investments will need to grow enough that they exceed this level of interest for him to be better off than he started.
Dinwiddie could also benefit from accelerating his income from an income tax perspective. The lump sum he receives will likely be immediately taxable at the top marginal rate, currently 37% for federal income taxes. Congress could raise taxes for high-income earners like Dinwiddie if Democrats take control of the White House and the Senate in the 2020 elections. Depending on the lump sum amount and the increase in tax rate, receiving the money sooner could translate into hundreds of thousands of dollars, or more, in savings.
Although I have yet to hear Dinwiddie’s plans for investing the lump sum, he may put it to work in venture capital. Increasing numbers of professional athletes are educating themselves on investing in venture capital and leveraging their celebrity to gain access to hard-to-access deals at significantly lower investment thresholds than are typical. Dinwiddie’s persona means it would not be surprising to find him among this group. After all, Dinwiddie describes himself in his Twitter bio as “Just a Tech guy with a Jumper.”
Venture capital, however, is very risky. A subset of private equity, venture capital involves providing funds to small or emerging startups with high growth potential. Venture capital, like other private equity investments, means taking on a lot of risk in pursuit of rare but significant financial rewards. A lot of startups fail, at least in the sense of providing a return for investors. In order to justify the risk, fees and illiquidity that investors take on, a venture capital fund needs to achieve an annual return of 12% or more; less than that, and its investors could do better by investing in a low-cost mutual fund or exchange-traded fund that tracks the S&P 500 Index. According to some measures, only about 5% of venture capital funds clear this benchmark.
This figure is not shocking when you consider how hard it is to launch a successful startup. Entrepreneur Tomer Dean wrote for TechCrunch that 80% of venture capital returns come from 20% of startups. This is why investors who focus on startups are always looking for “unicorns.”
As a financial adviser, I recommend that clients who meet the qualifications to invest in venture capital, or other private equity investments, limit the amount they invest. If Dinwiddie is committed to investing in venture capital, he could consider diversifying across the companies’ development stages – early, growth and late – to reduce some of the risk involved in investing in private equity. But I hope that Dinwiddie won’t put all of the money he raises solely into venture capital. Generally, I suggest my clients allocate no more than 10% to 20% of a portfolio to this asset class, depending on their time horizon, financial objectives and the size of their portfolios, even if they are very comfortable with risk.
There are potentially even riskier choices than investing one’s entire portfolio in venture capital. For example, I hope that Dinwiddie doesn’t keep his lump sum parked in bitcoin as if doing so were investing. Dinwiddie has bought bitcoin before and reportedly tried to convince his teammate Trevor Booker to do the same during the cryptocurrency’s steep rise in the winter of 2017-2018. However, as my colleagues wrote at the time, bitcoin represented an enormous bubble. After experiencing a steep drop, bitcoin’s value has climbed again in the past few months, though not to the heights of late 2017. Yet the fundamental problems remain. Bitcoin, and other cryptocurrencies, are neither effective stores of value nor useful mediums of exchange. Unless that changes, holding bitcoin will remain speculation, not investing.
All this is not to say that Dinwiddie has no hope of profiting from a lump sum. The time value of money means he could profit from a few years’ head start investing those funds for growth. As with any client who received a major sum, I would recommend Dinwiddie put most of it into a well-diversified portfolio invested for long-term growth. He can carve out a portion of the lump sum to pursue business interests that will allow him to maintain and grow his wealth long after his playing days end.
In addition to his interest in cryptocurrency, Dinwiddie has also demonstrated an interest in real estate; he reportedly owns a couple of rental properties and is in contract to buy the highest penthouse in Brooklyn. However he chooses to set up his financial affairs, Dinwiddie clearly has a high tolerance for risk – now the key will be pairing that tolerance with discipline. His choice to securitize his contract is neither good nor bad on its own. It’s all in how he plays the game.
As of this writing, the NBA Players Association has not commented on Dinwiddie’s plans, but the NBA has said the arrangement would violate the collective bargaining agreement. Dinwiddie, who previously said he was confident that neither the Players Association nor the NBA could block the deal, has said he will continue trying to negotiate with league officials. If he succeeds, we will see whether he makes the most of his unusual approach to compensation – and, if he does, whether more players follow suit.