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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
by 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 agoi 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 agoPut 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 agoYeah you're right. It should say something like the payoff of debt owned by the creditor looks like being short a put.
- TeMPOraL 11y agoStacking 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 agoNo 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)