7 ms·

Startups Lose in a Low-Rate World, and the Fed Is Blaming Itself

78 points by T-A 8y ago

JamesBarney 8y ago
This article is filled with large claims that run completely counter to all economic intuition and evidence we've gathered over the last century like "low interest rates hurt businesses and cause slower growth", "large companies buying startups for lots of money hurts start up creation". Extraordinary claims require extraordinary evidence but the article provides none, and the study's the article links to are behind a paywall.
- Alex3917 8y ago
  If business A can't borrow money at any price, and business B can effectively borrow unlimited amounts of money for free, then how is it counter to all economic intuition than business B would have an advantage over business A?
  - garmaine 8y ago
    Generally speaking startups don't borrow money to finance themselves.
    - thinkingkong 8y ago
      Thats completely untrue. They just dont borrow money from a traditional bank. Lots of growth is actually fueled by debt.
      - navigatesol 8y ago
        >They just dont borrow money from a traditional bank. I'd go a step further and say the vast majority of startups borrow money from traditional banks, through home equity, business loans or credit cards. The startup world is far larger than the stuff we read about on Demo Day.
    - Alex3917 8y ago
      Because they can't. Most people would be far less inclined to sell equity in their company if they could get a loan on fair terms that wasn't secured by their personal assets. If you watch the videos on Sweetbridge, reducing the WACC for startups and small businesses is one of the main promises of DLT.
      - navigatesol 8y ago
        >if they could get a loan on fair terms that wasn't secured by their personal assets. What constitutes a "fair rate", though? Despite popular opinion, banks are pretty damn good at assessing risk. The fact of the matter is, most small business fails. The rates reflect that. Sweetbridge looks interesting, but the risk falls somewhere, even if more diffuse.
        Alex3917 8y ago
        > The fact of the matter is, most small business fails. The rates reflect that. OK but if you look at only the small businesses that are going to go on to succeed and be around for the next couple hundred years, they still can't borrow at the same rates as Apple or whatever.
        AnimalMuppet 8y ago
        Because nobody knows which ones they are. If the banks knew which small businesses would be around for a couple hundred years, those small businesses could probably borrow rather cheaply today.
        Alex3917 8y ago
        > Because nobody knows which ones they are. This is obviously correct. But it contradicts the idea that banks are good at assessing risk, if the closest that banks can come is lumping 100% of startups into a 'startup' bucket. If banks really were good at assessing risk then the fact that the large tech companies have access to cheap capital wouldn't necessarily hurt startups, but that isn't actually the case.
    - jldugger 8y ago
      Depends on how you view borrowing. They don't get access to fixed rates, and have to sell off promises of future revenue in exchange for money up front instead. It's all financing in the end, whether you get it from bond issuance or equity issuance.
  - JamesBarney 8y ago
    Of course all things being equal a company that can borrow effectively unlimited amounts of money for free has an advantage or one that can't borrow. But specifically how does that relate to start-ups and hurting growth?
- paulpauper 8y ago
  The shape of the curve matters. In high interest rate environments, large companies borrow at a higher rate rate relative to smaller companies because the curve is flatter. In a low-interest rate environment, the curve is very steep, so large companies borrow cheap but small companies only borrow just slightly lower rate than they do in a high interest rate environments. Large companies are able to borrow at rates closer to the fed funds rate whereas small business borrows at am much higher rate. Low interest rates and cheap borrowing allows large businesses to expand and possibly crowd out smaller businesses, that have to borrow at much more unfavorable rates.
  - JamesBarney 8y ago
    Why does the steepness of the yield curve influence the interest rates small versus large companies get? Are you saying that if a big company can borrow at 'fed rate' + 2% and a small company can only borrow at 'fed rate' + 6% that as the fed rate gets smaller the relative differences in the borrowing rates increases so 8% vs 12% isn't as big of an advantage as 3% vs 7%?
    - Fjolsvith 8y ago
      From the viewpoint of the small business owner, I still have to come up with the 4% difference out of my profit margin. If I'm competing with a big corporation, that is a significant disadvantage.
      - navigatesol 8y ago
        It comes out of their profit margin too, though. And I'll bet the margins of good, small businesses are as good or better than large businesses. Of course, large businesses can generally borrow at lower rates, but that's the way "risk" works.
  - j15t 8y ago
    Are you talking about the yield curve or credit spreads? Either way, as far as I understand they are independent variables to the absolute value of federal fund rate -- what matters more is the stage in the business cycle.
- cimmanom 8y ago
  Maybe it makes it easier to start a startup and get funded, but more difficult to succeed in competition with the big guys?
7e 8y ago
Startups get more VC funding in a low rate environment, as money chases deals in search of yields. I've seen many silly startups funded this way, as well as "burn cash to grow" outfits like Uber and Tesla.
- CodingSucks 8y ago
  Startups that target mass scale operate like this. Smaller startups are doomed.
- weeksie 8y ago
  Sure but the large firms can borrow so cheaply that it makes it easier for them to buy promising startups. Making the startup ecosystem into an R&D arm of a few big companies. That's bad for innovation overall and our economy in the long term. It's probably the best time to be a founder looking for a quick exit though. Easy funding and lots of buyers willing to pay a lot.
  - avinium 8y ago
    > bad for innovation overall and our economy in the long term. It's probably the best time to be a founder looking for a quick exit though. Aren’t these two points contradictory? When acquisition opportunities are plentiful, people are more likely to start/invest in companies, leading to more innovation and development, no?
    - weeksie 8y ago
      No, because many of those companies are bought before they can hit an inflection point and become dangerous to an incumbent.
jondubois 8y ago
I think that it's because of the simple fact that when interest rates are lower, people borrow more and therefore more new money is created and enters the economy. This would normally create inflation but because investors are aware of this, they don't want to keep their wealth in cash during times of low interest rates, so they invest in index funds instead... Index funds are historically the safest store of value which can consistently beat inflation. The most popular index funds only invest in the top, biggest corporations. So basically most of the newly created money flows straight to big corporate shareholders and executives via share price increase (note that the majority of that value is not cashed out for spending on consumables; it stays within the corporate sphere as investments). The inflation only occurs in the corporate sphere and so it doesn't impact consumer prices (therefore inflation appears to be normal from the consumer perspective). All corporate activities become more expensive though; processes become slower, employees become less productive, advertising becomes more important and expensive. Wealthy corporate insiders lose their relative sense of value because they get used to seeing higher operational costs and lower Price to Earnings ratios. If all corporations have more cash and have nothing to do with it, they will just spend it on marketing... Otherwise they risk losing brand awareness. In a low rate environment, brand awareness is more valuable than cash because it has future value that will be carried through beyond the current economic environment... To a time when cash will have more value.
- dalbasal 8y ago
  I think in a broad sense you can consider shares (especially within the scope of index funds) "money supply." A company can issue shares and use them to pay people or buy companies with. That's money. I think that the later points you make about inefficiencies are great, and especially apt/worrying in the large cap tech world. FB & Twitter are a prime example. They increased headcount and costs by 10X-100X, after becoming massive platforms scaled to serve everyone in the world. The product twitter and Facebook serve is still the same product they served with a 10th of the employees. Sure, the ad-tech grew, but that cannot plausibly obsorb thousands of engineers. What mostly grew is various forms of administration. If Toyota got swallowed by the earth tomorrow, the world's ability to produce cars takes a real hit. Real investment will have to be made to replace this capacity. If Facebook or Twitter disappeared, a handful of resourceful people would have a clone up in days. That's a frightening level of inefficiency.
christianbm1 8y ago
I had thought it was the other way around. Lower interest rates induces riskier bets; the so called: search for yield. Which means more investments for companies with uncertain cash flows. This is the reason why the Ubers, Lyfts, Snapchats and others of the world are able to operate at huge losses. People are lining up to throw cash at these firms with the hopes to become, down the line, the next Facebook, Google or Apple.
- tumetab1 8y ago
  Me too but the theory they put forward is that big corporations can also get cheap credit and buy start ups.
  - christianbm1 8y ago
    I suppose it makes sense: the Leveraged Loan market has been going gangbusters for a while now. If the choice was between a startup and an experienced junk-rated company - I guess for those risk averse investors in this low-yield environment - the latter would be a wiser investment. One can achieve a much faster profit if the firm borrows for share buybacks, dividend recaps, etc. But in theory, this is good for startups. While lower-rates are crowded out, there are much more willing buyers (other companies) for the startups - more supply, limited demand, higher price: higher valuation.
mathattack 8y ago
This is very counterintuitive. Startups are valued based on discounting the future cash flows of when they (may) get big. Some of that is risk, some is the underlying risk-free. Let’s say the govt rate is 6% and the risk is 6%. If you’re discounting cash flows from 10 years out (when the company is full sized) then every future dollar is 1/(1.12^10) dollars today. If the riskfree rate is 2% then that future dollar is worth 1/(1.08^10) - a lot more! Since startups have no cash flows today, their value is all a risk adjusted bet in future cash. Another intuition is when you need funds, it’s best to get them when money is cheap. (The lower the interest rate, the less you have to pay later for money today) Note - this isn’t precise, and there are exceptions, but generally I’ve thought that startups do well with low rates.
- CompelTechnic 8y ago
  Although the article keeps everything in the abstract, I think an example should compare the interest rates different businesses can get. Say, when rates are low, an established business can get credit at 3%, and a startup at 6%. When rates are high, an established business can get rates at 6% and a startup at 9%. In this low-rate environment, the established business can take on 2x the leverage of the startup while paying the same interest, but in the high-rate environment only 1.5x. Low rates encourage all firms to use credit, but the countervailing competitiveness of large/stable firms diminishes the ability of startups to take advantage of it. This is all speculative on my part.
  - mathattack 8y ago
    You’re partially correct. Large firms are less risky so they have easier access to credit. Smaller firms have a higher percentage of their value tied up in the future, so they get a bigger future value than the startup. (Safeway’s profits today will be within a few X of their profits in 2029. Slack’s could be 50X.)
  - charlesdm 8y ago
    The question often isn't the interest rate. Any large multinational company can pay 1, 3 or 6% on debt. It's the amount of money firms can borrow. Banks are throwing money around at the moment, for free.
scarface74 8y ago
That financing advantage gives incumbents a big incentive to buy innovative competitors in a low-rate environment, which eliminates startups and leaves the subsuming company with greater market share. Technology startups that take any type of outside funding were never intended to go public and be an independent company. If the founders had any hope of that, they are blind. Look no further than YC. Only one company that it has funded has gone public - Dropbox and it isn’t looking to good financially.
- deleted 8y ago
  [deleted]

78 points by T-A 8y ago

This article is filled with large claims that run completely counter to all economic intuition and evidence we've gathered over the last century like "low interest rates hurt businesses and cause slower growth", "large companies buying startups for lots of money hurts start up creation". Extraordinary claims require extraordinary evidence but the article provides none, and the study's the article links to are behind a paywall.

Alex3917 8y ago
If business A can't borrow money at any price, and business B can effectively borrow unlimited amounts of money for free, then how is it counter to all economic intuition than business B would have an advantage over business A?
- garmaine 8y ago
  Generally speaking startups don't borrow money to finance themselves.
  - thinkingkong 8y ago
    Thats completely untrue. They just dont borrow money from a traditional bank. Lots of growth is actually fueled by debt.
    - navigatesol 8y ago
      >They just dont borrow money from a traditional bank. I'd go a step further and say the vast majority of startups borrow money from traditional banks, through home equity, business loans or credit cards. The startup world is far larger than the stuff we read about on Demo Day.
  - Alex3917 8y ago
    Because they can't. Most people would be far less inclined to sell equity in their company if they could get a loan on fair terms that wasn't secured by their personal assets. If you watch the videos on Sweetbridge, reducing the WACC for startups and small businesses is one of the main promises of DLT.
    - navigatesol 8y ago
      >if they could get a loan on fair terms that wasn't secured by their personal assets. What constitutes a "fair rate", though? Despite popular opinion, banks are pretty damn good at assessing risk. The fact of the matter is, most small business fails. The rates reflect that. Sweetbridge looks interesting, but the risk falls somewhere, even if more diffuse.
      - Alex3917 8y ago
        > The fact of the matter is, most small business fails. The rates reflect that. OK but if you look at only the small businesses that are going to go on to succeed and be around for the next couple hundred years, they still can't borrow at the same rates as Apple or whatever.
        AnimalMuppet 8y ago
        Because nobody knows which ones they are. If the banks knew which small businesses would be around for a couple hundred years, those small businesses could probably borrow rather cheaply today.
        Alex3917 8y ago
        > Because nobody knows which ones they are. This is obviously correct. But it contradicts the idea that banks are good at assessing risk, if the closest that banks can come is lumping 100% of startups into a 'startup' bucket. If banks really were good at assessing risk then the fact that the large tech companies have access to cheap capital wouldn't necessarily hurt startups, but that isn't actually the case.
  - jldugger 8y ago
    Depends on how you view borrowing. They don't get access to fixed rates, and have to sell off promises of future revenue in exchange for money up front instead. It's all financing in the end, whether you get it from bond issuance or equity issuance.
- JamesBarney 8y ago
  Of course all things being equal a company that can borrow effectively unlimited amounts of money for free has an advantage or one that can't borrow. But specifically how does that relate to start-ups and hurting growth?
paulpauper 8y ago
The shape of the curve matters. In high interest rate environments, large companies borrow at a higher rate rate relative to smaller companies because the curve is flatter. In a low-interest rate environment, the curve is very steep, so large companies borrow cheap but small companies only borrow just slightly lower rate than they do in a high interest rate environments. Large companies are able to borrow at rates closer to the fed funds rate whereas small business borrows at am much higher rate. Low interest rates and cheap borrowing allows large businesses to expand and possibly crowd out smaller businesses, that have to borrow at much more unfavorable rates.
- JamesBarney 8y ago
  Why does the steepness of the yield curve influence the interest rates small versus large companies get? Are you saying that if a big company can borrow at 'fed rate' + 2% and a small company can only borrow at 'fed rate' + 6% that as the fed rate gets smaller the relative differences in the borrowing rates increases so 8% vs 12% isn't as big of an advantage as 3% vs 7%?
  - Fjolsvith 8y ago
    From the viewpoint of the small business owner, I still have to come up with the 4% difference out of my profit margin. If I'm competing with a big corporation, that is a significant disadvantage.
    - navigatesol 8y ago
      It comes out of their profit margin too, though. And I'll bet the margins of good, small businesses are as good or better than large businesses. Of course, large businesses can generally borrow at lower rates, but that's the way "risk" works.
- j15t 8y ago
  Are you talking about the yield curve or credit spreads? Either way, as far as I understand they are independent variables to the absolute value of federal fund rate -- what matters more is the stage in the business cycle.
cimmanom 8y ago
Maybe it makes it easier to start a startup and get funded, but more difficult to succeed in competition with the big guys?

7e 8y ago

Startups get more VC funding in a low rate environment, as money chases deals in search of yields. I've seen many silly startups funded this way, as well as "burn cash to grow" outfits like Uber and Tesla.

CodingSucks 8y ago
Startups that target mass scale operate like this. Smaller startups are doomed.
weeksie 8y ago
Sure but the large firms can borrow so cheaply that it makes it easier for them to buy promising startups. Making the startup ecosystem into an R&D arm of a few big companies. That's bad for innovation overall and our economy in the long term. It's probably the best time to be a founder looking for a quick exit though. Easy funding and lots of buyers willing to pay a lot.
- avinium 8y ago
  > bad for innovation overall and our economy in the long term. It's probably the best time to be a founder looking for a quick exit though. Aren’t these two points contradictory? When acquisition opportunities are plentiful, people are more likely to start/invest in companies, leading to more innovation and development, no?
  - weeksie 8y ago
    No, because many of those companies are bought before they can hit an inflection point and become dangerous to an incumbent.

jondubois 8y ago

I think that it's because of the simple fact that when interest rates are lower, people borrow more and therefore more new money is created and enters the economy. This would normally create inflation but because investors are aware of this, they don't want to keep their wealth in cash during times of low interest rates, so they invest in index funds instead... Index funds are historically the safest store of value which can consistently beat inflation. The most popular index funds only invest in the top, biggest corporations. So basically most of the newly created money flows straight to big corporate shareholders and executives via share price increase (note that the majority of that value is not cashed out for spending on consumables; it stays within the corporate sphere as investments). The inflation only occurs in the corporate sphere and so it doesn't impact consumer prices (therefore inflation appears to be normal from the consumer perspective). All corporate activities become more expensive though; processes become slower, employees become less productive, advertising becomes more important and expensive. Wealthy corporate insiders lose their relative sense of value because they get used to seeing higher operational costs and lower Price to Earnings ratios. If all corporations have more cash and have nothing to do with it, they will just spend it on marketing... Otherwise they risk losing brand awareness. In a low rate environment, brand awareness is more valuable than cash because it has future value that will be carried through beyond the current economic environment... To a time when cash will have more value.

dalbasal 8y ago
I think in a broad sense you can consider shares (especially within the scope of index funds) "money supply." A company can issue shares and use them to pay people or buy companies with. That's money. I think that the later points you make about inefficiencies are great, and especially apt/worrying in the large cap tech world. FB & Twitter are a prime example. They increased headcount and costs by 10X-100X, after becoming massive platforms scaled to serve everyone in the world. The product twitter and Facebook serve is still the same product they served with a 10th of the employees. Sure, the ad-tech grew, but that cannot plausibly obsorb thousands of engineers. What mostly grew is various forms of administration. If Toyota got swallowed by the earth tomorrow, the world's ability to produce cars takes a real hit. Real investment will have to be made to replace this capacity. If Facebook or Twitter disappeared, a handful of resourceful people would have a clone up in days. That's a frightening level of inefficiency.

christianbm1 8y ago

I had thought it was the other way around. Lower interest rates induces riskier bets; the so called: search for yield. Which means more investments for companies with uncertain cash flows. This is the reason why the Ubers, Lyfts, Snapchats and others of the world are able to operate at huge losses. People are lining up to throw cash at these firms with the hopes to become, down the line, the next Facebook, Google or Apple.

tumetab1 8y ago
Me too but the theory they put forward is that big corporations can also get cheap credit and buy start ups.
- christianbm1 8y ago
  I suppose it makes sense: the Leveraged Loan market has been going gangbusters for a while now. If the choice was between a startup and an experienced junk-rated company - I guess for those risk averse investors in this low-yield environment - the latter would be a wiser investment. One can achieve a much faster profit if the firm borrows for share buybacks, dividend recaps, etc. But in theory, this is good for startups. While lower-rates are crowded out, there are much more willing buyers (other companies) for the startups - more supply, limited demand, higher price: higher valuation.

mathattack 8y ago

This is very counterintuitive. Startups are valued based on discounting the future cash flows of when they (may) get big. Some of that is risk, some is the underlying risk-free. Let’s say the govt rate is 6% and the risk is 6%. If you’re discounting cash flows from 10 years out (when the company is full sized) then every future dollar is 1/(1.12^10) dollars today. If the riskfree rate is 2% then that future dollar is worth 1/(1.08^10) - a lot more! Since startups have no cash flows today, their value is all a risk adjusted bet in future cash. Another intuition is when you need funds, it’s best to get them when money is cheap. (The lower the interest rate, the less you have to pay later for money today) Note - this isn’t precise, and there are exceptions, but generally I’ve thought that startups do well with low rates.

CompelTechnic 8y ago
Although the article keeps everything in the abstract, I think an example should compare the interest rates different businesses can get. Say, when rates are low, an established business can get credit at 3%, and a startup at 6%. When rates are high, an established business can get rates at 6% and a startup at 9%. In this low-rate environment, the established business can take on 2x the leverage of the startup while paying the same interest, but in the high-rate environment only 1.5x. Low rates encourage all firms to use credit, but the countervailing competitiveness of large/stable firms diminishes the ability of startups to take advantage of it. This is all speculative on my part.
- mathattack 8y ago
  You’re partially correct. Large firms are less risky so they have easier access to credit. Smaller firms have a higher percentage of their value tied up in the future, so they get a bigger future value than the startup. (Safeway’s profits today will be within a few X of their profits in 2029. Slack’s could be 50X.)
- charlesdm 8y ago
  The question often isn't the interest rate. Any large multinational company can pay 1, 3 or 6% on debt. It's the amount of money firms can borrow. Banks are throwing money around at the moment, for free.

scarface74 8y ago

That financing advantage gives incumbents a big incentive to buy innovative competitors in a low-rate environment, which eliminates startups and leaves the subsuming company with greater market share. Technology startups that take any type of outside funding were never intended to go public and be an independent company. If the founders had any hope of that, they are blind. Look no further than YC. Only one company that it has funded has gone public - Dropbox and it isn’t looking to good financially.

deleted 8y ago
[deleted]