Wednesday July 24, 2024

Debt comparisons

By Waqas Younas
March 01, 2017

In an article – titled ‘Pakistan’s debt problem’ –published in these pages on February 25, the writer wrote about Pakistan’s debt management issues. I totally concur with his views about how we use our debt unproductively. I also agree with him that we have not been able to create much value using our debt and need to re-evaluate our debt management plans.

However, comparing venture capital (VC) investments with a country’s debts – especially through examples of companies like Amazon and Snapchat, as the writer has implied – to show the difference between good and bad debt, does not appear to be valid. VC is overseen by partners who manage the VC fund and use it to make investments which are considered much too risky for bank loans in early-stage or high-growth companies. There are subtle differences between a country’s debt and funding provided to a company by a VC.

VC funding primarily differs from a country’s debt in that you are not legally bound to make interest payments and return the original whole payment provided by the VC – even if your company fails miserably. However, in the case of a country’s debt, not only do you have to repay the original amount, but you also have to pay the interest. Owing to this significant difference in the manner through which both forms of debt are managed, it is difficult to argue that the success of a VC-funded company reflects good debt management as compared to a country – although VC money is probably not technically even debt.

When venture capitalists fund a company, they receive an ownership stake in return. As a result, they want the company to do well. If the company achieves a good ‘exit’ – through IPO, mergers or acquisition – they are paid handsomely. The success of the VC is contingent on the success of a company. But we cannot assume that the success of an entity lending to a country is entirely contingent on the success of the borrowing country since they are going to get their money back.

In addition, ownership stake gives VCs significant decision-making power in a company. Although a lending entity can influence the borrowing country in certain ways, they never gain an ownership stake in anything – let alone receive decision-making powers. This makes it hard to evaluate the outcome of an investment made in the form of a loan to a country as compared to VC funding provided to a company.

People who run a VC firm are called “general partners”. They also put in between one and two percent of their own money in the VC fund to show their commitment. In the case of a donor agency, the person negotiating the country’s debt doesn’t have his own money at stake in the agency’s fund. This makes one wonder if the person representing a donor agency will care as much as a venture capitalist. Behind-the-scene stakes for VC firms are different from those of donor agencies and therefore make the comparison difficult.

VC funding is usually given to early-stage small companies or companies that show high growth potential. Early-stage companies are usually founded by one person or a few co-founders and the total headcount doesn’t amount to much. However, debt, on a country level, is given to a particular government in a country. The size of a government – and the human machinery that runs it – is immense as compared to small-scale companies. The difference in the size of the borrowers makes the comparison a lot more difficult.

Most early-stage companies are likely to fail. Even Bill Gates, before he founded Microsoft, founded a company called Traf-O-Data that didn’t work out. Data from Y Combinator – a well-known VC – reveals that 93 percent of companies that they have funded over the years have failed. Chances of success are quite remote. When we say that Snapchat and Amazon have succeeded, we should keep in mind that it is likely that 90 out of 100 start-up companies, by contrast, fail.

It is true that some companies that succeed go on to witness huge success, as we all know in the case of Google, Amazon and Snapchat. However, when we argue that the outcome of the money provided to Amazon and Snapchat was a lot more useful than the debt provided to a country, we cannot ignore the failure rate as well. How we choose to factor in the failure rate when comparing VC funding with a country’s debt also remains a tough question.

Venture capitalists perform a lot of due diligence and give considerable importance to their ideas, plans and teams. In light of empirical evidence, and how our country’s debts have been used, it is hard to gauge if ideas, plans and teams are deemed important.

The outcome of an investment made by a venture capitalist can therefore not be easily compared to the effect of an investment made by a donor agency to a country.



Twitter: @wyounas