3 ms·

> That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them. I don't follow. The gains are realized wh

by alxmng 4y ago

> That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them. I don't follow. The gains are realized when the company is acquired or goes public. If bond yields are 0%, the VC invests $9 and gets $10 after 10 years, the returns are $1. If bond yields are 5%, the VC returns are still $1. If they had instead invested in bonds, their return would have been $0.45. Even if bonds yield better returns, that doesn't change the VC's returns.

abm53 4y ago
The difference is that the bond return is (to first order) riskless and risk has a cost. What is the variance on the VC return (and is $9 a realistic mean of the distribution to begin with?).
- alxmng 4y ago
  Right, but that doesn't change the return. It would only change the amount of money being invested in VC or IPOs versus bonds. And the total money chasing stocks isn't evenly distributed amongst stocks, so less money in the stock market doesn't necessarily mean a lower valuation for a particular company (such as the big winner in a VC portfolio). The risk free return is an opportunity cost. If I invest $10 and get back $11, the net is $1 regardless of whether bonds yielded 0% or 100%.
  - abm53 4y ago
    And that cost is taken into account when people value the merits of a particular investment/company. If bonds yield 100% p/a then an investment with even a decent potential payout in 10 years time will be seen as worthless. But one that is likely to pay out a dividend tomorrow may not be. That’s the whole premise behind discounted cashflow analysis: mechanistically taking into account the opportunity cost of the risk-free interest rate to derive a valuation.
cameldrv 4y ago
These are equivalent ways of looking at the same thing. On one hand you could say that money today is worth 5% more than money next year, and then figure the return net of the risk free rate. Alternately, you could say that VC money must provide returns in excess of the risk free rate and say that startups now are expected to provide higher returns. Both are mathematically equivalent. The broader point is that the current need to provide higher returns than before is more acute for a company that isn’t going to produce big profits for 10 years because of all of the compounding over that time.

by alxmng 4y ago

abm53 4y ago

The difference is that the bond return is (to first order) riskless and risk has a cost. What is the variance on the VC return (and is $9 a realistic mean of the distribution to begin with?).

alxmng 4y ago
Right, but that doesn't change the return. It would only change the amount of money being invested in VC or IPOs versus bonds. And the total money chasing stocks isn't evenly distributed amongst stocks, so less money in the stock market doesn't necessarily mean a lower valuation for a particular company (such as the big winner in a VC portfolio). The risk free return is an opportunity cost. If I invest $10 and get back $11, the net is $1 regardless of whether bonds yielded 0% or 100%.
- abm53 4y ago
  And that cost is taken into account when people value the merits of a particular investment/company. If bonds yield 100% p/a then an investment with even a decent potential payout in 10 years time will be seen as worthless. But one that is likely to pay out a dividend tomorrow may not be. That’s the whole premise behind discounted cashflow analysis: mechanistically taking into account the opportunity cost of the risk-free interest rate to derive a valuation.

cameldrv 4y ago

These are equivalent ways of looking at the same thing. On one hand you could say that money today is worth 5% more than money next year, and then figure the return net of the risk free rate. Alternately, you could say that VC money must provide returns in excess of the risk free rate and say that startups now are expected to provide higher returns. Both are mathematically equivalent. The broader point is that the current need to provide higher returns than before is more acute for a company that isn’t going to produce big profits for 10 years because of all of the compounding over that time.