Options Investors have Outright Beside Funding YOUR Startup | Morgan Stanley Investor, Andy Chase

So I'm going to talk today about money and financing, and I'm going to bring it back into venture, what you guys are trying to do in terms of raising money for people and how it's going to go down for you when you actually try to go raise money for people. Because you're going to try to raise it from people like me or from like Tim, and you're going to have to make a presentation to them, and you have to make sense. Investors always have choices, and before they take a risk on one of you, you better understand and you better be able to think like they think because I personally, I mean, I'm looking around, I'm like, I'm not going to take a chance on one of you guys. Why would I do so? I mean, I can buy lots of things out there. Investors, that's how they think, and you better be able to at least talk part of the jargon. It can't be about how swell my technology is or something like that. Yeah. You've got to translate it back in how they can make money. So I always start this off with how, why do you start a business? Give me a couple of, what's the purpose to start one of your companies? What's your— Solve a problem. Solve a problem, okay. Create value. Create value, okay. Live autonomous. All right. Those are actually better answers than I usually get here. I've had people say to create jobs and for social good and this kind of thing. No, the reason you start a business, any business, is to make money, period. If you don't make money, you're out of business. It's that simple. It is that simple. And another way to say it is if you're trying to start a business, which theoretically some of you want to own, you don't want to own the business unless it's making money. Right. Otherwise you wanna be employee of that business. That clear? You wanna work for the company and draw a salary because if you own the business and it's losing money, it means you're writing a check into it. I don't care if you own a gas station, a flower shop, a startup company. If you own that business and it's losing $100 grand a year, who's writing the $100 grand a year? I am. Yeah. If there's money left over after you've paid all your employees, then you get it and you put that in your pocket. But at the end of the day, that's why I said if it's not making money, Then you'd better— it's much better to be an employee than to own it. Pretty simple. What— so then what is a business worth? What is an asset worth? Anyone? How do you value an asset? Anyone got an idea? Yeah. The more people are willing to pay for it at the early stage. The more people are willing to pay for it, the more it's worth. That's a good answer, yeah. Another one? Discounted rate of future cash flows. Those are the best 2 answers I've heard ever. Also, this is a good group. I don't usually get that. There's another answer? Comparables. Comparables. Whether it's real estate assets or if it's businesses, what other businesses have you got? The true answer for assets, unless it's a collectible like an art or something like that, and then it goes back to the first answer. Assets, and people learned this back in like '09 when things crashed, Assets are worth what somebody else is willing to pay you for it. 'Cause sometimes they're not willing to pay anything for something, even if it has a value. But if it's art, something on the wall, most people in business will value an asset based on its future cash flows, based on its future, if it's a building, they'll value it based on its future rents. If it's a business, they'll value it based on its future earnings. And you look at a lot of the companies out there these days, And they're not— they have a lot of sales, but they're not making money. And I hear these things, oh, they're worth $1 billion, and I'm like, the hell they are. I mean, if somebody was willing to pay them $1 billion, that's great. That usually means they raised money at that valuation. They didn't sell the business for that. And if they're not making money, other than a couple of purchasers, i.e., like a Facebook or a Google or something like that, there's nobody else that could pay that kind of money, would pay that kind of money. And it's gonna get tricky for you. How many people here are working on apps? Anyone here working on an app idea? A lot of hands. Yeah, I see this all the time. It may work. So, I mean, it may work, I'm just saying. But I mean, I've taught classes down at Stanford and I go to a lot of symposiums down there and— show of hands here, how many people have more than 30 apps on their phone? Most people probably. 50 apps? How many people pay for more than 5? Yeah. Do you actually pay money? Yeah. Give me, name 3 of them. Well, I've created apps that we pay, in the top 15 paid apps too, but all top financial ones. You're paying to use them? I've like paid to purchase them, like one-time deal. Oh no, no, I'm talking about like, no. Most people have on their phone, they'll have a travel app, they'll have a music app like Pandora. You want no commercials, you'll pay for something like that. I'm not talking about going to the Apple Store and paying a one-time thing. But my problem when I hear all these app things, and I'll go back to the finance thing in a second, is people in this generation are not used to paying for stuff on their phone. And they say, oh, that's gonna be worth a lot of money, I'm making these apps. And I'm like, whoa. If none of you pay for an app, and the trend is getting worse, not better, people want to pay less money than they did a long time ago, why is it of value? So the best thing you can hope is that you're going to get incorporated into— and the only people that have been able to monetize any apps really have been kind of Facebook and Google. Even Yahoo is having a hard time monetizing anything on the mobile side. And so unless you get incorporated into a feature set in one of their things, And they're willing to pay you for it. And when I hear people doing apps, I mean, they're so similar and that it always scares me that how are people gonna make money on these things? Yeah? I think you're talking about consumer apps, not business apps. Well, do you pay for a business app? I don't, but I mean a company— There are a few of them. These are general rules. They're not all— there are always exceptions to these things. But not that many people pay for that many apps. I mean, there's some supply chain apps. I mean, there's some things you can do for apps. But I'm just saying that most of the apps that people have on these things are consumer apps. They're not business apps. There are different monetized strategies to make money from apps, not necessarily from purchasing the app directly. There are services you can go to. Yep, I agree with that. So let me go through— I'm gonna go through some finance. I just want to get back— I just want to get back here. I want to get back into my topic. So let's talk about how we value a business for a second. When you buy a bond, what is the value of owning a bond or a CD? Yep? Cash flow. Interest rate, interest, yeah. So the bond, when you talk about a bond, it's interest over price. That's a yield, right? And that's a bond. Think of that as, you know, if this is a bond or anything in the fixed income world, penmanship's bad. Okay, if you buy a piece of real estate, what's the benefit? Real estate. Why would you buy real estate as an investment? Yeah? Capital growth. What's that? Capital growth or rental yield. Yeah, it's the benefit, the benefit is rents. And I hear people say answers, well, the real estate's going to go up in price. No, real estate doesn't go up unless rents go up. I mean, that's— and if people think the rents are going to go up, they might bid up the price. But the reality is when you buy— and it's actually called— there's a term called cap rate, which is net rents, net rents over the price you pay. And I'll say net rents here because I'm not sure people here actually own homes. How many people here own any real estate? Anyone here own real estate or home or condo? I do. Yeah. So a few of you. When you own real estate, pride of real estate and owning real estate is expensive, or it can be, because you got property taxes, you got insurance, you got— if it's a house, you got mow, blow, and go gardeners. There's stuff going on in homes that costs money, and, and this is called the cap rate, and it can also be expressed as a yield. Now, does anyone know What the yield on a 10-year Treasury is right now in the United States? 10 years out? Less than 1. What's that? Less than 1, it's really low. It's like, it's 2.05, like 2%. Anyone know what a 10-year bond is in Germany? Negative. It's 0.6. 0.6% for going out 10 years. Like 0% or something? Like 0.2% for going out 10 years. And in our money world, you keep hearing, oh, you get rates back to normal rates. And it's like, well, OK. I'm not sure what normal is. Because normal in the '60s, '70s, and '80s, America was in the catbird seat globally. Because Seoul was bombed. Paris was bombed. Tokyo was bombed. London was bombed. There wasn't anything left. And we were the only game in town. And we had higher growth, higher inflation, and rates were higher. But if you went back right prior to World War II, 1929 to 1946, '47, until the war ended, they went 17, 18 years with 15% unemployment in the United States. FDR was president. He was building roads and bridges. Rates were low. Nothing he did could get the economy kickstarted. I mean, it's just that— so these things go in cycles. And I'm not sure the world's going into a great growth phase here. That's what you're seeing. That's why you're seeing rates down is all the central banks are trying to goose things along by having rates lower. By the way, this is very good for you guys raising money. I'll come back to that why, because it's very good having rates down in the venture community. But up here, if you buy like a Treasury bond out 10 years, you got $100, let's use $100, you're going to get $2, $2, $2, $2, At the end of the 5 years, for example, you're gonna have $10 in your pocket. Markets are not stupid. So if you buy a bond in a good company like an Apple, Johnson Johnson, what do you think your yield's gonna be? What's that? You got an idea? No? 3? 3. Yeah, markets, they trade on what's called a spread. So if Treasuries, which are on a scale of 1 to 100, are they the 100? if you want to be in dollars, then you buy a good quality corporate name like an IBM or a Johnson Johnson or an Apple or something like that, you're going to get 3% to 3.5%. So because they'll pay you 1% more for buying a name like that. You buy a name like a General Motors or a good company, but car businesses have been up and down over the last a bunch of years, you're gonna get like 5 or 6%. You're gonna get a higher yield, it makes sense. If you're gonna loan your money to somebody else, wouldn't you wanna get paid a higher rate of return if you're loaning it? If you're gonna loan money to him, would you give him money? No. No? At what rate would you loan him money? If he promised to pay you back 10% a year, would you loan him money? No. No, maybe, yeah, I don't know. I don't know. I don't know. It's called a credit spread. So they refer to this as the bonds are trading at plus 150, which would mean plus 1.5%. Because in this thing, if you were getting $3, you get $3, $3, $3, $3. At the end of 5 years, you got $15 in your pocket. But it's static. There's no growth to it. So whatever you lock in your yield at, It's 2% or it's 3% or it's like, as I said, General Motors are probably paying 5% right here. And you get what you get and you lock it in. And that's what it is. And it goes all the way up right now. If you're buying an oil company bond right now, anyone have an idea what oil bonds are yielding? And these are— this is not Exxon, but like, you've never heard of this, something like Chesapeake Energy or Plains Exploration. These are big $20 billion companies. Anyone have an idea what they're paying? 5%. 15 to 20%. Now if you're in my business, what does that tell you? If somebody has to borrow money at 15 to 20%? Very high risk. It almost tells you they're going to be going out of business, something's wrong. You can't borrow money at 20%. If your cost of capital is 20%, that means as a business you have to out-earn that in order to To make money, you're screwed if that's your cost of capital. It basically means you can't borrow any money. And how it got there, they didn't borrow money at 20%. What happens is they borrowed money probably at 7%, but the bonds have dropped from 100, they're fractions, right? You get a bond that's paying 7 on 100, and all of a sudden the bond is now down to 50. So now it's paying 7 on 50, which is 14. 14%. But the bond has to mature at 100. It has to mature at 100 or the company's out of business. And if that's in 5 years, the company's got to come up with that money to pay you back, which means whoever buys the bond gets 14% while they wait and they also have to double their money in 5 years, another 20% per year. On the atom. 34%. It's a big number. And that's what happened to the people. Everyone thinks these oil businesses are going to be going out of business. And I just want to point out, because you've got to have a— you don't need to know where oil bonds are trading, but you have to have a basic idea of where 5- and 10-year Treasuries are trading, what 5- and 10-year rates of return are. Because when you go to raise money, people are going to look at you like, wait a minute, I can— and I'll bring it back to Roos when you go to raise money. X dollars by buying a bond in Johnson Johnson. Why would I take a risk on you guys?