CrowdFunding Platform for Investing In Fine Art

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If you’re looking to invest in a physical store of value – then you might be considering the merits of gold, silver, diamonds, or real estate.

With that being said, many within the investment space note that fine art is an excellent asset to store your wealth. Not only does it act as a diversification tool against a downfall in the traditional stock markets, but fine art typically increases in value over time.

But, there is a slight problem with accessing the fine art investment arena if you’re an everyday investor. This is because top-grade art pieces often sell for millions of dollars, subsequently putting it out of reach for the vast majority of us.

That was until the team at Masterworks launched its crowdfunding-style platform that enables you to purchase fractional shares of a fine art piece. Each share is worth $20 of the total value of the piece, with your ownership percentage proportionate to the number of shares you decide to buy.

If this sounds like something you would like to explore further, we would suggest reading our in-depth Masterworks review prior to taking the plunge – not least because an alternative investment such as fine art is somewhat complex in comparison to purchasing blue-chip stocks.

Within our review, we’ll cover the ins and outs of what you need to know, such as what Masterworks is, how the investment process works, how you are likely to make money, whether or not your funds are safe, and more.

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What is Masterworks?

Launched as recently as 2017, Masterworks is an online platform that allows everyday consumers to invest in the multi-trillion-dollar fine arts arena. While we will explain the fundamentals in more detail further down, Masterworks operates on a crowdfunding-style business model, insofar that fine art pieces are purchased by the platform, and then sold to investors in the form of fractionized shares.

We are not talking about any old paintings here, but the likes of masterpieces from artists such as Monet and Warhol. The project’s founder and CEO – Scot Lynn, is a seasoned art collector with more than 15 years worth of experience in the space.

Supporting Lynn is a team of 17 employees who also possess a wealth of experience in the fine art industry, with the company’s headquarters located in New York.

In a 2017 BBC article on the advantages of investing in the fine art space as a retail investor, it was noted that individuals will need to have a starting fund of anywhere between £5,000 and a whopping £500,000. As such, the fine art investment space has traditionally been reserved for the wealthy. However, Masterworks takes a completely different approach to the investment process, insofar that it allows multiple-ownership of a single piece.

The platform does this in the same way as any other crowdfunding-style website, such as those operating in the real estate sector. For example, the team at Masterworks will initially start the process by sourcing and identifying potential investment opportunities by locating fine art pieces that are available for purchase.

This could be a direct sale, or through an art auction. Nevertheless, once a fine art piece has been identified, Masterworks will then list it on its platform. Once they do, Masterworks investors will have the opportunity to inject capital into the listing, with each share broken down in increments of $20.

Blockchain and Tokenized Securities

While the investment process might sound somewhat basic at first glance, there is a lot more to the platform that will require further discussion.

For example, Masterworks utilizes the benefits of blockchain technology to execute fractional ownership, with each fine art purchase subsequently registered with the Securities and Exchange Commission (SEC) as a tokenized security.

It is crucial to note that such an investment vehicle is extremely new, so it’s important that you understand what you are investing in before we go any further.

Artists — Some of the artists on the platform

Blockchain

First and foremost, the Masterworks platform is fully supported by blockchain technology.

For those unaware, the blockchain was initially launched in 2009 as the underlying technology supporting the world’s first cryptocurrency – Bitcoin. Since then, thousands of additional cryptocurrency projects have been created – with some choosing to build their own blockchain protocol, and others deciding to merge their platform on top of an existing blockchain. In this sense, Masterworks has decided to go with the latter.

Nevertheless, the blockchain protocol affords Masterworks investors with a range of key benefits. At the forefront of this is the ability to fractionize physical assets. You see, once Masterworks proceeds to purchase a fine art piece, each $20 share is represented by a digital token.

In order to facilitate a transparent, secure, and seamless investment ecosystem, these tokens are subsequently stored on the blockchain. Moreover, the blockchain protocol also makes it a straightforward process to transfer ownership to another person or entity.

For example, let’s say that you have 100 shares of a particular fine art piece, which amounts to an initial investment of $2,000 (100 shares x $20).

If the value of your shares increased and you decided that you wanted to sell half of them on the open marketplace, this could be done in a seamless manner. Take note, the specifics surrounding a secondary marketplace are yet to be established by Masterworks, although we’ll cover what your options are surrounding redemption further down.

Tokenized Security and the SEC

If you’re still somewhat confused about the legitimacy of having your investment represented by a tokenized security, the key word in this respect is ‘security’. In a nutshell, your investment – which is in the form of a digital token, is protected by the very same consumer rights and safeguards as found in any other financial security.

Whether it’s investing in stocks and shares, bonds, government treasuries, options, or futures – those behind the financial security in question must follow the rules set out by the SEC. This ensures that the underlying issuer of the security meets and complies with all relevant US laws and regulations surrounding investor rights and protections.

Without getting too technical, the team at Masterworks will register each and every fine art purchase with the SEC under Regulation D. Each offering is publically available to view via the SEC website. Here’s the posting for The Andy Warhol Catalogue Raisonné purchase that Masterworks made, which it paid just over $1.8 million for.

So now that you know the ins and outs of how your investment with Masterworks is backed by the blockchain protocol – and that each investment is protected by the SEC’s regulations on securities, we are now going to explore whether or not an investment in fine art is worthwhile.

Is Fine Art Worth Investing in?

Like any asset class in the financial arena, you need to assess whether or not fine art fits in with your long-term investment goals. When you first land on the Masterworks homepage, you will instantly be presented with a comparison between fine art and the S&P 500. For those unaware, the S&P 500 is an index fund that tracks the movement of the 500 largest companies listed on the US stock markets and thus – it is a strong indicator of how the wider US economy is performing.

As per Masterworks, while the S&P 500 declined by 4.4% in 2018, the fine art market saw an increase of 10.6% in the same period. As such, publications such as the Wall Street Journal puts fine art as the top-performing asset class of 2018. On the flip side, the S&P 500 typically yields an annual return of 9.8% over the course of time, while fine art is estimated to average a long-term return of 7.6% annually.

With that being said, if you’ve never invested in fine art previously, it is crucial to note that the value of your investment will be determined in a completely different manner to the traditional stock markets. In its most basic form, fine art represents a store of value, insofar that it is an excellent way to protect your wealth against the threats of inflation and/or a downfall in the stock markets.

However, this also makes your investment highly illiquid, meaning that you won’t be able to withdraw your fine art investment as easily as you could do with a blue-chip stock. In reality – and much in the same way as a real estate investment, you will likely only be able to realize your gains if and when the fine art piece in question is sold.

In the near future, Masterworks will look to install a secondary marketplace for its investors, which will allow you to sell your fractionized tokens to other investors, without a requirement for the property to be sold. Until then, you need to view your Masterworks investment as a long-term holding, much in the same way as you would with any other illiquid, store of value.

Ultimately, if history is anything to go by, top-tier fine art pieces such as those created by the likes of Picasso, Warhol, Monet, Wou-Ki, and Condo will likely continue to appreciate in value over the course of time – although this is still not a guarantee.

How Does the Investment Process Work?

If you’ve read our Masterworks review up to this point, and you like the sound of what a fine art investment entails, we are now going to breakdown the end-to-end investment process in more detail. Each section contains a wealth of important information, so be sure to read them all!

Step 1: Masterworks Sources Fine Art Pieces

First and foremost, the team at Masterworks will actively source fine art pieces that it believes represents a good long-term investment. This will typically center on blue-chip pieces, meaning that the team will only consider the finest of pieces created by hallmark artists that are recognized globally and timelessly. Masterworks aims to source a new fine art piece every two months, subsequently allowing its investors to diversify across multiple paintings.

Interestingly, Masterworks will actually purchase the fine art piece itself, as opposed to relying on the capital it raises via its tokenized security sale. On the one hand, this would at first glance illustrate that Masterworks has sufficient levels of cash flow at its disposal, which is always a good sign. On the other hand – and as we cover shortly, although investors can purchase a fractional share in increments of just $20, Masterworks does require a minimum security deposit of $1,000. This could, in theory, be used by the company as a means to raise the required capital to purchase art pieces before engaging in the public offering.

Step 2: Tokenized Security Offering

Once the team at Masterworks has made a fine art purchase, it will then register the asset with the SEC as a security. This then allows the firm to proceed with its tokenized offering. As noted earlier, this gives investors – who are referred to as ‘shareholders’, a range of regulatory protections and investor rights – as per the laws dictated by the SEC.

Once a fine art piece becomes available for investment, it will then be listed on the Masterworks platform. Each investment will come with a wealth of information linked to the fine art piece, not only with respect to the history of the painting itself, but with respect to the financials. For example, you will be able to view the historical purchases and sales that have been made on the painting in question, as well as the projected value of the piece moving forward.

While these projections can never be guaranteed for their accuracy, it does at the very least provide you with an indication of how much your investment could be worth in the near future. In this sense, you are best advised to perform additional due diligence of the piece before proceeding.

You don’t necessarily need to have any knowledge or experience of fine art to be able to do this, not least because the internet is jam-packed with reliable sources. This is especially the case with fine art that is purchased by Masterworks, not least because the platform only makes investments in blue-chip pieces that were created by some of the most sought-after artists in the world.

Step 3: Apply for Membership

Unlike other crowdfunding-style investment platforms in the online space, Masterworks requires an enhanced application process in order to become a member. First and foremost, you will need to fill out a membership invitation form through the website. This will ask for your full name, email address, and phone number.

You will also need to state the type of account you wish to open, such as an individual investor account, investment advisor account, or art dealer account. If you’re just looking to engage in fractionized investments, then simply select the individual investor option. Masterworks will also ask you how much you would be looking to invest in over the course of the next 12 months, and the size of your current investment portfolio (all securities, not just art).

Once you submit the initial application request, somebody from Masterworks will then call you to complete a brief interview. This will give you the opportunity to receive a full explanation of how the investment process works, as well as settle any questions or concerns that you might have. Once the interview has concluded, Masterworks will get you set up as an investor.

Step 4: Make an Investment

Once you have identified an investment opportunity, and had your account application approved, you are then ready to make your first purchase. Let’s take the ‘Colored Marilyn’ Andy Warhol piece as an example – which was the first tokenized offering listed at Masterworks. In total, 99,825 shares were listed for sale, which at $20 per share, amounted to a total funding campaign of $1,996,500.

If you proceeded to purchase one share at $20, this would give you legal ownership of the painting at a proportionate rate of just over 0.00001%. In other words, if you purchased $19,980 worth of shares, you would own a fraction over 1% of the fine art piece. It is important to note that while you are perfectly fine to purchase just one share at $20, Masterworks does require you to make an initial deposit of $1,000.

The deposit amount will be taken during the registration process. As such, you have the choice of using the full $1,000 deposit on a single investment, or save some of it for future fine art opportunities that are listed on the platform. Once the investment has been made, you will then have legal ownership of the painting in the form of a Special Purpose Vehicle – proportionate to the number of shares you buy.

Note: A Special Purpose Vehicle, or simply an ‘SPV’, is a common financial instrument that is used by parent companies to reduce risks for its investors. As such, were the parent company (Masterworks in this case) to go bust, investors would still retain their ownership rights on the underlying asset (tokenized fine art securities in this case).

Redeeming Your Investment Funds

One of the most important considerations that you need to make when purchasing a physical store of value is what your options are when it comes to redeeming your investment. As we have noted throughout our review, fine art is a highly illiquid investment, insofar that in most cases, you will only be able to withdraw your funds back out as and when the painting is actually sold on. Before we get to the process of redemption, it is important to outline what happens to the fine art piece once it is purchased by Masterworks.

In a nutshell, the painting will be stored and displayed in its private gallery in Soho, New York. As a private location, individuals are required to set up an appointment with Masterworks before gaining access to the gallery. This is the same process required by potential private art collectors that wish to view a particular piece for purchase. As an investor, you will have the opportunity to do this by contacting the investor relations team.

As soon as the painting makes its way to the Masterworks gallery, it is effectively available for sale – were a private investor be looking to purchase it at the asking price set by the team. However, Masterworks notes that in most cases, it will plan to hold on to the painting for at least 3-5 years before a sale is sought, subsequently allowing it to appreciate in value. In this sense, Masterworks would likely engage in a public auction to facilitate the sale.

Once a sale is eventually made on the painting, you as an investor will be entitled to your share of the ‘net’ proceeds. We highlight the word ‘net’ here, because there will, of course, be costs involved in the selling process. Auction houses can be a costly endeavor for sellers, with some estimates putting the average commission rate at between 12% and 25% of the final sale price – although this can be considerably more.

As we briefly noted earlier, Masterworks plans to eventually create a secondary marketplace that will allow investors to trade shares before the fine art piece is sold. In what it calls a ‘Planned Liquidity Window’, the secondary marketplace will effectively allow you to liquidate your investment as and when you find a suitable buyer. Masterworks also notes that it will install a mandatory lockup period before the secondary market option is permitted, although it hasn’t started what this will be as of yet.

Ultimately, until the secondary market is given the required regulatory green light, you will need to hold on to your investment until the painting is sold. In this sense, you should expect your funds to be locked up for at least 3-5 years.

What Fees Will I Need to Pay?

As is the case with any investment platform, you will, of course, need to make some considerations regarding fees. In the case of Masterworks, fees will be charged on two key fronts – an annual maintenance fee and a fee on any subsequent profits that are realized once the painting is sold. This operates in a similar nature to a Wall Street investment house that charges a yearly fee on your injected capital, and then a commission on the gains that the fund manager makes on your behalf.

At Masterworks you will pay an annual maintenance fee of 1.5% This will be charged on the total amount that you have invested at the platform in the form of tokenized shares. For example, if you have $10,000 held in shares, you will pay $150 per year. This is charged to cover a number of ongoing costs encountered by the company, such as storing the fine art in its private showroom, regulatory expenses, distribution costs, and insurance.

In terms of the profit share, Masterworks will take 20% of the net proceeds once the painting is sold. For example, if the painting was purchased at $1 million, and after costs, the piece netted $2 million, Masterworks would keep $200,000 before distributing the remaining balance to its shareholders. We would argue that this represents a good value commission structure – even at 20%, not least because Masterworks will only earn revenues if they are able to sell paintings for more than what they paid. As such, they will be extremely motivated to ensure that the sourcing process is carried out in a highly stringent manner and thus – investments are chosen very wisely.

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