Entrepreneurs and Raising Venture Capital with Rising Interest Rates
Friday, February 18th, 2011
As an entrepreneur funding can be a important to drive growth in a business and can be an important element in a mix of what drives a startups success. In the United States venture capital investment has been an essential element in silicon valley startups initial funding.
Consider these two major Internet titans, Twitter who got in a series D and F funding in 2009 and 2010 of $100M and $200M. As well as Groupon in a series C funding received $135M in 2010. These two companies through the venture capital funding process were able grow and scale their business successfully and are typical examples of the US venture capital success stories.
However consider that not every company is a Twitter or a Groupon. Not every tech startup will succeed or will actually even pay back their venture capitalists their agreed rate of return. Note some would require approximately an average 20 percent internal rate of return (IRR) and investors can typically have funds invested on a portfolio basis. Interestingly lately though If you look on Techcrunch their seems to be projects being funded almost daily with millions in investments and my concern would be that the amount of funding available to startups is not likely to be so carefree in the longer term with a potential increase in the cost of funding.
To examine the funding side of things, consider in the United States a standard CD may return approximately an APY of 0.60% depending on your financial institution as the Federal Reserve has set its interest rate at 0.25%. To me this is low, but hard to really imagine without putting it in context. A 1 year fixed CD $1M could give only a return of $6000 or about $500 a month. So for a major investment firm scaling that would be $1B or $1000M for the opportunity cost of a potential $6M or $500,000 a month.
Now this is a simple representation and of course there is other better yielding investments, however I am just pointing out that in the current low interest scenario there is a significant amount of capital able to invested because of their is such little incentive to keep capital tied up with low rates available for risk free investments. It makes sense that capital is available for venture projects that have a good business model and although they do have risk, on a portfolio basis may produce a better return than a risk free investment in a bank CD or even other investments such as stocks and bonds.
However the downside risk is what if interest rates go up and CD yields hit 3%, this does not impact a projects risk but essentially its funding has gone up 500%. Investments in venture capital projects would now need to be more prudent because a higher proportion of capital will flow into risk free investments. So while the business case for many projects right now may look like a good return in a low rate environment, consider an increase in rates may force less venture capital dollars around and potential increase in funding costs for startups.
Article by James Jones
The views expressed are the subjective opinion of the article's author and not of FinancialAdvisory.com
Tags: entrepreneurs , groupon , interest rates , raising venture capital , rising interest rates , twitter , venture capital , venture capital funding
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