Debt, equity and a third thing that might work better(sethgodin.typepad.com)
sethgodin.typepad.com
Debt, equity and a third thing that might work better
http://sethgodin.typepad.com/seths_blog/2009/11/debt-equity-and-a-third-thing-that-mightworkbetter.html
6 comments
not sure i'm convinced by the economics of this. amateur investors would compare this to other more standard investment options. let's say they invest a typical seed amount of $25k. assume they could earn approx 10% a year via "safe" investments.
as suggested in the article, you offer to double the investment by paying 4% of sales. that means you need to be bringing in $1.25 million in sales to repay the investor. using an (admittedly rough) assumption, let's say that takes 5 years to achieve. in the same time, if the investor had played it safe, their $25k would be (assuming compounded monthly interest at the 10% rate) $41k i.e. almost doubled anyway.
in the current economic climate 10% interest might be higher than expected and you could obviously fiddle around with all the numbers/assumptions to make it a more attractive investment but my instinct is that to sell this to the types of investors who would entertain something like this, it could end up being a more expensive way of raising finance than it initially appears.
as suggested in the article, you offer to double the investment by paying 4% of sales. that means you need to be bringing in $1.25 million in sales to repay the investor. using an (admittedly rough) assumption, let's say that takes 5 years to achieve. in the same time, if the investor had played it safe, their $25k would be (assuming compounded monthly interest at the 10% rate) $41k i.e. almost doubled anyway.
in the current economic climate 10% interest might be higher than expected and you could obviously fiddle around with all the numbers/assumptions to make it a more attractive investment but my instinct is that to sell this to the types of investors who would entertain something like this, it could end up being a more expensive way of raising finance than it initially appears.
What safe investment pays 10%? And if you had a 4% royalty $250K in annual sales, that's $10K per year in revenue -- which you'd probably value at something much higher (maybe $50K if you thought it wouldn't keep growing; maybe $250K or more if you expected further growth).
What safe investment pays 10%?
i use lendingclub.com http://en.wikipedia.org/wiki/Lending_Club
during less severe economic times you could also make around 10% via high yield savings accounts
i use lendingclub.com http://en.wikipedia.org/wiki/Lending_Club
during less severe economic times you could also make around 10% via high yield savings accounts
Unsecured lending to individuals is not, in general, a "safe" investment. Lending Club hasn't even been around long enough to reasonably estimate how safe it might be. Note that I'm not claiming it's a bad investment, but it really stretches the traditional financial definition of "safe."
And the highest I've ever seen for high yield savings accounts was around 6%, generally only for a promotional period, around 2007. Unless you're talking about the high inflation years in the late 70s and early 80s, in which case, yes, you could get 10% in a savings account, but the real rate of return was well into the negative due to inflation.
And the highest I've ever seen for high yield savings accounts was around 6%, generally only for a promotional period, around 2007. Unless you're talking about the high inflation years in the late 70s and early 80s, in which case, yes, you could get 10% in a savings account, but the real rate of return was well into the negative due to inflation.
That may be true, but safe investments generally pay less than that. Lending Club might be a good investment, but I'd think of it as a peer-to-peer credit card, not as something that competes with T-bills and commercial paper.
"assume they could earn approx 10% a year via "safe" investments."
An instrument with a risk adjusted return of 10%/year is called a junk bond.
An instrument with a risk adjusted return of 10%/year is called a junk bond.
Most people will want to cash in their investments at some point. In order to facilitate that we'd need a secondary market in these instruments so people could sell them on. The price would then vary based on future earnings projections. Either that or the understanding is that the payments continue until some fixed point in time, or until the investors death. So, depending on how you look at it, these are either dividend paying shares, corporate bonds or a kind of annuity. All of which exist already.
EDIT: although I'm not sure if anyone's really doing corporate bonds that are linked to profits, that might be new.
Having said all that, I agree with Seth that society could do with being a lot more creative in how it funds businesses.
EDIT: although I'm not sure if anyone's really doing corporate bonds that are linked to profits, that might be new.
Having said all that, I agree with Seth that society could do with being a lot more creative in how it funds businesses.
Yup having a secondary market is extremely important. That's why it already exists (just like mezz finance, which is what he has reinvented here, also exists). The idea of having an instrument that pays linked to a particular income stream is also not new - covered bonds, asset-backed securities, pfandbriefe etc for example all work this way.
...oh, and covered bonds linked to a specific income stream is also not new. XS0271006602 for example is a covered bond linked to the income stream on a chain of pubs in the UK.
It's pretty much the principle of dividends. With prefered shares you can even define the conditions of dividends, index them on the company's income.
To expand on this a bit more for the uninitiated, preferred shares are a more sophisticated version of what he's talking about. They basically work like debt that doesn't blow up the company if you can't make your payments. They tend to be junior to debt and senior to common stock if there is a liquidation, there is a secondary market on public exchanges, and there are many variants such as preferred shares that pay higher dividends in years with good earnings or that can be converted into common shares on terms similar to convertible bonds. This is already a well solved problem, but the solution isn't very sexy, so it's not as well known as debt and common stock.
The purposes of financial instruments (like debt and equity) are to replace these sorts of inefficient transactions.
Did Seth Godin just invent taxes?
He "invented" royalties for investors. Typically the royalties go the other way, because it's not just financing, it's also production, distribution, promotion, etc. (for books, movies, music). But more and more that's changing. Most startups are generally self-sufficient except for money.
It's a sensible idea which, if put into practice, might result in funding of a wider range of startups. As Godin pointed out, a lot of VC funding is highly stilted toward businesses that can sell out in a short time frame (go public or get bought), not just businesses that can become profitable in that time frame.
It's a sensible idea which, if put into practice, might result in funding of a wider range of startups. As Godin pointed out, a lot of VC funding is highly stilted toward businesses that can sell out in a short time frame (go public or get bought), not just businesses that can become profitable in that time frame.
Royalty-based financing is not a new idea and one that is being increasingly explored (a trend that started on the east coast if memory serves). A few links: http://blogs.sun.com/sun4startups/entry/vcs_look_to_royalty_... and http://www.technologytransfertactics.com/content/2009/10/21/...
edit - more here on the origins of the idea: http://www.xconomy.com/seattle/2009/10/07/royalty-based-vent...
edit - more here on the origins of the idea: http://www.xconomy.com/seattle/2009/10/07/royalty-based-vent...
Nothing new under the sun?
voluntary taxes
The coupon stream on mezz notes can be linked to income on specific assets (like covered bonds).
Subordinated debt and preferred shares are examples of mezz finance instruments.