How does VC behavior change when interest rates are cut?

https://news.ycombinator.com/item?id=44771

by NoMoreSnow • 19 years ago

5 4 19 years ago

news.ycombinator.com

I was an intern at a fixed wireless broadband start-up when the dot-com bubble burst and I witnessed how all of the excitement for the start-up vanished when investors were afraid to give out money. It came down to bad timing for this start-up -- if they had only started a year earlier.

How will the speculation that interest rates will be cut further affect the investment activities of angels, private equity, and VCs? This may affect when a lot entrepreneurs may launch their companies, right?

RyanGWU82• 19 years ago

Interest rate cuts generally encourage business investment for two reasons.

1. Interest rate cuts make equity investment more attractive. Equity investment is riskier than making loans (buying bonds) or cash (money markets, CDs). Investors do it anyway because equity pays a risk premium: equity returns tend to be higher than the return on cash or bonds.

Example: Today, a hypothetical venture fund might offer a 10% expected return, and a hypothetical money market might offer 6%. So, you could make 4% more by investing in a VC fund. That's nice, but not necessarily worth the risk.

But if interest rates are cut and everything else stays equal, the money market APR might drop to 4%. Now you can make 6% more by investing in the venture fund, which makes it more attractive to investors.

2. Reduced interest rates encourage businesses to spend money. Lower rates make it cheaper for them to borrow money, which means they can justify spending money on projects which would be unattractive when interest rates are high. If your revenue comes from other businesses, such as through B2B sales or through advertising, this may make them more likely to spend money with your company.

Obviously, lower interest rates aren't going to bring customers to your door -- you'll still need to fill your own sales pipeline. But it may make it more likely that your customer will pull the trigger and close the deal.

zcoelius• 19 years ago

Ryan is right. Cutting interest rates is great for startups. But, that is not what people are scared. The problem is the economy might tank as a result of all the money being lost in the equity, and debt markets right now. If that happens we are in for some pain.

mattmaroon• 19 years ago

Does it even matter? Build something people want, and customers will come to you. When customers come to you, VCs won't be far behind.

byrneseyeview• 19 years ago

Any economist would say "Marginally."

A more useful answer: not enough to be worth caring about. Unless you're a specialist in interest rates, there is no point at which the money you'll make from an hour of pondering the Fed will exceed the amount you'd make from an hour calling customers or something. And keep in mind that experts don't do very well at predictions -- their main function is to help people hedge. In other words, even the people who care the most about such problems spend all of their time helping everyone else care less.

How does VC behavior change when interest rates are cut?

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