
Startups Lose in a Low-Rate World, and the Fed Is Blaming Itself - T-A
https://www.bloomberg.com/news/articles/2019-03-19/startups-lose-in-a-low-rate-world-and-the-fed-is-blaming-itself
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jondubois
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.

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dalbasal
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.

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pmart123
So for a counter factual example, what if you could legally download all of
Renaissance Technologies source code? How much would your company be worth?

You still need to hire a team, implement the hardware, understand the nuances,
and also build up datasets of trade history, etc. What once in theory sounds
easy, might not be as simple as you think.

Facebook and Twitter have the users, old content and built social networks.
They have data on user patterns, relationships with advertisers, etc. I don’t
think it would be as simple as you think.

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dalbasal
I didn't mean you can (or should) clone fb, get the users, etc. thought
experiment.

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7e
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.

~~~
weeksie
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_.

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avinium
> 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?

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weeksie
No, because many of those companies are bought before they can hit an
inflection point and become dangerous to an incumbent.

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mathattack
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.

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CompelTechnic
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.

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mathattack
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.)

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christianbm1
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
Me too but the theory they put forward is that big corporations can also get
cheap credit and buy start ups.

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christianbm1
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.

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JamesBarney
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.

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paulpauper
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.

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JamesBarney
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%?

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Fjolsvith
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.

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navigatesol
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.

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scarface74
_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.

