Natural Finance Soft Loans are business loans without fixed repayment terms. Instead, they are repaid when business cashflow materializes.
the major advantages of natural finance:
Advantages for borrowers,
The issues with traditional financing of startups
The key comparative advantage of natural finance for startups
Natural finance tools for startups
Another key feature of natural finance is its encouragement of communal partnerships. The ideal organizational structure a business should aim to eventually accomplish is that of ownership by equal partners. The advantages are the prevention of abuse by majority owner(s), and the power of shared supervision to prevent any other abuse.
The tool most handy for startups is deposit options which allows one (or communal partnership of) owner(s) to promise a future equal share at a locked in buy-in price in exchange for monthly payments. The buyer of the option has the right to abandon it at anytime, by not making the next monthly payment. The "strike price" (buy in price) of the option is based on a specific total value of the company divided by however many partners happen to exist at the time it is exercised. The strike price is adjusted down based on the monthly payments made and/or dividends paid.
Very early stage financing
Deposit call option premiums of $4000/month buy a much lower partnership share strike price than does an $2000/month premium. These premiums are paid directly to the founder and not to the company. The founder might accept both offers if the lower immediate "salary" justifies a much higher future partnership share sales price, and he is confident in achieving that future value.
Another option that necessarily suits the founder, and likely is more attractive to the potential partner is a call option premium of $4000 with the added condition that $2000 of that premium received by the founder be reinvested as "low interest" loans to the business to cover sales, travel, and other investment acquisition expenses. The re-investment condition ensures that the founder is focused on generating revenue so that he may have those loans repaid. Compared to a $2000 option premium and a $2000 additional monthly loan investment into the company, the investor is much more likely to prefer a lower future purchase price of a partnership share over the potential small returns on small monthly loans.
Recent post on communal equity options is most focused description of communal equity options. Deposit options are most likely to help design-type startups, and does so without hampering the company's borrowing capacity.
Organizing a company with external sales and investment agents
While sales and investment functions can be separated from a company, it is not completely clean to do so. Both sales and investment have a tendency to over-promise on what can be delivered, and the concern is amplified if sales and investment teams are external to the company. There is also often the need to get the operations department involved in a sale to both negotiate on what is possible how fast, and help close the sales or investment. The only other major issue in using external sales agencies is you likely need that they are not involved in any competitive companies.
To control the investment sales over-promising tendency, its compensation can be based on investor repayments. Natural finance can completely align the interests of investors and their solicitors by ensuring they are paid by the same transaction. It should provide the investor with confidence knowing that a soft loan he "buys" only results in a payment to the salesman when the investor himself is repaid the loan with interest.
To form a closer partnership with marketing sales agents, you likely want them to intend to become partners in the business through deposit call options, and/or reinvestment of sales fees into soft loans for the business. The benefit to the sales agency for such arrangements can include territorial exclusivity or other favours. To handle the involvement of the operations department in closing and negotiating sales, the sales agent can "hire" the operations department (with fees conditional upon closing sale).
The benefit of external agents is lower fixed costs, which tends to be important for a startup. The benefit of having the function in house is tighter control over people's lives and behaviour.
How a 30% interest initial loan for almost any venture is profitable
For someone that invests in a natural financed startup at a 30% interest rate, he has an immediate interest in becoming an investment agent for the company, and needs no formal agreement with the company to do so. This is fundamentally the same conflict of interest that exists within the traditional financial industry: creating hype for what they own. But, the behaviour benefits the startup, and the financial promoter's help is likely much needed.
The advantage of accepting exploitative and onerous loans from investment or sales agencies is that you get their services for free. They become instantly motivated to promote your startup so that they may be repaid their high interest loans.
If the company takes a few years before earning revenue, then whether a loan is at 30% or 10% won't matter too much because of the total cap of 100% interest. The importance of the cap is detailed here
Hiring a first employee
Closer partnerships with suppliers
Part of ongoing operations of a natural finance company is to fund large projects with new financing rounds that are placed in last payment priority. Getting the people and companies that will receive what the funding will be spent on to help fund the project provides benefit to both the buyer and sellers.
Partnerships with customers
While getting a product among the first is likely the most compelling reason for a customer to fund a startup, natural finance loans can provide the same features as kickstarter pledges by allowing lenders the option of redeeming their loans for products, collectable gimmicks and promotions. While that practice can slightly violate the natural finance rule of always repaying investors at the head of the queue before repaying those behind them, it is excusable if the profit margin on redeemable loans for products is high, and it is fully justifiable if the intent of the loan was for a specific product redemption at the time the loan was made, and if not, also fully justifiable if replacement financing is obtained to produce what is necessary to honor the loan redemption.
Natural finance loans, in addition to providing any kickstarter ability, also allows business customers that may be able to profit from your product to help support and improve it. It further provides customers compensation for delays in developing the product, and the opportunity to withhold product redemption until the next generation product is released, or otherwise change their product redemption intentions based on new collectibles or promotions offered.
(see the grocery cooperative example near end of paper)
I define strategic investment as investment for the benefit of seeing something accomplished rather than out of concern for the direct profits possible, or their distribution, from that accomplishment. Helping a company get oil or copper out of the ground has the strategic benefits of lowering the price of oil and copper. Helping society build roads gives me the strategic benefit of customers and myself getting to my place of work easily.
We often think of proposals with social strategic benefits as worthy of petitioning government to assist with. In the case of developing an affordable cure for AIDS, government can be corrupted against such a social interest, by the financial interests of an expensive life prolonging established solution.
Social sponsorship of projects whether they are high profit, low profit, or non profit is made easier through natural finance. "Donors" can treat their contribution as a donation, but if the project is successful they will receive a direct benefit from that donation whether it is through cheap social distribution of the innovation, or their share of the financial benefits from a not so cheap distribution of the innovation.
Another way to invite social commitment for your project is to grant a permanent right for any social institution to purchase your company at a fixed price. It may or may not be generous to allow society the right to purchase your company for $100M or $20M, but it is still an explicit gift, than can be judged simply on its merits, and is unlikely to discourage the efforts required of you that might make society consider this opportunity.
The great benefits of many partners
As more partners join, the affordability of a partnership share improves. For 1000 partners, every 1M in company valuation costs $1k for a new partner. If it is affordable for more people interested in the viability of the company, then there is more demand for a partnership share, and part of the investment may become justifiable through intangible benefits of influence and status.
For the original owner(s), 20 or more partners means selling 95%+ of the shares in the company. No matter how many partners or how long ago the founder gave up authoritarian control over the company, odds are that the founder's ideas and direction are still likely to be valued in some role, even if perhaps the huge salaries and perks he might be able to bestow on himself if absolute control were denied to him.
One advantage of large partnerships is decentralized governance where partners bid for the right to lead projects or perform functions rather than have them bestowed through a hierarchy. Its similar to my natural governance principles for wider society, and creates competition within the enterprise that benefits all partners.
The control freak's guide to starting a commune
The benefits to future partners is that relief from your tyrannical ways is eventually assured, and so the attractiveness of a partnership share greatly enhanced, and so the rewards (monetary partnership share value) of selling future partnership shares greatly enhanced for you. You gain the protection to make the right decisions for the company for the next 5 years so as to further enhance partnership value, and will continue to have significant advantages in having your ideas heard after your 5 year reign.
A company, and partnership share in that company, is always more valuable without a monopoly over ideas, including a monopoly on deciding the leadership's salaries.
The Power of the comptrollership function
As shown in the next example, an even stronger benefit of natural finance is the preference for higher interest rate loans by the borrower, that is created by trust and flexibility.
- Product may be lost, stolen or break: The most serious risk. If I borrow against my house, I lose $24k if product is lost. If it is a soft loan, I still lose the profit opportunity. This risk can be mitigated with insurance. For the lender, a soft loan can be seen as equivalent to a loan + insurance product. The extra interest may compensate for risk, but insurance for the investor's benefit is an option that may be both less risky and still more profitable.
- There may be delays in shipment, personal or medical emergencies that delay my ability to sell the product: Such delays could cause me to incur expensive credit card debt to meet fixed loan obligations. Under a soft loan, if these are merely delays, then it is not a burden on the borrower, and results in higher returns for the lender.
- I may lose interest in selling drinks, or it is not as profitable as hoped due to competition: Solution options include selling the drinks in larger lots at less profit, or hiring/delegating the sales efforts to others. Although I feel much more pressured to enact one of these options quickly under a fixed loan than a soft loan, there is still moderate profit opportunity sufficient to repay the investor under the soft loan option.
Virtual corporations and open source
One reason not to collect product sales revenue, is that it would be expensive/complicated for partners in the software to audit sales, and decide how to distribute rewards based on contributions. A 3rd party natural finance comptrollership, or 3rd party mediator, or internal committee can assist with that function.
A virtual corporation is one where there are no physical offices. All the employees work from their homes or at client offices. Software and web companies are suited to this model, as is any startup with either no revenue, or no strict requirement for customers to come to their office. Any corporation could technically benefit from the cost savings of virtualization, but ornamental office space can enhance trust by giving the impression of financial stability.
A far more useful trust and confidence enhancement tool than office space is 3rd party natural finance comptrollership of the company's bank accounts. If employees and investors cannot see the customers, they need accurate information to base whether and when they can be paid, and assurances without requiring nagging and repeated requests that they will be repaid when they are supposed to. Natural finance comptrollership is likely much less expensive than office space, and may have some of its costs deferred. NFCs provide especially significant trust enhancement to international stakeholders.
Solar cell industry
Natural finance soft loans can help somewhat stop overproduction by not having fixed repayment obligations, and so enable the strategic option of not overproducing, but more importantly because natural finance companies have lower fixed costs, the option of overproducing to drive competitors out of business is also an option.
Because investing in solar power, even in residential installations, is one of the lowest risk possible investments, where power savings is a tax free return for residences, and so should be competitive at 3% ROI over 25-30 years. Natural finance's power to form cooperative agreements with customers, and delay cash outflows to meet inflows, and even get company investors to finance customer purchases. If the problems with the solar cell industry can be described as under purchasing instead of over supply, then facilitating customer purchases/financing would cure the industry.
A Grocery store cooperative
As mentioned earlier, the customer discount benefit of ownership alone may be worth $3000 per owner, and so $3M communal equity with 1000 owners with no profitability. Every time an owner joins, all of the other owners are paid directly with the proceeds. This means that there is significant incentive for a non-customer investor to get in early. If initial capital and inventory costs are $500k, even if initial 50 partners are brought in at under 1M communal equity, and next 200 owners buy in at $2M, there is significant financial profit opportunity just from growing the network of partners.
The difference between what allows a 1000 owner (customer) coop and 10,000 member coop is not only price and quality performance that draws people from further away, but also store capacity. A supermarket can serve more people than a smaller store. Wider product selection means greater value in the customer-owner discount. Expansion into a larger store or more locations increases customer-owner capacity (going from 1000 owners to 2000 owners at $3k/share, raises an additional $3M for ownership pool, and so 1000th partner would get most (about $2250) of his purchase price back). Expansion into other retail categories (pharmacy, brewing supplies) increases selection and so the value of the discount. Expansion into warehousing and wholesale services, or buying store location instead of renting would increase either profit or the discount percentage. All of the above either increase the value per share or increase the capacity of owners and customers that can be served.
To expand from a 1000 member small store coop to a potential 10000 member supermarket coop, and raise the initial investment to do so, 1000 additional shares could be sold at $6000 each, with most of the proceeds set aside for development, or individual existing shareholders or outside investors can lend to the coop for any part of the development costs. Growth from 1000 to 10000 owners still provides substantial profit opportunities for the 1000th and 2000th partners. A 10000 member coop with $3000 owner discount benefit is worth $30M even if it makes 0 profit.
One issue with the grocery store owner discount benefit is that is worth much less to a single person, than to a family of 12. Its not necessarily a major issue as it would simply make large families more eager to be shareholders, but there is an actual solution that is an overall improvement. If a 10% discount to owners results in 0 profit, then an 7% discount results in a 3% surplus that can be distributed to owner partners. The small shopper that is an owner (or lenders) profits from the large and average shopper owners, while the average shopper owner is unaffected. This is an overall improvement because it makes the value of a share more attractive to more people, while still providing a great deal for large and average shoppers.
A bigger issue, is that for simple customers the thought of investing over $10k or even just $3k is not a typical conscionable occurrence regardless of the potential benefits. The natural finance solution is deposit call options. One solution might be to offer customers a (version 1) call option with strike price of $3.5M where premiums are based on 7% of purchases. This would mean that any customer that spends $50k in the store would automatically become an owner after 1000 other owners exist. They automatically gain ownership after spending $25k if 2000 other owners exist. From the existing partnership perspective, they prefer the first scenario to the second, and they don't like the lack of a fixed commitment to the option. Because the owner discount provides a unique value to a share that is independent of the number of owners, the partnership may feel cheated if it receives less than $3k for one share. A solution that keeps the customer simplicity of the first option is that if a customer either spends $50k, or pays the difference between 7% of what he spent and $3500, then he will receive the 7% discount in the future, and when there are at least 1000 partners, he will become a full partner. Another alternative is to allow the customer the option of purchasing a share at $500 more than whatever the partnership wants to sell it for but allowing the customer to deduct 7% of all past store spending. All of the above alternatives have no cost to the customer, and no benefit until a share is acquired. Its like a long term rewards program, but may be too long to seem attractive.
A more balanced deposit call option terms is to offer a $4M communal equity strike price for premiums of $400/year ($34/month). This is using the version 2 deposit call option formula. Assuming an initial (arbitrary) 360000 non-voting shares, the call buyer gets in return for his $400/year in premiums in addition to the call right, 36 shares per year, and an 8% discount (1% higher than owners) while he maintains the option. Because, in this scenario, the owners and company are paid each month/year for the benefit of the discount, they benefit if the customer doesn't spend very much, and they benefit if they spend a lot. Whether there becomes 1000 or 2000 partners before the option is exercised, there is no loss to the owners from granting the option. Note that although the option is for a $4M total equity value, the option buyer is accumulating non voting shares at the cost of $400/36 ($11.33). With 1000 owners, once he owns 360 non-voting shares he gains full owner status, and so after 8 years of the option he has accumulated 288 shares, if the communal equity market for a full share is at $3M, he can abandon his option and pay $600 for 72 remaining shares that he needs instead of $800 over 2 years for those shares. There are significant advantages to the partnership of granting such options. For one, if a happy target value of the company is $3M in the future, then selling shares today at a $4M value is good for the partnership. Also, non-voting shareholders do not receive any proceeds from communal equity transactions when new buyers join the partnership, and so early partners are not diluted by option holders when it comes to sharing new share buy ins or option income.
Yet another option for financing share purchases that is useful both when there are very few partners and very many is to create a natural finance soft loan queue to finance the share purchase. Since buying a share involves paying cash directly to the partnership group, the partnership giving a loan to the purchaser instead is always an alternative. The partnership would be advised to take at least a small deposit, but it can then finance the rest of the share purchase at say 12%/year. Under natural finance principles, anyone and any individual partner can underbid the collective partnership by offering part of the loan at a lower interest rate and thereby receive higher payment priority. The terms of the loan are likely to include a payment schedule, and the new buyer/borrower may abandon his share at any time by stopping the payments. Let's say the founder who spent $500k on creating the business will sell you the next day half the business for a total equity value of $1M, and so your required payment would be $500k. If the founder allows you to leverage that investment by only putting down $1k, and having a $499k loan at 12% with $50k/year in payment obligations. One way to meet the payment obligations is by having new partners buy in. If a 3rd partner paid cash ($200k) for a $600k equity value, although you appear to be losing money because the company value is going down, $100k of that $200k would go towards paying down your loan, and you have no payment obligation for 2 years as a result. If instead the 3rd partner bought in at $1.2M equity but used a $400k loan instead of cash, you may be ahead on paper, but you have not received any liquidity help in making your required annual payment. Incidentally, you becoming the 2nd 50% partner at say $600k equity value with very little of your own money would be a sensible proposal if you were going to manage the operations. It can be great for you because you have so much leverage, and can walk away without losing much. It can be good for the financial partner because of the high interest returns or getting back their share while keeping any payments if it doesn't work out.
For a smaller partnership buy-in fee of $3000 (1000+ partners), some people might still prefer a loan. A $300 annual payment and 5% interest. Doing so purely for the benefit of the owner discount may make sense, and if you don't want to shop at the store often after some years, you wouldn't really lose anything if you abandoned your share, and neither would the partnership or company.
Communes and cooperatives are always worth more than the same company under traditional corporate structure because first, communal equity values shares at the median owner value rather than the most pessimistic owner's opinion, and second and more importantly, equality of ownership prevents the systemic bias towards a majority owner. That systemic bias necessarily pushes actions towards corruption and oppression even if those actions don't cross a thin binary moral/legal line that defines corruption and oppression.
IMO, it is a mistake to advocate for cooperatives on the basis that they are a near charity to the employees. This places employees above and in opposition to investors and customers. Instead, the proper way to reward the contribution of labour in a broader more open commune is through a performance bonus "tax".