Our Investment In CFX Markets

We met Jordan Fishfeld and Juan Hernandez last March to talk about their company, CFX Markets.   We had a great first meeting and we were interested.  I had known Juan from prior years.  A few years ago, Juan and my friend Tony Wilkens contacted me about being the front man for a Hispanic focused startup accelerator.

I looked into it and seriously considered it.  I spoke with people that had started accelerators and the folks that started TechStars.  The reason I didn’t do it was because I wasn’t the right person.  It had nothing to do with my skin color, and everything to do with my experience.  I fully believe the people that should lead and operate startup accelerators should have started and been CEO of a startup that has raised venture capital.  Getting to know Juan was a benefit to that exercise.  He is a great person, and a very capable person as well.  Over the course of the past several months, I have developed a relationship with Jordan too.  He also is impressive.

West Loop Ventures initially committed to the deal but due to a lot of different weird one-off circumstances, it didn’t proceed.  We decided with Jordan and Juan to take the lead.  So here we are.

CFX is right in our wheelhouse.  They create transparency and liquidity in alternative assets that need them.  It’s a two-sided marketplace.  It really bugs me when layers of distribution force investors to pay tolls to get into and out of positions. Artificial friction in marketplaces sucks.   CFX initial target market is a $90B, with a B, market.  if we look at the notional volume of all alternative assets that might be able to use the services of CFX, it’s $4.2T, with a T, market.

Public non-listed REIT’s have been a poster child for broker abuse and featured prevalently in the debates leading up to the Department of Labor’s (DOL) fiduciary rule. When originally listed many of the REIT issuers would pay a 15%+ commission to brokers who sold shares to mid net worth financially unsophisticated individuals. Many of the REITs would then immediately start paying a dividend before they had any performing assets.

By the time the assets were stabilized the principal remaining could be 60% of the original investment.  Commission and dividend costs ate into the principle. Understandably the REIT yield would be much lower than anticipated. This gave the asset class a poor reputation and deflated trading prices.

Often owing to a life event (divorce, death, etc) when the end shareholder wanted to sell their stock, they would call up their broker and ask them to facilitate the trade. The broker would only earn a negligible commission and their effort reflect this. They would make a few calls around the BD network and take the first price offered. A 50% discount to the underlying REIT’s Net Asset Value (NAV) was not uncommon.

Public non-listed REIT’s have stiff reporting requirements.  They have the standard 10-K/10-Q filings of a public company, but also as a public REIT they have to have a third party do regular asset appraisals to come up with a “good” NAV. Ernst & Young and Accenture are large providers of this service.  When we say the trades are happening at 50% discount to NAV, it’s this third party determined valuation we’re referring to.

One aspect of the DOL’s fiduciary rule is that now brokers have to show they made a good faith effort to find the “true” market price before executing their customer’s order.  CFX is filling this void by providing a marketplace and access to the platform trading history.  Brokers looking to execute a customer sell order now can do so easily.

Sellers on CFX are still seeing slippage of 30%+, but that’s down from 40% when CFX first started investigating the platform, and 50% using the traditional BD phone call approach. The buyers to date are generally opportunistic traders.  Incidentally, if you’re a trader reading this you might want to take a look.  There is inefficiency in the market and you can make some money by creating a more efficient marketplace.

The public non-listed REIT market is growing.  Cantor and Blackstone are currently raising funds in excess of $1 BN using a compensation model that makes sense.  In Blackstone’s case 5% hurdle and 15% carried interest, the rest going to the investor as the assets produce. Additionally recently interval funds have become popular which invest roughly 70% of their capital in public non-listed REIT’s.

Existing investors co-invested with us in this round.

Michael Rosenthal of Poisinelli was our attorney on the transaction.  We have known each other a long time but we never had actually done a deal together. Kenny and I are very committed to growing the Chicago venture scene, and we are trying to make it a habit to use attorneys that are local.  Over the last ten years, I have developed relationships with various attorneys at Hyde Park Angels and I intend to use them.  I first met Kathleen Swan of Lorde Locke with HPA and we used her for our fund documents and first deal.

WLV will be taking a board seat.  We like to take board seats in early rounds, add value, and then give them up to newer investors in succeeding rounds.