If you are a startup founder seeking to raise money, you may have come across the principle of the time value of money (TVM). This is particularly relevant for investors looking to invest in your business. In effect, TVM says that money right now is worth more than it is in the future. TVM has important implications for how much investors will provide your startup right now. This article will further explain the principle of the time value of money and its relevance to startup financing.\u00a0<\/p>\n\n\n\n
The time value of money (TVM) refers to a general financial rule that the money you hold now is worth more in the present than in the future. <\/p>\n\n\n\n
This may seem counterintuitive, but consider this thought experiment: Would you agree to loan another of your startup\u2019s cash for free? Unless you are being generous, the answer is no. This is because we all expect our money to \u201cwork\u201d for us. The money you lend to another business could be used instead to invest in another project. Therefore, you would charge your borrower an additional amount on top of the loan amount to compensate for the \u201copportunity cost\u201d of lending cash to this particular business. <\/p>\n\n\n\n
This \u201cadditional amount\u201d will also factor in the inflation rate and the risk that the borrower will not pay you back. It may take the form of interest charged on top of the loan. Alternatively, you may require the borrower to repay you a larger sum than what they borrowed at the end of the loan period. <\/p>\n\n\n\n
An alternative arrangement is where your business receives shares in the borrower\u2019s business. These shares entitle your startup to dividends whenever your borrower declares a profit. This is the premise behind an investor participating in equity financing<\/a>. <\/p>\n\n\n\n The three factors that determine how an investor puts a price on the time value of their money are:<\/p>\n\n\n\n All three of these factors determine how an investor sets their expectations for a return on their investment. <\/p>\n\n\n\n Startup investors are considered high-risk investors. That is, they know that it is likely that most startups fail. Accordingly, they expect a higher rate of return on their investments to offset this risk.<\/p>\n<\/div>\n\n\n\n Similarly, investors invest in businesses that have promising growth potential. This reflects the fact that successful startups can generate returns on investment considerably higher than other investment opportunities. For instance, successful startup equity investments can produce returns over a few years of at least 30%. This massively outstrips the returns investors can get from government bonds. <\/p>\n\n\n\n Finally, we are currently in a high-inflation\/high-interest market. Accordingly, investors can obtain more competitive returns investing in debt than in low-interest markets. This may mean that investors prefer investing in debt rather than equity. <\/p>\n\n\n\n\n\n Continue reading this article below the form\n <\/i>\n<\/a>\nTime Value of Money and Return on Investment<\/h2>\n\n\n\n
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