Less Is More: Scarcity Drives Better Financial Terms

Want to shift negotiating power in your favor when raising capital? Borrow a page from Mark Twain.
Reuben Daniels and Craig OrchantAugust 1, 2011

LinkedIn’s shares more than doubled on the initial day of trading last spring when the firm went public. Leaving aside questions of market bubbles or whether the IPO was priced properly, the sale clearly illustrates one of the most fundamental principles of success in the capital markets, one we refer to as “scarcity.” In the words of Mark Twain, “In order to make a man or a boy covet a thing, it is only necessary to make the thing difficult to attain.”

Scarcity creates competitive tension through a favorable supply-and-demand balance, and it is a cornerstone of every successful offering. Whether you are raising capital through debt, equity, loans, or derivatives, limiting the availability of investable assets shifts negotiating power in your favor. Investors must work harder, and pay more, to participate in the smaller supply.

In LinkedIn’s case, the company achieved scarcity partially by being the first IPO of a social media company in the United States and by retaining most of its venture-partner owners. LinkedIn also sold only a small share, less than 10%, of the firm. Facebook is achieving a similar dynamic by having pursued a private-market transaction prior to a prospective public offering. The company’s private-market offering involved a limited number of shares, while at the same time giving the placement agent the opportunity to disseminate information in a form that maximized the firm’s valuation.

Scarcity is by no means limited to hot stock offerings. Any company can utilize a wide variety of tools to develop the dynamics that drive optimal transaction execution. Scarcity can be created by limiting the size of the transaction or segmenting investors through different maturities. A company can drive competitive tension by pursuing alternate corporate structures, a range of capital structure profiles, or diverse combinations of debt and equity instruments. The key is to limit the size of the offering in any one instrument to avoid creating an overabundance, which is just the opposite of scarcity.

The scarcity principle works on every transaction and for every company from the smallest to the largest. One of our major blue-chip clients raises billions of dollars every year. With so much capital required, the market is rarely surprised by the company’s capital markets activities, and limiting the size of its offerings is nearly impossible. However, the company successfully commands premier capital availability, terms, and pricing by using many of the tools to drive scarcity.

The company continuously monitors multiple markets, perpetually evaluates its bank and investor capital providers, and regularly welcomes new ideas for opportunistic and alternative market financings. For example, it has found that by financing some needs in a private offering, it can relieve some of the overhanging pressure created by expectations that the firm will raise money in more traditional markets.

The old adage holds true that “the best time to raise money is before you need it.” But when you do need the money, Tom Sawyer will tell you that a little scarcity will help convince just about anyone to paint your fence and, in this case, achieve more favorable financing.

Reuben Daniels and Craig Orchant are founders of EA Markets, an independent corporate finance and capital markets advisory firm based in New York.