Loyal3 Investing: Why Folio First Took Over

Back in 2011, Barry Schneider launched Loyal3 for the purpose of allowing the mom-and-pop small investor to have a chance to invest alongside institutional Wall Street investors in initial public offerings.

Perhaps most popular of all, Loyal3 enabled investors with as little as $10 to invest in the initial public offering for Square (SQ) on November 19, 2015. Oddly enough, the price of Square’s IPO was $10, meaning investors with minimal investment funds could access a stock that now trades at $75 per share just four years later.

The IPO investing opportunities that Loyal3 provided, for no fee on the investor end, was absolutely unparalleled.

Of course, there were only a five or six IPOs, at most, that could capture an investor’s attention over the course of a year, and to build an ongoing business model outside of these one-time events, Schneider entered into relationships with approximately 75 publicly traded American stocks, including heavyweights such as Coca-Cola, Altria, Anheuser-Busch, Starbucks, Disney, Pepsi, Berkshire Hathaway, Apple, Google, and Alphabet, in order to reach an agreement that would enable small shareholders to buy the stock with no trading charges–i.e. for free.

The small shareholders obviously benefits from the prospect of building a position over time at no cost, but the company also benefits because it is raising capital at minimum out-of-pocket costs that is much cheaper than, say, obtaining a bank loan to fund their operations.

At its peak in 2017, approximately 200,000 brokerage accounts were in use through Loyal3. By this time, Schneider had already left Loyal3 a year earlier for undisclosed reasons.

At this time, Folio First purchased Loyal3 for an undisclosed amount of money (that’s why, if you haven’t touched your Loyal3 brokerage account since 2017, you now find yourself having a Folio First account).

Many times, as free investing portals that charge no commission become commercially available, I hear small investors say something like: “I am going to keep growing this investment through Loyal3 [or insert free brokerage option] for the next fifty years and watch it grow over time.”

While that is a great goal, there will almost never be a case in which free brokerage options will remain free for much longer than a period of five years or so.

This is because the ownership of any business tends to flow to the person or entity that values it highest. When someone is charging no fees to invest, the operation is essentially that of a non-profit by another name. It requires a capable market actor who is motivated exclusively by altruism.

Along came Folio First, which had plans to attach a $5 monthly investing fee to the accounts, plus a $25 fee for each stock that is ever transferred away from the account. Even though Folio First lost approximately 60,000 accounts after instituting its fee, it still has approximately 140,000 accounts generating a $5 monthly fee, for a monthly revenue stream of $700,000 or so.

My guess is that the value of the Loyal3 accounts was worth something close to $100 million in the hands of Folio First and its new fee regime. I don’t know precisely what it was worth to the Loyal3 owners, but since it was not charging users a fee to generate revenue, their own value of the firm had to have been considerably less than that.

Nowadays, I see small-time investors flocking to RobinHood, the smart-phone stock purchasing and selling app that also declines to charge fees due to a similar arrangement as that which Loyal3 entered into with America’s largest companies.

Robinhood, which has 3 million users and is owned by Greenoaks and Thrive Capital among others, will either charge a fee in the coming years or will be sold out to someone who does so. I would say that one of these realities will occur prior to 2022. It is an elementary economic reality that someone who plans to charge a fee to the assets under management will value the firm higher than someone who owns it but declines to charge fees. Even with moderate user attrition in response to the initiation of fees, the brokerage accounts that remain have far more value than a higher number of accounts that pay nothing.

When you see a new brokerage house come along, particularly one that promises to charge no fees, it is theoretically fine to open up an account and invest through them provided that there is adequate SIPC insurance (personally, though, I think someone should suck it up and pay the $4.95 for an established firm like Fidelity or Charles Schwab for enhanced safety and security measures since we are talking about your wealth). Still, if you plan to go the route of finding a no-cost brokerage house, I would expect that you will have to shuffle your assets every few years.

It is a distinctly modern characteristic for a business to adopt the philosophy of “get users now, we’ll earn a profit later.” From an investor in Loyal3 and now Folio First’s perspective, the business model was never “adopt rules and keep them intact as the business grows” but rather “get more users as quickly as possible and try to keep 70% of them when we start charging them.” I don’t enjoy a business model where the financial success comes from a premise that is different than that which brings in the customer initially.

But using the term bait-and-switch isn’t fair either, since the favorable terms are honored until the acquisition occurs, at which point, the customers have notice of what is occurring and can leave if they so choose.

All told, the $5 monthly fee that Folio First charges is not terrible. Heck, it’s better than discount brokerages that charge $4.95 per trade. If you are purchasing thousands of dollars in several stocks per month, Folio First remains a good deal. But if you are someone who invests in a lump-sum pattern, with months of inactivity, a traditional brokerage house may be preferable because Schwab won’t charge you during the period of inactivity while Folio First will.  

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