Debt, equity and a third thing that might work better

http://sethgodin.typepad.com/seths_blog/2009/11/debt-equity-and-a-third-thing-that-mightworkbetter.html

by bdfh42 • 17 years ago

33 18 17 years ago

sethgodin.typepad.com

noss• 17 years ago

Did Seth Godin just invent taxes?

netcan2• 17 years ago

voluntary taxes

InclinedPlane• 17 years ago

He "invented" royalties for investors. Typically the royalties go the other way, because it's not just financing, it's also production, distribution, promotion, etc. (for books, movies, music). But more and more that's changing. Most startups are generally self-sufficient except for money.

It's a sensible idea which, if put into practice, might result in funding of a wider range of startups. As Godin pointed out, a lot of VC funding is highly stilted toward businesses that can sell out in a short time frame (go public or get bought), not just businesses that can become profitable in that time frame.

cwan• 17 years ago

Royalty-based financing is not a new idea and one that is being increasingly explored (a trend that started on the east coast if memory serves). A few links: http://blogs.sun.com/sun4startups/entry/vcs_look_to_royalty_... and http://www.technologytransfertactics.com/content/2009/10/21/...

edit - more here on the origins of the idea: http://www.xconomy.com/seattle/2009/10/07/royalty-based-vent...

d4nt• 17 years ago

Most people will want to cash in their investments at some point. In order to facilitate that we'd need a secondary market in these instruments so people could sell them on. The price would then vary based on future earnings projections. Either that or the understanding is that the payments continue until some fixed point in time, or until the investors death. So, depending on how you look at it, these are either dividend paying shares, corporate bonds or a kind of annuity. All of which exist already.

EDIT: although I'm not sure if anyone's really doing corporate bonds that are linked to profits, that might be new.

Having said all that, I agree with Seth that society could do with being a lot more creative in how it funds businesses.

huntse3• 17 years ago

Yup having a secondary market is extremely important. That's why it already exists (just like mezz finance, which is what he has reinvented here, also exists). The idea of having an instrument that pays linked to a particular income stream is also not new - covered bonds, asset-backed securities, pfandbriefe etc for example all work this way.

huntse3• 17 years ago

...oh, and covered bonds linked to a specific income stream is also not new. XS0271006602 for example is a covered bond linked to the income stream on a chain of pubs in the UK.

Harj2• 17 years ago

not sure i'm convinced by the economics of this. amateur investors would compare this to other more standard investment options. let's say they invest a typical seed amount of $25k. assume they could earn approx 10% a year via "safe" investments.

as suggested in the article, you offer to double the investment by paying 4% of sales. that means you need to be bringing in $1.25 million in sales to repay the investor. using an (admittedly rough) assumption, let's say that takes 5 years to achieve. in the same time, if the investor had played it safe, their $25k would be (assuming compounded monthly interest at the 10% rate) $41k i.e. almost doubled anyway.

in the current economic climate 10% interest might be higher than expected and you could obviously fiddle around with all the numbers/assumptions to make it a more attractive investment but my instinct is that to sell this to the types of investors who would entertain something like this, it could end up being a more expensive way of raising finance than it initially appears.

byrneseyeview2• 17 years ago

What safe investment pays 10%? And if you had a 4% royalty $250K in annual sales, that's $10K per year in revenue -- which you'd probably value at something much higher (maybe $50K if you thought it wouldn't keep growing; maybe $250K or more if you expected further growth).

Harj2• 17 years ago

What safe investment pays 10%?

i use lendingclub.com http://en.wikipedia.org/wiki/Lending_Club

during less severe economic times you could also make around 10% via high yield savings accounts

Daniel_Newby• 17 years ago

"assume they could earn approx 10% a year via "safe" investments."

An instrument with a risk adjusted return of 10%/year is called a junk bond.

proemeth• 17 years ago

It's pretty much the principle of dividends. With prefered shares you can even define the conditions of dividends, index them on the company's income.

bwd2• 17 years ago

To expand on this a bit more for the uninitiated, preferred shares are a more sophisticated version of what he's talking about. They basically work like debt that doesn't blow up the company if you can't make your payments. They tend to be junior to debt and senior to common stock if there is a liquidation, there is a secondary market on public exchanges, and there are many variants such as preferred shares that pay higher dividends in years with good earnings or that can be converted into common shares on terms similar to convertible bonds. This is already a well solved problem, but the solution isn't very sexy, so it's not as well known as debt and common stock.

huntse3• 17 years ago

Nothing new here. This "third thing" is mezzanine finance. Mezzanine finance sits between debt and equity in the capital structure and mezz investors choose a variety of risk/reward options making their investment more debt-like or more equity-like.

The coupon stream on mezz notes can be linked to income on specific assets (like covered bonds).

Subordinated debt and preferred shares are examples of mezz finance instruments.

jam• 17 years ago

The purposes of financial instruments (like debt and equity) are to replace these sorts of inefficient transactions.

Debt, equity and a third thing that might work better

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