Entrepreneurs and Hot Money Flows and Investments

The Symbiotic Relationship between Financiers and Entrepreneurs

Entrepreneurs need funding and venture capitalists and financiers need emerging businesses with great potential for investments. Therefore, there is a symbiotic relationship with entrepreneurs and the financiers wherein each need the other for mutual gain.

While the entrepreneurs would use the capital invested by the financiers to grow and expand their businesses as well as the more important aspect of returning profits on the investment, the financiers would benefit from the profits since their investments are generating returns.

Having said that, it is certainly not the case that financiers invest in just about every new business without doing their due diligence.

Indeed, one of the key aspects about entrepreneurship and entrepreneurs is that they need to have compelling business idea and a robust business model that would convince the financiers to invest in their companies.

This is one of the reasons why entrepreneurs find it hard to raise funds especially during economic downturns since the financiers would insist on robust and profit making business models which not all entrepreneurs can come up with.

What is “Hot Money” and How it Impacts Entrepreneurs

Turning to how financiers fund during economic booms, when money is plenty and capital is abundant, the financiers would be more than willing in pump in large amounts of money in what they deem to be solid ventures.

Now, when does capital become abundant and when does it become scarce? As mentioned earlier the former is when there is a boom wherein “hot money” is in search of good investments and the latter is when during economic recessions when capital is hard to come by.

In recent years, the Western world has seen the rise of many financiers who have benefited from the ultra loose monetary policies and the fact that interest rates in the West are close to zero. This is an incentive for them to look for avenues to channel their capital.

Indeed, this is what is referred to as “hot money” wherein there is so much liquidity in the system that the financiers would be willing to invest even in mediocre startups that promise modest returns.

As can be seen from the points made so far, whenever there is hot money in search of investments, there tends to be a boom in the rise of the startups wherein even those entrepreneurs who have earlier not fancied their chances become hopeful of investments into their ventures.

Creation of Bubbles

Having said that, there needs to be a note of caution here especially when such hot money flows result in “bubbles” being created.

A bubble in economic terms is when there is an artificial inflation or increase in the value of an asset or an entity which is not supported by fundamentals.

In other words, say you have a house which is worth a Million Dollars. When there is easy money flowing in the system, the same house can be sold for more than a Million Dollars since there are more buyers willing to shell out more money. This is because the buyers are flush with funds due to easy financing, increased salaries, or even the growing economy because of which they feel that they can invest more since the prices would go up in the future.

Such bubbles can be seen in many of the recent crop of startups especially in the Indian eCommerce sector. This is because there are many Western financiers who find themselves with abundant capital and hence, need to invest such capital somewhere.

Considering that most asset classes in the West are not generating the kind of returns that the investors want, they are looking for greener pastures in Asia which they feel would justify their investments.

Further, with the future projections for the Indian economy being forecast as very bright, these investors feel that they would be more than getting their anticipated returns.

The Indian eCommerce Sector and Hot Money

This has led to a situation in the Indian eCommerce sector wherein even companies that have not generated any returns or profits are the subject of Billion Dollar investments and valuations so high that one wonders whether there is another bubble in the making here.

Indeed, the situation in this sector is reminiscent of the Dotcom bubble in the 2000s wherein investors were willing to invest just about in any venture with a .com suffix since capital was so abundant that it needed avenues for investments.

Of course, the investors are not fools now or even then since at the first sign of the bubble bursting, they would withdraw their funding and “exit” from the ventures just as they did when the dotcom bubble burst. Therefore, entrepreneurs have to be conscious of this fact and not promise the Moon when all they can deliver are modest reruns from their businesses.

In addition, the individual investors in the stocks of these companies must proceed with caution especially when they invest in IPOs (Initial Public Offerings) of these companies.

What Goes up has to Come Down

Finally, it is always better to remember that “what goes up has to come down eventually” which means that despite all the hype and marketing as well as “spin” over the prospects of the startups, unless the business fundamentals are strong, there is a tendency for “correction” sooner or later and hence, all stakeholders must be cognizant of the basics of economics.

In conclusion, when the flows of “hot money” subside eventually as the interest rates in the West are poised to be hiked in the coming months, the companies and businesses of entrepreneurs that have the business models based on sound economic and management principles would be the ones that would remain in contention.