Cost of carry

The chronological price pattern of futures contracts here isn’t conceptually dissimilar to the valuation of a business asset. It isn’t uncommon for near-dated cash flows to be negative, in the early stages of a business, when carry costs outpace revenue… up to a point, some time in the projected future, at which the business starts to turn a profit as it comes into its own.

WSJ – Oil Prices Skid, With May Contract in Negative Territory

In one way of looking at it, business valuation is a price view on a series of futures contracts, discounted for variances in expected results over time. The cash flow forecast tends to rise but the discount factor keeps the uncertainty of distance in check. Or so goes the theory.

In practice, venture capital (in the conventional sense) enters the picture when the business has its greatest cost of carry, when revenue growth is unknown, or possibly nil. As the business matures, and if all goes according to “plan” – which is rarely the case, even when the business is successful – subsequent funding rounds see lower negative cash flows, up to the crossover point where the business is self-sufficient and profitable. At that point, in practice or at least in theory, the business is sold for a multiple of its profit.

Oftentimes this happens before the business is profitable, just as sometimes profitable businesses aren’t sold. It all depends on circumstance and environment and a price that clears the market, so to speak. The same is true for funding rounds that precede the “exit”.

The behavioral constant, however, is the implied evaluation of underlying futures contracts in all these cases, and the balancing of carry costs with profits to arrive at a positive present value in the aggregate. So, when the expected carry costs don’t support such a result; or when, as may be currently the case, there isn’t a strong view on what these carry costs will be and for how long, this is what happens…


If, theoretically, business insiders are in tune with their realities much more than investors, traders, and the outside market, there is a signal here in the composite. It says: we don’t know what’s on the other side of now, and now the carry costs are high.

Related reading: Market notes from up above (when the economy is a restart).