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Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. A venture investor is expecting a 10x return on

Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. A venture investor is expecting a 10x return on their investment. That means they are expected a much greater realized interest rate than debt - money that effective comes out of the pockets of the business owners. If you can get debt, if is often preferred if you can figure out how to manage the default risk. You do not give up equity (which could be worth a massive amount), rather you only have to pay back the debt at some future time with some much minor interest. Also interest is often tax deductable, thus debt has further tax advantages. One Nobel winning economic theory leads to an optimal capital structure of 100% debt: https://en.wikipedia.org/wiki/Modigliani%E2%80%93Miller_theorem https://en.wikipedia.org/wiki/Modigliani%E2%80%93Miller_theo... Example: Apple is buying back shares (the opposite of equity funding), while issuing massive amounts of debt.

Dwolb 11y ago
Right, but MM's "optimal capital structure" isn't taking into account if your company can't raise debt on the public markets while maintaining cash flow. Debt is essentially selling a put option on your assets, but early stage companies don't have substantial assets. That's why convertible debt exist and why early stage financers demand equity.
- sportanova 11y ago
  i always enjoy the "x is essentially a <somewhat_obscure_financial_instrument>". I feel like it's moderately common in startup thought leader type posts
  - eru 11y ago
    Put and call options are about as basic as it gets in finance. Though, the more and more I think about the grand-parents comment, the less I understand it: With debt, you can go into default: so all your assets go to the creditor, instead of you paying. That's like buying a put option, not selling one.
    - Dwolb 11y ago
      Yeah you're right. It should say something like the payoff of debt owned by the creditor looks like being short a put.
  - TeMPOraL 11y ago
    Stacking those together ("X is essentially an Y, 100K of Y are essentially Z, 100K of Z generally behave like U") is what got us the 2008 financial crisis.
  - MagnumOpus 11y ago
    No need to be dismissive - simple financial instruments are only obscure to those who willfully remain ignorant. Your parent post's statement is a reference one of the basic financial models in asset pricing literature, the "Merton model" (Merton RC. 1974. "On the pricing of corporate debt: the risk structure of interest rates." J. Finance 29:449–70)
fweespeech 11y ago
Apple is doing it as regulatory arbitage which is distorting the normal signals. I'm not saying you are wrong, more its a really bad example.
robzyb 11y ago
> Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. Honestly? That statement seems a tad simplistic to me. Especially in the context of startups.
- hguant 11y ago
  What makes a start up different than any other business?
  - joshmn 11y ago
    The urge to aggressively, rapidly grow.
    - jjaredsimpson 11y ago
      This is a distinction without difference. You could've also said, "Startups have fewer employees" for instance. How does the urge to grow separate a startup from a business in the desire to obtain low cost debt?
  - robzyb 11y ago
    Investing in getScale is vastly different to investing in IBM. Lending to getScale is vastly different to lending to IBM. Therefore the debt/equity argument and balance is vastly difference.
  - rdlecler1 11y ago
    From a lenders perspective: Credit worthiness, free cash flow, ability to service loans, lack of collateral.
- azernik 11y ago
  The big difference is that startups generally can't get bank loans on the scale they need, because the risk is so high that it's bad for the lender. If I could replace an investor with a 10% staake with a bank that I have to pay back at 8% interest, I'd take it in a heartbeat.
vidarh 11y ago
> Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. That is the central thesis of the linked article as well.
deleted 11y ago
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deleted 11y ago
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- wjnc 11y ago
  No, they have a different risk-reward structure. They finance those firms that probably cannot issue debt. They take equity for their funding. That's what parent is saying. Once you are in the league of issuing debt, you probably want to. Since it suggests that you are deemed to be an adequate counterparty. A small chance of default wreaks havocs on nominal interest rates.
  - deleted 11y ago
    [deleted]
anifow 11y ago
Words like "debt" can be tricky to pin down, which is why we have an accounting profession who's job it is to establish a cohesive and consistent language system with specific meanings. Kickstarter money represents both revenue and a liability for the company that is doing the project. There are many types of liabilities which are not exactly debt in the sense that we think about a bank loan (which is also a liability). The thing that all liabilities have in common is that they represent an obligation of the company which could require them to spend money or other assets to fulfill. This does not mean they have to satisfy the liability, it just means that there is a financial justification for any work they do relating to that. I am sure the accounting profession is continually being tested with new business models and trying to capture the financial reality for people who are playing very different games in the world of capital.
girmad 11y ago
Apple is only issuing debt because all of its cash is overseas. At this point the interest is cheaper than paying US taxes.
sukulaku 11y ago
> One Nobel winning economic theory leads to an optimal capital structure of 100% debt Too bad the theory is complete nonsense. >> The basic theorem states that under a certain market price process (the classical random walk), in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. In short, the theorem states that in conditions that will never exist in the real world, the value of a firm is unaffected by how it's financed. >> the value of the company increases in proportion to the amount of debt used First they say "the value of a firm is unaffected by how it's financed", but then: "the value of the company increases in proportion to the amount of debt used", so if "debt used" counts as "financing" then the theory contradicts itself, at least as described by Wikipedia. This is where I rambled about some other related stuff, but decided to just leave it out because fuck everything about mainstream economics.
- yummyfajitas 11y ago
  In short, the theorem states that in conditions that will never exist in the real world,... If only Modigliani and Miller weren't total idiots. Then they might have repeated their calculations with these assumptions relaxed. First they say "the value of a firm is unaffected by how it's financed", but then: "the value of the company increases in proportion to the amount of debt used", so if "debt used" counts as "financing" then the theory contradicts itself, at least as described by Wikipedia. If you bothered to read the article, you'd recognize that Modigliani-Miller actually did the exact calculation you previously criticized them for not doing. Similarly, if you read it, you'd recognize that the claims you think are contradictory actually apply to different circumstances (taxes vs no taxes). What next, medicine is contradictory because "if you don't eat cyanide, you probably won't drop dead, but if you do eat cyanide you will"?
  - sukulaku 11y ago
    It doesn't matter what and how they calculated, because your preferences and valuations are not externally determinable. For example, there's no way to calculate how much you'll be willing to pay for a can of cola tomorrow at 17:56, but your decision to buy one (or not) will factor into the economy as a whole. If you buy a cola at noon, that results in a different state for the whole economy than would have resulted from you buying it at 17:56, and so on. An economy is an aggregate of all the individual choices that factor into it, and all of those choices are based on people's individual preferences and therefore incalculable. This is why all of mainstream economics is at best misguided nonsense and academic mental masturbation. In reality, of course, its real purpose is to serve justifications for government intervention in our lives - it's not like Austrian Economics is some arcane knowledge that's only available to a handful of insiders somewhere. You can go to http://mises.org http://mises.org and learn to understand how economics really works.

Dwolb 11y ago

Right, but MM's "optimal capital structure" isn't taking into account if your company can't raise debt on the public markets while maintaining cash flow. Debt is essentially selling a put option on your assets, but early stage companies don't have substantial assets. That's why convertible debt exist and why early stage financers demand equity.

sportanova 11y ago
i always enjoy the "x is essentially a <somewhat_obscure_financial_instrument>". I feel like it's moderately common in startup thought leader type posts
- eru 11y ago
  Put and call options are about as basic as it gets in finance. Though, the more and more I think about the grand-parents comment, the less I understand it: With debt, you can go into default: so all your assets go to the creditor, instead of you paying. That's like buying a put option, not selling one.
  - Dwolb 11y ago
    Yeah you're right. It should say something like the payoff of debt owned by the creditor looks like being short a put.
- TeMPOraL 11y ago
  Stacking those together ("X is essentially an Y, 100K of Y are essentially Z, 100K of Z generally behave like U") is what got us the 2008 financial crisis.
- MagnumOpus 11y ago
  No need to be dismissive - simple financial instruments are only obscure to those who willfully remain ignorant. Your parent post's statement is a reference one of the basic financial models in asset pricing literature, the "Merton model" (Merton RC. 1974. "On the pricing of corporate debt: the risk structure of interest rates." J. Finance 29:449–70)

fweespeech 11y ago

Apple is doing it as regulatory arbitage which is distorting the normal signals. I'm not saying you are wrong, more its a really bad example.

robzyb 11y ago

> Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. Honestly? That statement seems a tad simplistic to me. Especially in the context of startups.

hguant 11y ago
What makes a start up different than any other business?
- joshmn 11y ago
  The urge to aggressively, rapidly grow.
  - jjaredsimpson 11y ago
    This is a distinction without difference. You could've also said, "Startups have fewer employees" for instance. How does the urge to grow separate a startup from a business in the desire to obtain low cost debt?
- robzyb 11y ago
  Investing in getScale is vastly different to investing in IBM. Lending to getScale is vastly different to lending to IBM. Therefore the debt/equity argument and balance is vastly difference.
- rdlecler1 11y ago
  From a lenders perspective: Credit worthiness, free cash flow, ability to service loans, lack of collateral.
azernik 11y ago
The big difference is that startups generally can't get bank loans on the scale they need, because the risk is so high that it's bad for the lender. If I could replace an investor with a 10% staake with a bank that I have to pay back at 8% interest, I'd take it in a heartbeat.

vidarh 11y ago

> Just to be clear though debt is actually a preferred type of financing because it is one of the cheapest forms. That is the central thesis of the linked article as well.

deleted 11y ago

[deleted]

deleted 11y ago

[deleted]

wjnc 11y ago
No, they have a different risk-reward structure. They finance those firms that probably cannot issue debt. They take equity for their funding. That's what parent is saying. Once you are in the league of issuing debt, you probably want to. Since it suggests that you are deemed to be an adequate counterparty. A small chance of default wreaks havocs on nominal interest rates.
- deleted 11y ago
  [deleted]

anifow 11y ago

Words like "debt" can be tricky to pin down, which is why we have an accounting profession who's job it is to establish a cohesive and consistent language system with specific meanings. Kickstarter money represents both revenue and a liability for the company that is doing the project. There are many types of liabilities which are not exactly debt in the sense that we think about a bank loan (which is also a liability). The thing that all liabilities have in common is that they represent an obligation of the company which could require them to spend money or other assets to fulfill. This does not mean they have to satisfy the liability, it just means that there is a financial justification for any work they do relating to that. I am sure the accounting profession is continually being tested with new business models and trying to capture the financial reality for people who are playing very different games in the world of capital.

girmad 11y ago

Apple is only issuing debt because all of its cash is overseas. At this point the interest is cheaper than paying US taxes.

sukulaku 11y ago

> One Nobel winning economic theory leads to an optimal capital structure of 100% debt Too bad the theory is complete nonsense. >> The basic theorem states that under a certain market price process (the classical random walk), in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. In short, the theorem states that in conditions that will never exist in the real world, the value of a firm is unaffected by how it's financed. >> the value of the company increases in proportion to the amount of debt used First they say "the value of a firm is unaffected by how it's financed", but then: "the value of the company increases in proportion to the amount of debt used", so if "debt used" counts as "financing" then the theory contradicts itself, at least as described by Wikipedia. This is where I rambled about some other related stuff, but decided to just leave it out because fuck everything about mainstream economics.

yummyfajitas 11y ago
In short, the theorem states that in conditions that will never exist in the real world,... If only Modigliani and Miller weren't total idiots. Then they might have repeated their calculations with these assumptions relaxed. First they say "the value of a firm is unaffected by how it's financed", but then: "the value of the company increases in proportion to the amount of debt used", so if "debt used" counts as "financing" then the theory contradicts itself, at least as described by Wikipedia. If you bothered to read the article, you'd recognize that Modigliani-Miller actually did the exact calculation you previously criticized them for not doing. Similarly, if you read it, you'd recognize that the claims you think are contradictory actually apply to different circumstances (taxes vs no taxes). What next, medicine is contradictory because "if you don't eat cyanide, you probably won't drop dead, but if you do eat cyanide you will"?
- sukulaku 11y ago
  It doesn't matter what and how they calculated, because your preferences and valuations are not externally determinable. For example, there's no way to calculate how much you'll be willing to pay for a can of cola tomorrow at 17:56, but your decision to buy one (or not) will factor into the economy as a whole. If you buy a cola at noon, that results in a different state for the whole economy than would have resulted from you buying it at 17:56, and so on. An economy is an aggregate of all the individual choices that factor into it, and all of those choices are based on people's individual preferences and therefore incalculable. This is why all of mainstream economics is at best misguided nonsense and academic mental masturbation. In reality, of course, its real purpose is to serve justifications for government intervention in our lives - it's not like Austrian Economics is some arcane knowledge that's only available to a handful of insiders somewhere. You can go to http://mises.org http://mises.org and learn to understand how economics really works.