Came across Venture Beat’s post on why VCs win in a rising rate environment. It’s a follow up on a story by a VC, Keith Benjamin.

Net-net, venture capitalists are very happy about rising rates, for a few reasons.

For one, it makes debt financing much more expensive. When I was a high-paid executive, I set up numerous lines of credit for a rainy day. When I made up my mind to start a company, I knew that I could eventually tap those credit facilities at any moment and basically avoid a cash flow problem. That, in a nutshell, allowed me to focus on building a company that I thought would be valuable over time and not focus too much time trying to find investors and pitch them the latest trend or buzzword they were chasing. Today, with the company’s client list growing, the redesign and relaunch a reality, and “scale propostion” crystal clear, I can bide my time and choose the best VC and action plan.

Thankfully, I’ve not needed to tap into those credit lines, but this financing strategy made a lot of sense because debt was cheap. Today, with interest rates much higher than they were a few quarters ago, I’m not sure the idea of (or even considering) using debt to finance a project would be much risker.

Mainly, I could avoid VC altogether and flip the company, whereas raising financing gives VC final say on when and to whom and for how much I can sell…

More reason to come, but I have a call to jump on at 5:30 that I actually need to focus on… Back with more.

All right, waiting for folks to jump on the call…  

Reason #2 why VCs love rising rates: it becomes harder for private equity firms to raise money.  We’ve seen how angels are squeezing VCs from the bottom and private equity firms are applying pressure from the top.  If it the cost of capital rises, then PE firms can’t raise as much, as easily, because much of what they do is in the form of debt financing.

Reason #3 is that angel investors suddenly get attracted to safer, higher yielding investments that in low-rate environments simply offered little investment return.  Say you are an angel who made $20M and current interest rates are at 5%.  At that rate, the return on bonds are low, so you will be more prone to allocate more capital to high-risk, higher-yield investments that historically VCs only considered at.  But now say the prime rate goes to 7.5%, and the rate a bank pays you is, for example, 12.5%.  On a $5M or $10M account, that’s starting to look like a decent return given the much lower risk profile, no?

The fourth and most important reason is the flight to quality that ensues when the cost of capital rises amongst VCs.  Let’s face it, there are some great VCs who know what they’re doing, then there are some pretty lousy ones (like with every segment and subset of a sample population).  By making it harder for VCs too to raise money, guess what, Darwin’s survival of the fittest kicks in and the wheat gets separated from the chaff.

Wow, I actually used that in a sentence.

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