Money makes the world go around

In all my time in industry, the main thing we worried about was money. Whether we had enough, whether we could get any more, how much we had to spend to get more and so on. I got to musing about it all recently when the debate about a Green Investment Bank appeared and receded. What is the best financial support mechanism for a Government to use? In industry we used to worry about 3 main types of money. Since becoming a public servant, I have learnt that there are 2 other types. There may be more!

The first (and best) type of money is the stuff you get from customers in exchange for products and services. This is the goal of all companies – to sell their output for more than it cost to produce it, and to sell lots of it. This money is rightfully yours and what you can do with it is totally up to you. Unfortunately, it is hard to get. You have to make or supply something that people want and you have to be better or cheaper than the other companies who make similar things.

To be in a position to get this most desirable type of money, you tend to use the two other types. The first is debt. This is usually the money you get from a conventional bank. It is a strict business deal. You borrow an amount of money for (often) a fixed period of time and for a specific purpose, and as well as paying back the money, you pay extra for the privilege of having had it. The money has provided an income for the provider and usually been used by the company to make even more extra money than the interest paid. The rate of interest is often varied to take account of the risk involved in the loan, either of the specific use of the money or the strength of the company that is borrowing it – but mostly, this is low risk money for the lender. Those who lend the money know a lot about money, but their assessment of risk and therefore interest rate is based on financial factors.

The second type of money common in business is equity. This is where someone provides the money to the company in exchange for a share in the ownership of the company itself. The company pays a dividend (which is equivalent to interest) to the lender but also the size of the money grows with the size of the company and thus the lender gets benefit when the company is successful as well. For large companies, this money is provided by shareholders, who are either individuals or companies who are good at looking after money and do so on behalf of others. For smaller companies, the money may well come from venture capitalists or business angels. This is more risk tolerant than debt, but consequently expects a higher rate of return. Large companies who invest in other companies do a fair amount of analysis of the market the company serves, their standing in the market, their comparison with competitors, the people involved and so on. Venture capitalists are even more engaged and often provide human resources at senior management level to try to maximise the chances of success. Overall, this sort of money requires a larger return and stronger interaction between company and money source, but it does tolerate more risk.

Since joining the Technology Strategy Board, I have discovered there are 2 other types of money. The first is usually called subsidy. This is money provided to companies and sectors to try to affect economic activity at an international level. Having large multinational companies resident in the country provides jobs, drives supply chains and has all sorts of positive impacts – and so is seen as a good thing. Thus it is normal for Government to make it financially attractive for such companies to operate in their country. The money can be provided in the form of loans with low interest rates or grants with implied long-term economic returns, or it may be provided through other fiscal means.

Not surprisingly, it is the sort of grant support that government sponsored organisations like the Technology Strategy Board provide that interests me most – at the moment. This money is often provided as grants for part of a specific project. It is “invested” against the specification of the project and, although there are provisions in most contracts I have seen, it is rarely taken back if the project is unsuccessful. That is because it is (mostly) invested in more risky projects. The logic is easy – if the Government can encourage companies or groups of companies to take on more risky projects, then – if the projects are successful – those companies will be more profitable in the future, and therefore employ more people and pay more taxes.

At this point it is necessary to introduce another distinction between organisations that I was taught a long time ago. It is best summed up as the difference between policemen and doctors. There are some groups who, if you step outside the rules of society, are there to punish you for the position you find yourself in. There are other groups who, if you find yourself outside the normal states of society, are there to help you get back inside. One punishes transgression, the other helps reverse it.

Both sets of response exist in the “money business”. If you cannot pay back the money you take as debt, would the lender punish you or work with you to help you pay it back? Most just charge more and leave it as your problem. If you cannot pay back money you take as equity, then the lender is more likely to help you, because they share the liability. With grants, it would be possible to punish those who don’t deliver by cancelling the grant and even requiring repayment, and if you wanted to be a simple funding agency, that is probably what you would do. On the other hand, if when those who take the grants fail to deliver but have tried, you give them support, add to their expertise and help them understand what they did wrong, then – next time – they may well do better. Sounds like a plan to me!

 

Last updated on Friday 24 February 2012 at 10:08

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