

Debt, equity and a third thing that might work better - bdfh42
http://sethgodin.typepad.com/seths_blog/2009/11/debt-equity-and-a-third-thing-that-mightworkbetter.html

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huntse
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.

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Harj
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.

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byrneseyeview
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).

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Harj
_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

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ianferrel
Unsecured lending to individuals is not, in general, a "safe" investment.
Lending Club hasn't even been around long enough to reasonably estimate how
safe it might be. Note that I'm not claiming it's a _bad_ investment, but it
really stretches the traditional financial definition of "safe."

And the highest I've _ever_ seen for high yield savings accounts was around
6%, generally only for a promotional period, around 2007. Unless you're
talking about the high inflation years in the late 70s and early 80s, in which
case, yes, you could get 10% in a savings account, but the real rate of return
was well into the negative due to inflation.

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d4nt
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.

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huntse
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.

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proemeth
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.

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bwd2
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.

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

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noss
Did Seth Godin just invent taxes?

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InclinedPlane
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.

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cwan
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_...](http://blogs.sun.com/sun4startups/entry/vcs_look_to_royalty_based)
and
[http://www.technologytransfertactics.com/content/2009/10/21/...](http://www.technologytransfertactics.com/content/2009/10/21/royalty-
based-venture-financing-could-shake-up-vcs/)

edit - more here on the origins of the idea:
[http://www.xconomy.com/seattle/2009/10/07/royalty-based-
vent...](http://www.xconomy.com/seattle/2009/10/07/royalty-based-venture-
financing-born-in-boston-could-shake-up-vcs-and-startups-from-new-england-to-
the-northwest/)

~~~
netcan
Nothing new under the sun?

