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2 minute read / Apr 1, 2018 /

The Importance of Time Value of Money for Startups

A dollar today is worth more than a dollar tomorrow. This statement underpins all of finance. The idea has a fancy name: the Time Value of Money. It applies to all types of investments, including startups. Time Value of Money is the economic argument for startups to raise money when it’s available.

If I give you a million dollars today, you can invest it. You might buy 151 bitcoins. Or invest in a certificate of deposit at 1.5%. Or pay a team of four engineers to build a feature for your software startup. Each of these are investments with some risk and some potential reward.

If I promise you a million dollars a year from now, that’s worth much less. Bitcoin might 10x in that time, and you wouldn’t have missed the rally. You would have lost $15k in interest income from the CD. You would have to wait to build the feature that could have won your startup more business.

Cash today empowers the holder to buy options. The more cash today, the broader the option portfolio available to the CEO. The CEO is the asset allocator in chief. He or she decides which options to buy. The more cash the company has, the more options are available.

Google has $102B in cash. They can afford many options. And very expensive ones. Google calls them Moonshots: self-driving cars and lengthening human longevity. This investment portfolio diversifies the risk of company success in the long term.

A startup with $1M in cash has far fewer options - maybe just one or two - which is why focus is critical. The investment they make must succeed, else the business fails.

There’s another reason Time Value of Money matters to startups. Cost of capital. It doesn’t cost Google much to raise $1M. They are big and have great credit, a big balance sheet and many assets. They can borrow at the best rates. On the other hand, a startup must pay a much higher price to raise capital, either debt or equity. The startup is a much riskier investment.

This cost of capital is also called the discount rate. The greater the discount rate, the more a dollar today is worth relative to a dollar in the future. Here’s the formula to calculate the ratio:

Present_value = Future_value / (1 +cost_of_capital) number_of_years

Raise money when you can. You’ll access more options and provide the business a broader universe of paths to success.

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