Equity financing of books

A rather uncharitable view of the book advances that legacy publishing houses give out to established (non first-time) authors is to look at it as “convertible debt”, as this piece by Matthew Yglesias points out.

An advance is bundled with a royalty agreement in which a majority of the sales revenue is allocated to someone other than the author of the book. In its role as venture capitalist, the publisher is effectively issuing what’s called convertible debt in corporate finance circles — a risky loan that becomes an ownership stake in the project if it succeeds.

Now, as I consider possibly self-publishing my book, while simultaneously attempting to sell it to established publishing houses, I realise that apart from the convertible debt, publishing a book also involves a massive sale of equity.

I’ve finished the manuscript, and edited it once. It needs further editing, but I’ve put it off so far in the hope that I can sell the book to a mainstream publisher, who will then take care of the publishing. However, given that I might end up self-publishing, and from what I read that publishers don’t do a great job of editing anyway, I might need another pass or two.

And then there are other things to be done before the book comes out in print – a cover needs to be designed, illustrations need to be put in, maybe we should get someone to do an audiobook, and all such. Now, if a mainstream publisher picks up the book, I’d expect them to take care of these. Else I’ll need to spend to get people to do these things for me.

When people first told me that royalties in book publishing are of the order of 7.5% of cover price, it was a little hard to believe. However, looking at the costs involved in the publishing process, it’s not hard to see why publishers take the cut that they take. The problem, though, is that it involves you selling equity in your book.

By going for a mainstream publisher (rather than self-publishing), you are saving yourself the upfront cost of getting your book edited, designed and “typeset”, in exchange for a large portion of the equity of the book.

Looking at it in another way, you are trading in your limited downside (what you spend in designing, printing, etc.) for what might be a massively unlimited upside (in case my book is a runaway success). For the most part, considering that most books don’t do that well, it isn’t a very bad deal. However, considering that downside is limited (in terms of costs) I wonder if it makes sense to trade it in for a large stake of what could be a large upside.

In any case, the main reason I’m still pushing to get mainstream publishers is because the self-publishing market is a “market for lemons“. With barrier to entry not being too high, lots of bad books are self-published, and so anyone who thinks they’ve written a half decent book will try to find a mainstream publisher. And this further diminishes the average quality of self-published books. And further dissuades people like me from self-publishing!


Revenue management in real estate

Despite there continuing to be large amounts of unsold inventory of real estate in India, prices refuse to drop. The story goes that the builders are hoping to hold on to the properties till the prices rebound again, rather than settling for a lower amount.

While it is true that a number of builders are stressed under bank loans since banks have pretty much stopped financing builders, this phenomenon of holding on to houses while waiting for prices to recover is actually a fair strategy, and a case of good revenue management. Let me illustrate using my building.

There are eight units in my building which was built as a joint venture between the erstwhile owner of the land on which the building stands and the builder, both receiving four units each. The builder, on his part, sold one unit from his share very soon after construction began.

Given the total costs of construction, the money raised from sale of that one apartment went a long way in funding the construction of the building. It wasn’t fully enough – the builder faced some cash flow issues thanks to which construction got delayed,  but since he managed to raise that cash, he didn’t need to sell any other units belonging to his share. He continues to own his other three units (and has rented out all of them).

The economics of real estate in India are such that the cost of land forms a significant part of the cost of an apartment. According to a lawyer I had spoken to during the purchase of my property (he also has interests in the construction industry), builders see a significant (>100%) profit margin (not accounting for cost of capital) in projects such as my building.

What this implies is that once the builder has taken care of the cost of land (by paying for it in terms of equity, for example, like in the case of my building), all he needs to do to fund the cost of construction is to sell a small fraction of the units. And once these are sold, there is absolutely no urgency to sell the rest.

Hence, as long as the builder expects prices to recover (when it comes to house prices, builders are usually an optimistic lot), he would rather wait it out (when he can realise a higher price) than sell it currently at depressed prices. Hence, downturns in housing markets are not characterised by an actual drop in prices (few builders are willing to drop prices) but by a drop in the volume of transactions.

While there might be a large number of housing units that remain unsold, it is unlikely that there are apartment complexes which are completely unsold – there will be a handful of bargain-hunting early buyers who would have bought and funded the construction of the complex. And given the low occupancy rates, these people are losers in the deal, for it will be hard for them to move in.

And it is also rational for the builder to invest in new projects even when they are currently holding on to significant inventory. All they need to do is to find a willing partner who can contribute the necessary real estate in the form of equity. And new projects will inevitably find the first set of early buyers looking for a bargain, irrespective of the builder’s track record.

And so the juggernaut rolls on..

Startup salary survey

I think I’ve come up with what I think is a really cool metric to value the tradeoff between your salary at a startup and the equity stake that you are given. For lack of a better name, I call this “multiple of foregone income”:

Let’s say that your “market salary” is $ 100,000 (pulling this number out of thin air), and since you are joining an early stage company which 1. cannot afford your market salary and 2. wants you to have some skin in the game, let’s say that you agree for $80,000. Now, your “foregone income” is $80,000 per year since that is the cut you are taking from what you think is your “market income”.

Let’s say the company is worth 10 million dollars (as per the latest round of funding before you join, assuming there has been one) and they give you a 1% stake (which amounts to $100,000), then the “multiple of foregone income” is 5 years ($100,000/$20,000 per year). If the company gives you equity that is worth $200,000, then your “multiple of foregone income” is 10 years.

Now I’m trying to figure out what the “normal” range of this multiple is. For this purpose I’ve created this form that I request you to fill out. I’m not asking for any personal details, the survey is completely anonymous and it will only take a minute of your time.

Thanks in advance! In return for your participation in the survey, I’ll publish aggregated results on the measure!