Economics and Entrepreneurial Finance

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16 Responses

  1. A.J. Sutter says:

    One reason venture money is not fungible is that it comes attached to people. Who gave you money is important for validation. E.g., if the lead in your last round was some small Asian VC fund, that often is not as persuasive to (i) subsequent investors or (ii) potential corporate partners (some of them, anyway) as if you got money from an A-list, Sand Hill Road VC. (Caveat: I’m speaking of a tendency, not an ironclad rule.) When I was at Sony and was scouting for possible investments and, more importantly, alliance partners, identifying who had funded the start-up was a very material factor for building confidence.

    OTOH, one company in the clean energy area that I was looking at was an early favorite in its field, in part because an A-list fund did invest in it. Yet when I interviewed the partner who’d made the investment, it turned out he was entirely ignorant of a major regulatory roadblock to bringing the business plan to fruition. Nonetheless, that company remained in the news, and did an IPO (though in a reverse-triangular way — in my book, that kind of going public is a sure-fire de-validation ). To date, that application is not yet commercialized by anyone, including some big Asian electronics firms who’ve sunk years and millions into it.

    In short, whether angel or early-round money is smart often may be less important for multiple round funding success than whether it is reputed to be smart. And not everyone with a good reputation for smartness deserves it.

  2. JP says:

    A.J. is right. Doesn’t your article show that: “just as popular economic thinking would suggest, money is fungible, but the people and strings attached to it are not.”?

  3. Darian Ibrahim says:

    A.J. & JP–

    But doesn’t money always come attached to people? It just usually doesn’t matter who the people are. For example, when you get a mortgage, some bank is providing the funds. But which bank really doesn’t matter, it’s just the interest rate (the money) that matters. In fact, the mortgage is sold as soon as it’s entered into, and you as the borrower don’t care. So mortgage loans are fungible, whereas entrepreneurial finance is not.

  4. c'mon Darian says:

    In short, comparative entrepreneurial finance is important, both theoretically and practically. This sort of money, contrary to popular economic thinking, is not all fungible.

    Which serious scholar of venture capital suggested that funding by a VC is equal to funding by a random person from the street? C’mon. There are lots of papers showing that founders select not only VCs over non-VCs, but also some VCs over other VCs, on the basis of things other than money. It is well-known, and well-described in the literature, that VCs bring things other than money. I am not sure which “conventional economic thinking” you are debating.

  5. c'mon Darian says:

    In short, comparative entrepreneurial finance is important, both theoretically and practically. This sort of money, contrary to popular economic thinking, is not all fungible.

    Which serious scholar of venture capital suggested that funding by a VC is equal to funding by a random person from the street? C’mon. There are lots of papers showing that founders select not only VCs over non-VCs, but also some VCs over other VCs, on the basis of things other than money. It is well-known, and well-described in the literature, that VCs bring things other than money. I am not sure which “conventional economic thinking” you are debating.

  6. JP says:

    “It just usually doesn’t matter who the people are.” I’m not sure this is true. (Maybe to an extent for transactions with liquid secondary markets, such as stock in public companies, or mortgages pre-2008.)

    I might choose to borrow money from Vinny rather than Ivan (at the same interest rate) because Ivan is known to break arms when payments are late, whereas Vinny usually just goes for fingers. But I don’t think this says anything about the commonly understood fungibility of money (which might suggest that it doesn’t matter whether I spend the loan directly on food or gambling, so long as my gambling expenses increase by the same amount in either case).

    Your article seems interesting, and I don’t know anything about the prior literature, but it seems confusing to portray your argument as a refutation of conventional wisdom re: the fungibility of money.

  7. Jeff Lipshaw says:

    Darian, it seems like we have three concepts mixed up in here. First, “money is fungible,” in my experience relates to the idea of commingling and tracing, not finance. Second, there’s Modigliani-Miller, which says that in a perfect world (like a Coaseian perfect world) the type of financing, whether debt, lease, equity, doesn’t make a difference. That’s more what I thought you were suggesting. Finally, the services provided by the VC, which happen to be bundled with a particular form of financing, but are really something separate. In theory, you ought to be able to buy that expertise unbundled as well.

  8. Jeff Lipshaw says:

    By the way, I do agree with your comment about government botching up the investments. If you don’t cite in your article (which I haven’t read yet), there’s a Josh Lerner piece out there somewhere on that point. The idea is to create critical mass – say, in Indianapolis, but Evansville, Fort Wayne, Kokomo, and Gary all want piece of it.

    My intuition is that industrial centers spring up organically and hit a critical mass, like Detroit in the 1920s, or Silicon Valley in the 1980s. The reason you can identify some areas, Austin, Boston, Dulles, is because they went critical. It’s a big deal for drawing human capital, because if you go to work for a startup, there’s a good chance you are going to be looking for a new job in two years, and you don’t want to be stranded in, well, wherever.

  9. Darian Ibrahim says:

    Jeff (and A.J. & JP)–

    You all may have a point that the “money is fungible” idea is not the best hook for my paper, and in fact I don’t use it in the paper. (Although while Jeff argues against the point by noting that the VC’s value-added services could theoretically be delinked from its financial capital, I don’t know that this ever happens in practice.) I do find it interesting to think through to what extent my comparative entrepreneurial finance analysis gels with established economic theory, and appreciate all of your help in doing so.

    Also, I don’t invoke Modigliani & Miller or other capital structure theories in the present paper, which only discusses equity, but will discuss all that in my next paper titled “Debt as Venture Capital,” which highlights the financing of start-ups through loans despite the conventional wisdom that debt and start-ups don’t mix.

  10. c'mon again says:

    I do find it interesting to think through to what extent my comparative entrepreneurial finance analysis gels with established economic theory.

    Darian, once again: name one respectable modern finance/economics scholar who wrote that VCs supply only money, not money attached to services. There is a large literature, both theoretical and empirical, showing why VCs normally (though not always) supply both.

    My point is not that you are wrong, but that you are not saying anything new. But perhaps I am wrong — please give us a few links to top finance/econ journals arguing otherwise.

  11. c'mon again says:

    I do find it interesting to think through to what extent my comparative entrepreneurial finance analysis gels with established economic theory.

    Darian, once again: name one respectable modern finance/economics scholar who wrote that VCs supply only money, not money attached to services. There is a large literature, both theoretical and empirical, showing why VCs normally (though not always) supply both.

    My point is not that you are wrong, but that you are not saying anything new. But perhaps I am wrong — please give us a few links to top finance/econ journals arguing otherwise.

  12. Darian Ibrahim says:

    “C’mon” — of course it’s not new to say that VCs offer value-added services in addition to money. I cite multiple sources for this proposition in both my current piece and my last one (on angel investment contracts). Never meant to imply otherwise, & don’t think that I did.

    What’s new about my work is adding angel investors, and to a lesser extent state-sponsored venture capital, to the mix to see how that money, and those value-added services, compare to private VC.

  13. A.J. Sutter says:

    Thanks for your reply. My point was that who the people are does matter, though I think you eventually recognized that during the evolution of the thread. BTW, here in Japan VC financing used to be (~10 years ago and more) mainly debt financing — though without great success. One obstacle may have been that many VC financiers were bank employees, so maybe the model can be improved.

  14. cosmas sikahala says:

    I somewhat concur with Darians Statement on VCs fungibility.Recent trends have questioned the viability of VCs as a source of start-up funding. Has anyone noticed that the funding of venture capital has decreased since the financial crisis began in 2008 making it harder for VCs to invest or advance loans, and therefore, threatening their future operations? For the record the financial crisis that started in 2008 is associated with at least 20% decrease in the average amount of funds raised per funding round in the venture capital market. Although this effect can only be found in later funding rounds, firms needing capital to survive cannot avoid a deduction induced by the financial crisis, whereas firms that seek initial funding postpone their funding and expansion plans until the capital markets have stabilized. Furthermore, firms in later phases of the venture cycle are more likely to be negatively affected by the weak initial public offering (IPO) market than firms seeking initial funding. Will VC capitalists be able to fund or sustain venture capital? Or is VC destined for RIP?

    • Eric Williams, Ph.D says:

      In response to Cosmas Sikahala question…”Will VC capitalists be able to fund or sustain venture capital? Or is VC destined for RIP?,,,,” hahaha i like the ‘RIP’. Cosmas, a great question, no correct answer…it depends. Venture capital will always be available with increased volatility/fluctuations on interest rates, of course based on ROI risk. Funders will always be there hoping to be “sharks” in the deep unlimited seas of investment opportunities. Ideas will always be there and the demand for seed funding will ever be there. On the other hand, the financial markets are very unpredictable and the fear of huge losses may scare VC capitalists into their own game probably drying out venture capital…but the odds are insignificant

  15. Randy Sullivan says:

    Sikahala,
    Great insight. [VCs are destined for "RIP"]…i like that. Is it accurate to state that fungibility of any trade instrument will depend on the criteria of assessment at that time or its sorrounding circumstances? Thoughts?