One Way to Finance Tech Startups Outside of Superstar Cities
By Edward Jung
Preliminary Analysis
Local Innovation Bonds (LIBs) are a new form of debt financing that connects local wealth and local talent to build strong economies in regions outside the world’s booming tech hubs. LIBs serve the many innovative but less disruptive tech startups that emerge around universities, hospitals, and research centers in heartland communities. These are typically early-stage companies developing B2B products for local customers. Their market-value ceilings are likely to be lower than the high-risk “unicorns” that attract venture capital. But because they are developing niche products in response to quantifiable demand from known customers, they also have lower capital requirements and faster time to proof-of-concept and sales. And, not incidentally, they’re a lot more common than unicorns.
Those attributes make such companies a relatively safe bet for bond investors. The investment is further de-risked with a diversified fund and government guarantees to cover loan payments until the companies start making revenues on their new products. This sample analysis models a diversified LIBs fund with or without government guarantees. The analysis shows an IRR of 5.3% without government subsidies and 15.3% when subsidies are included. These returns assume the ability to identify more than a dozen viable investments per year that will show more than $100K of revenue within a year, with projections that every successful investment of $250K will lead to developed revenue of $21M/yr within 20 years of initial funding. The model also uses the same trajectory for revenue growth for all enterprises. There’s room to adjust these assumptions and still get competitive returns.
LIBs aren’t an investment model that launches another Google or a new pharmaceutical compound—and that’s the point. LIBs offer a much-needed alternative to the high-risk, winner-takes-all success stories of venture capital and the global tech giants. Local debt financing helps keep value within the community and local entrepreneurs in charge. Companies that are funded locally are more likely to maintain a local presence, hire locally, and pay taxes in their own home towns as they grow. It’s a more distributed and sustainable paradigm for tech-based economic growth.