Financial Derivatives

In finance, a derivative is a contract whose value is based on the performance of another underlying asset.

An option, for example, is an agreement to purchase a stock at some date in the future for a pre-agreed price. The option makes a profit or loss depending on whether the actual price on that future date is above or below the pre-agreed price. Once in place that option becomes something which can be valued and in some cases even traded independently of the underlying asset – although their prospects are inextricably linked, at least in one direction, because without the underlying company there is no option.

While some people have become famously rich as a result of derivatives, many are very critical of them – e.g. Warren Buffett called them “financial weapons of mass destruction” in 2002. A few years later a form of derivatives called Collateralised Debt Obligations (or CDOs) were one of the causes of the global financial crisis.

Mathematical Derivatives

In calculus, a derivative measures how much one value changes in response to changes in some other value.

For example, as an object moves we can measure its speed (the first derivative of its movement) and its acceleration (the second derivative of its movement).

Or, when measuring the revenues of a business we can consider the amount in dollars, the percentage revenue growth (the first derivative) or the acceleration in revenue growth (the second derivative). See: Size vs Growth vs Acceleration

Again, without the underlying objects, there are no derivatives.

Startup Derivatives

I’d like to propose some new types of derivatives for start-ups: all of the other people and organisations who depend on the founder/s and their ventures.

Active investors are first derivative founders. They are the tender not the engine, although many acting in this role think of themselves in opposite terms. Passive investors, or anybody investing indirectly via a group or fund, are second derivative founders, since they are two steps removed from the underlying venture.

Incubators and accelerators are first derivative ventures, since ultimately the success of an incubator or accelerator is a function of the ventures they work with.

Government grants are first derivative capital, in the hands of the founder. Allocated funding for government grants is second derivative capital, in the hands of the development agency. When the government funds a development agency to fund an incubator to fund ventures … well, I start to lose count of how derivative that is.

Mentors and consultants and advisors are first derivative team members (ref: this great tweet – most first derivative team members mistakenly believe that others ideas are more worthy than their own).

A shared working space is a first derivative office.

How does this help?

There are a lot of people who would like to see a bigger more vibrant and more successful ecosystem of startup ventures in New Zealand.

In order to achieve this more people need to realise that what we’re missing are more impressive underlying ventures. Until we have that we can layer on as many start-up derivatives as we like and it will make little difference.

Contrary to popular opinion, the derivatives are not pre-requisites, it’s the other way around.

Of course, not everybody can be a founder – indeed that would be an undesirable mess. But, if you are currently involved in a first, second or even third derivative capacity, my advice to you is to think about how you move up the chain, because that is how you will make a bigger impact.

One thought on “Derivatives”

Comments are closed.