An Alternative To Convertible Debt In Emerging Markets

Editor’s note: Conrad Egusa is the CEO of Publicize. Eddie Arrieta is the COO of Publicize and is the Co-Founder of Espacio, which is based in Colombia.

Cities across the planet have been trying and failing to replicate Silicon Valley’s talent for going on 50 years now.

However, it’s not talent per se that makes Silicon Valley what it is. It’s the investment ecosystem that attracts the talent. It’s the assurance of major acquisitions that attracts the investors. “What Silicon Valley does better than anyone,” writes Mark Cuban, “is create exits.”

But, if the premier innovation engine in the world is indeed running on exits, what does that mean for startup scenes that don’t have such a well-established investment hierarchy or potential acquirers, and possibly never will?

Perhaps the best approach isn’t to mimic the specific, and at times surreal, architecture of Silicon Valley finance, and to instead emphasize new and more adaptable models of entrepreneurial expansion.

Why exporting Silicon Valley won’t work for emerging economies

If tech innovation is to stand at the forefront of the world’s emerging economies, developing countries need to find a different, more grounded way of structuring their startup ecosystems.

Take Colombia, one of Latin America’s burgeoning tech hubs. Last November, I wrote that a lack of venture capital is “the biggest ceiling on startup growth” in the country. In the short-term, that’s true, and the government has taken steps to address the problem, incentivizing venture capital firms to relocate to the country.

But in the end, the efficacy of efforts oriented toward attracting venture capital will be severely limited, unless venture capital is confident there are exits to be had in the country. Currently, only one or two Colombian startups are acquired each year.

However, there are many profitable and promising ventures throughout the world that neither expect nor want to be acquired in the near future. It’s easy to forget that, despite how successful it’s been at generating massive IPOs and acquisitions, Silicon Valley’s model works for a very specific subset of companies and investors. It is a great–and perhaps the only–place to make the magical leap from a vaguely defined concept to a major windfall overnight. But what about all the entrepreneurs and businesses staking their futures on more realistic aspirations?

So what’s the alternative?

Consider a startup that brings in $1 million a year in revenue but needs a cash infusion for a vital expansion project. The founder doesn’t have enough credit history or collateral to qualify for a personal loan of, say, $500,000, and the startup is too young for a small business loan. (If the startup is based out of a country like Colombia, credit in general may be highly restricted, regardless of how long the company has been around.)

In the past few months, a number of venture capital firms have approached the founder with offers, but she knows that the equity needed to secure VC funding will be worth, after just a few years, not to mention the full life of the company, far more than the loan itself. Besides, the founder is passionate about the company, and has no plans to sell or take it public.

Now consider the flip side. A successful chef has just retired and sold his restaurant. He’s flushed with cash but doesn’t know where to invest it. He reads the business section, and fears that the stock market, while booming, is headed for another crash. Real estate is picking up, but he’s not interested in managing a property in his old age. And the current yield on a 10-year US Treasury bond is sitting at just over 1.7%, its lowest point in 20-months.

Their situations align perfectly. All they need is a framework to reach an arrangement.

The Interest Investment

This standardized agreement would be for a two-year, $250,000 loan with 12.5% annual interest and 15% of the company offered up as collateral.

For the retiree, ~25% is better return than what he’d get from any conventional option–as much, even, as the accrued value on a convertible debt investment stretched over the same period. And for the founder, as well, ~25% is still a bargain compared to the future value of the equity she would have to give up otherwise.

The collateral, in this case, is also safer for both parties. The founder avoids the risk of losing her company altogether in the event of a default. And ownership stake in a steadily profitable company is what any smart investor would want from her in the first place.

What you have, then, is a financing structure more grounded than venture capital but more accessible than traditional debt, more profitable than conventional investment but safer than the rat race–an investment scheme that works for bootstrapping, not pipe dreams, and may just change the way emerging markets do business.

Right now, there are thousands of potential investors around the world who will simply never take to the VC model. To be sure, they’d like to get involved in the startup scene, which they’re smart enough to recognize as an lucrative opportunity. But they’re intimidated by its pace and abstractions and feel more comfortable around traditional investments.

As things currently stand, the startup scene has no entry point for these types of investors or their capital. And entrepreneurs are stuck elaborating their ideas around ambitions they may not share and which may not serve their interests.

This is why we are introducing the Interest Investment: an alternative to convertible debt in emerging markets.

The vast majority of companies in the world aren’t aspiring to multi-million valuations before they’ve made their first dime. For the vast majority of investors and entrepreneurs, dependable profit and steady growth are the stuff good opportunities are made of.

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