Portfolio Churn — Enemy of Investment Returns

Churn destroys investment return.  Strangely, traditional private equity builds itself to churn.  Churn reduces investment returns for several reasons such as transaction costs, business disruption, and the difference in tax rates between ordinary income and capital gains.compound interest einstein  This last difference is the easiest to quantify as did Charlie Munger of Berkshire Hathaway in a talk to the University of Southern California Marshall School of Business on April 14, 1994.  Whenever possible, a buy and hold strategy has many advantages, including the built-in tax advantage of capital gains.

Munger demonstrates how the difference between ordinary income and capital gains income creates several percentage points of advantage each year, which creates large differences in value over time.  The chart below provides a basic example of how one can make over 2.5 times more by compounding at capital gains rates rather than ordinary income rates.

Charlie Munger on Compound Interest, Tax Rates, and Investment Returns

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes.  If you’re going to buy something that compounds for thirty years at fifteen percent per annum and you pay one thirty-five percent tax at the very end, the way that works out is that after taxes, you keep 13.3 percent per annum.Tax Rates and Compound Interest

In contrast, if you bought the same investment but had to pay taxes every year of thirty-five percent out of the fifteen percent that you earned, then your return would be fifteen percent minus thirty-five percent of fifteen percent — or only 9.75 percent per year compounded.  So the difference there is over 3.5 percent.  And what 3.5 percent does to the numbers over long holding periods like thirty years is truly eye-opening.  If you sit on your ass for long, long stretches in great companies, you can get a huge edge from nothing but the way income taxes work.

Even with ten percent per annum investment, paying a thirty-five percent tax at the end gives you 8.3 percent after taxes as an annual compounded result after thirty years.  In contrast, if you pay the thirty-five percent each year instead of at the end, your annual result goes down to 6.5 percent.  So you add nearly two percent of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with low dividend payout ratios.

But in terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes.  I see terrible mistakes from people being overly motivated by tax considerations.

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The Mirage and False Hope of an “Exit Strategy”

At best, an exit strategy becomes overrated and a waste of breath.  At worst, an exit strategy becomes a destructive mirage of certainty and false hope.  exit strategy mirageI realize that it is conventional wisdom for every entrepreneur to specify their exit strategy.  I have even heard investors say that “I will not invest in anything that does not have an exit strategy.”  The problem becomes — every exit strategy is a fantasy.  It is a waste to spend time and energy on such a fantasy.

An exit strategy is simply a made-up prediction of how the world will work in the future and how the stars may be aligned perfectly for someone to make a multi-million dollar decision that works for your company.  It reminds me of trying to predict that your “marriage strategy” will be to meet the perfect spouse on a ski trip in five years at the Squaw Valley apres ski bar while performing karaoke.  No one has any business predicting that.

Build “Exit Options”

In my opinion, the only way to make sure you have exit options is to build the most profitable business that you can. Build a good business with its widest moat; build a business that is not dependent upon the kindness of strangers, that is not dependent on future equity or debt financing rounds, a business managed (by yourself or someone else) in a way that does not drive you bananas, and that you would be proud to own for the rest of your life.  The goal should not be an “exit strategy” but “exit options” that are available whenever you decide.

Such exit options are also a way to make sure that you are never forced to make decisions with bad timing or bad circumstances, and that time is working on your side.  There is no greater strategic advantage than having time on your side, and no greater strategic weakness than being forced to do something on someone else’s timeline.

Recently, an entrepreneur said to me that he never entered something that he did not know how to exit.  Fair enough.  However, no one knows how to exit everything we begin (even buying a house).  And, such an “always exiting” philosophy causes us to be overly cautious.  Thus, I recommend not to focus on that — it is just a waste of energy.  I recommend focusing your energy on the work that creates the best company today and tomorrow.  You have more control over that.  It is more productive. A good business will create plenty of exit options as time goes by so that there is an exit ramp when you wish it.

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Private Equity Trending Toward Longer Term Models Like Greybull Stewardship

Momentum is growing toward private equity structures with longer term time horizons and movement toward more “permanent capital” — structures that are more similar to Berkshire Hathaway and Greybull Stewardship (my private equity fund focused on companies with $1-3 million in profit).super return conference 2015

Blackstone private equity stretches the field

At last month’s SuperReturn conference in Berlin, Blackstone made headlines by pronouncing its interest in forming a “coalition” to invest outside its ten-year funds.  Blackstone’s Head of Private Equity, Joe Baratta, said, “I don’t know why Warren Buffett should be the only person who can have a 15-year, 14% sort of return horizon.”  He continued, “There are clearly assets” that benefit from such a structure, and “it opens up a whole universe of companies that we are not currently accessing.”

Baratta explained that Blackstone’s structure (like most of private equity) is best when transforming a company over a 3-6 year time frame.  “To do that you have to find a company that you can fundamentally transform,” he said.  “But there are a whole bunch of other companies in the world that would benefit from private governance rather than public governance, or a more active owner rather than a corporate owner, that have low volatility, and good competitive positions.”

Private equity long-term already inside Greybull

This is exactly why I formed Greybull Stewardship.  There is a universe of great companies that do not want to sell themselves to a competitor and risk losing their uniqueness or sell themselves to a private equity firm that needs to “transform” the business quickly in order to generate their return and sell the business.

As Fortune magazine explains, This structure “would give Blackstone more investment flexibility, as traditional private equity fund terms require portfolio copanies to sometimes be sold before the firm otherwise would like to exit.  Remember, no one tells Buffett he needs to sell a company because of market-standard fund terms.”

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A Business Strategy to Capture More Value

The best entrepreneurs and business owners know that capturing value, not just creating value, is critical to success. The phrase “capturing value” is not meant to convey a zero-sum concept of one person capturing what another person loses. It is a way of saying that just creating value is not enough.

Peter Thiel explains this when he says, “If you have a valuable company, two things are true.  Number one, it creates ‘X’ dollars of value for the world.  Number two, it captures ‘Y’ percent of ‘X’.  The critical thing that I think people always miss is that ‘X’ and ‘Y’ are completely independent variables.  So, ‘X’ can be very big and ‘Y’ can be very small.  To create a valuable company, you have to both create something of value and capture some fraction of the value of what you have created.”

An example that comes to mind for me is TiVo.  TiVo revolutionized the watching of television and has created huge value for many people, but it essentially did not figure out a way to capture that new value for itself.

Business Strategy Should Focus on Value Capture

Source: Stefan Michel

Source: Stefan Michel

The concept of capturing value should be present in every strategy discussion and decision. To help with this, I came across a recent article in the Harvard Business Review that places a framework to help the discussion. It was written by professor Stefan Michel of IMD in Lausanne, Switzerland and can be found here.  This chart has some of his ideas and methods for capturing more value.

In his article, Michel identifies 15 ways to capture value in five clusters:
  1. Changing the price-setting mechanism.  Some people are used to the idea of setting price based more on the value received by the customer rather than the cost of the product or service.  Michel goes beyond that to identify other concepts such as (a) auctioning, (b) demand-driven pricing, and (c) name your own price that are worth considering in a value capture brainstorming session.
  2. Changing the payer.  Michel explains that this often comes up in two-sided markets, or in a market where multiple parties could benefit from a service or product which can create opportunities for multiple revenue streams.
  3. Changing the price carrier.  The price carrier is “the part of the experience you hang the price tag on.”  In today’s world, subscription services for snacks, make-up, men’s razor blades, and more are creating dramatic change.  I have seen the power of the subscription model in Massage Envy that charges a monthly membership fee for massage therapy rather than only a per massage model.  Michel expands this idea to bundling, unbundling, and all-inclusive offerings.
  4. Changing the timing.  Everyone knows the “razor-and-blades” model of business, and Michel explains how this is a way to capture more value by capturing the value from later in the series of transactions.
  5. Changing the segment.  This idea is adding a new customer base to a business.  As Michel writes, it starts with “identifying customers who are unwilling or unable to pay current prices but display a need for a given offering, So, then the business must determine how to create a profitable offering for them.”

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2014 Berkshire Hathaway Annual Letter – Buffett and Munger Observations From 50 Years

Saturday, Feb. 28, 2015, Berkshire Hathaway posted their 2014 Berkshire Hathaway annual letter2014 Berkshire Hathaway Annual Letter - Shareholder LetterAs this is the 50th anniversary of Warren Buffett taking control of Berkshire, this letter included two extra sections. Both Buffett and Vice Chairman Charlie Munger wrote about their observations about the first fifty years of Berkshire Hathaway and what each expects in the next fifty years.

I have come to think of the Berkshire Hathaway strategy as an “open source” strategy — they provide an open book about their strategy and are willing to share it with anyone who will listen. It remains a mystery why more people do not attempt the strategy because it is there for anyone to use: it does not require particular intelligence, and is not particularly difficult to accomplish pieces of the puzzle. The probable answer is that it is unconventional (better to fail conventionally than succeed unconventionally?), and it takes time to get the various components put together properly. Thus, the results do not appear quickly and it is difficult to have the patience for the strategy, even though compounding means the results compound immensely later on.

Nonetheless, I am happy to say that I am on track building a strategy based on the “open source” components of Berkshire Hathaway at my investment fund, Greybull Stewardship. I am forever grateful to Berkshire for being such an open book, and I am doing my best to use the source code wisely. Here are some of the observations from Buffett and Munger about what made and makes their strategy work.

2014 Berkshire Hathaway Annual Letter

Observations From Buffett on Reasons for the Success of Berkshire Hathaway:

 

  1. Efficient allocation of capital among portfolio companies.  This is the first thing that he writes showing why the Berkshire structure and strategy are so attractive. Buffett writes, “we can — without incurring taxes or much in the way of other costs — move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise.” This sounds simple, but most other investment structures cannot do this or it is very difficult. Traditional private equity funds cannot usually do this. Deal-by-deal investment strategies cannot do this. Buffett even writes of the difficulty that tax-exempt investors such as pension funds have in accomplishing this.
    • At my Greybull Stewardship, we also have this advantage. We use flow-through tax structures and are commonly harvesting capital from some businesses, investing deeply in other businesses, and moving capital efficiently to the best opportunities.
  2. Wide ranges of Opportunities. Berkshire also has the ability to invest in a wide variety of things. This provides a proper “opportunity cost” perspective about what is the best allocation of capital at any point in time.
    • At Greybull Stewardship, we have a little of this. We use an “opportunity cost” way of thinking more than most because we have a broad range of choices to reinvest into our existing portfolio or buy new companies. However, we traditionally do not invest in public companies.
  3. Perfect home of choice for certain business owners. For owners who do not want to sell to a competitor nor sell to a private equity fund that will flip ownership of the company in a few short years, Berkshire is the perfect choice. As Buffett writes, “Some sellers don’t care about these matters. But, when sellers do, Berkshire does not have a lot of competition.” This factor is huge — many short-term fund investors greatly underestimate this.
    • At Greybull Stewardship, we also have this advantage. We use an evergreen fund structure that allows us to hold businesses as long as we want, and it provides the management teams maximum flexibility to pursue strategies that make sense for their business. We strive to provide a perfect home for the life-long work of business owners and management teams.
Observations From Munger on Reasons for the Success of Berkshire Hathaway:
  1. Continuous maximization. Munger makes the point that Buffett has invested using this structure for 50 years, and was very good at focusing on a few things such as capital allocation and constantly learning in order to continually improve. At shareholder meetings, I have heard Munger refer to Buffett as “a learning machine.” He also makes the point that the portfolio companies also have this advantage because their CEO’s are in place for a long time and are free of many distractions because of Berkshire’s ownership.
  2. Gained loyalty by giving loyalty. Munger often describes Berkshire as having a “seamless web of trust” in the way they trust their portfolio companies.  Munger observes that Buffett constantly searches for win/win scenarios and gains loyalty by giving it.
    • At Greybull Stewardship, we also have this advantage. We are pursuing the effective decentralization strategy as described so well in the book The Outsiders by Will Thorndike. Berkshire Hathaway is a great example of this strategy.
  3. Avoiding bureaucracy. Both Buffett and Munger  mention how staying lean at the corporate level was key to the strategy. They did not impose work on the portfolio companies by having departments and bureaucracies at the corporate level.
    • At Greybull Stewardship, we also have this advantage. We have chosen our partners to be the management teams at the portfolio companies. We give them tremendous decision-making responsibility and they are doing a marvelous job.
  4. Tax Advantage of Long Term Holds. Although he does not mention it in this letter, Munger has frequently spoken about the small “one or two point per annum” tax advantage that accrues by holding investments for the very long term.
    • At Greybull Stewardship, we also have this advantage. We have the flexibility to hold investments and let the value compound. I plan to write a bit more about this advantage on financial returns in a later post.

In the end, the list was pretty simple, which is also makes it so interesting. There is no rocket science to it. That does not mean it is easy, but the strategy is available to those who can be learning machines.

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Super Investor, Seth Klarman, on Lessons Learned from Buffett

Seth Klarman has a legendary hedge fund that you may not know, the Baupost Group.  His returns in that fund have been Buffett-like.

Seth Klarman of the Baupost Group

Seth Klarman of the Baupost Group

He is a value investor . . . truly, not just someone who likes to say that word.  His insights are treasured, and the only book he wrote sells on Amazon for $2,500 each.  I saw this article recently in the Financial times and it is worth republishing in its entirety — 12 great lessons that make you think.  Number 11 is particularly great for my investment fund, Greybull Stewardship, because that’s the point of my evergreen fund structure.  Here is the link to the original article at the Financial Times.

Klarman in Financial Times

By Seth Klarman:

As Warren Buffett was a student of Benjamin Graham, today we are all students of Warren Buffett.

He has become wealthy and famous from his investing. He is of great interest, however, not because of these things but in spite of them. He is, first and foremost, a teacher, a deep thinker who shares in his writings and speeches the depth, breadth, clarity, and evolution of his ideas.

He has provided generations of investors with a great gift. Many, including me, have had our horizons expanded, our assumptions challenged, and our decision-making improved through an understanding of the lessons of Warren Buffett.

1. Value investing works. Buy bargains.

2. Quality matters, in businesses and in people. Better quality businesses are more likely to grow and compound cash flow; low quality businesses often erode and even superior managers, who are difficult to identify, attract, and retain, may not be enough to save them. Always partner with highly capable managers whose interests are aligned with yours.

3. There is no need to overly diversify. Invest like you have a single, lifetime “punch card” with only 20 punches, so make each one count. Look broadly for opportunity, which can be found globally and in unexpected industries and structures.

4. Consistency and patience are crucial. Most investors are their own worst enemies. Endurance enables compounding.

5. Risk is not the same as volatility; risk results from overpaying or overestimating a company’s prospects. Prices fluctuate more than value; price volatility can drive opportunity. Sacrifice some upside as necessary to protect on the downside.

6. Unprecedented events occur with some regularity, so be prepared.

7. You can make some investment mistakes and still thrive.

8. Holding cash in the absence of opportunity makes sense.

9. Favour substance over form. It doesn’t matter if an investment is public or private, fractional or full ownership, or in debt, preferred shares, or common equity.

10. Candour is essential. It’s important to acknowledge mistakes, act decisively, and learn from them. Good writing clarifies your own thinking and that of your fellow shareholders.

11. To the extent possible, find and retain like-minded shareholders (and for investment managers, investors) to liberate yourself from short-term performance pressures.

12. Do what you love, and you’ll never work a day in your life.

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Simple Strategy Lessons: Better before cheaper. Revenue before costs.

Sometimes the best ideas and best advice are the most simple. Strategy Rule of ThumbWhen I read the following article a while back, I loved it. And believed it. And continue to believe it. Michael Raynor and Mumtaz Ahmed from Deloitte Consulting performed a study that began with 25,000 companies to find outstanding companies that truly perform.  A longer piece they wrote for the Harvard Business Review can be found here and it goes beyond their simple “truisms.” Their book is The Three Rules: How Exceptional Companies Think.”

Here are there three rules, simplified:

  1. Better before cheaper.  In other words, compete on differentiators other than price.  Some companies create a successful strategy on price (Walmart, Costco, GEICO, etc.) but I agree that it is more likely that one will be able to create a competitive advantage on things other than price. With price and efficiency, it is too easy for competitors to observe what you are doing and eventually copy your product or service. With other elements of differentiation, it is easier to find areas where your competition could not compete even if they wanted to because of something inherent in their product, their customer base, their investor base, their sales channel, or from many other factors.
  2. Revenue before costs.  That is, prioritize increasing revenue over reducing costs.  It is difficult to be world-class at reducing costs more than the next guy.  It is just too easy for others to copy (usually) and reducing costs as a core competency is not really a competitive advantage. Being frugal and cost-conscious is a part of many successful companies, but it is not their core strategy. Plus, reducing costs is difficult and no fun. It creates a different vibe. Some people can be excellent at this strategy, such as 3G Capital or certain other private equity funds, but I agree that it is not a primary path to greatness.
  3. There are no other rules, so change anything you must to follow Rules 1 and 2.

Foundational concepts

As the authors write, “The rules don’t dictate specific behaviors; nor are they even general strategies. They’re foundational concepts on which companies have built greatness over many years. How did these organizations’ leaders come to adopt them? We have no idea—nor do we know whether the executives even followed them consciously. Nevertheless, the rules can be used to help today’s and tomorrow’s leaders increase the chances that their companies, too, will deliver decades of exceptional performance.”

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Disparate Data Points: Entrepreneurship Exploding or Dying?

An explosion of young companies that are bootstrapped, or financed outside of traditional venture capital (i.e., Silicon Valley) or traditional bank financing, is what I see every day.  I see many companies finding their way to a point of lift-off, stability, and medium-sized revenue and profit without ever raising traditional financing.bootstrap financing and entrepreneurship  These companies are therefore more independent and able to plot their future with more flexibility.  Having gotten to this place, they treasure flexibility to pursue business strategies of their own choosing.  By all means, they should strive to maintain that flexibility and I hope my investment fund, Greybull Stewardship, is a vehicle for them to do that.

Trends of entrepreneurship now

Data below suggest that entrepreneurship and dynamism are declining in America.  I do not see that.  Some of the current trends that I believe are supporting the idea that there are more companies reaching lift-off without conventional financing are:

  • Entrepreneurship education and role models are available.  More education and training of entrepreneurs exist in the world today as more schools offer entrepreneurship courses. Also, more books, conferences, and advisers are available to aspiring entrepreneurs.
  • Growth of angel investing.  The growth of Angel List and of many angel investing communities around the United States demonstrates how this has become a common financing tool for young firms.  There are many more books and other forms of education for angel investors that are helping standardize how this is done.  I see quality companies everyday that have had some help from angel financing and have grown well beyond that stage.  Angels tend to be a bit more forgiving than professional investors, and that helps get companies off the ground.
  • Companies cost less to start.  From simple productivity tools to inexpensive servers, storage, and bandwidth, to the ability to build software overseas, to the ability to avoid office space and have a virtual company, many of the costs of creating companies seem to have declined.
  • Internet scale.  The Internet is enabling younger companies to reach larger markets enabling them to grow and to achieve some level of stability.
  • JOBS Act.  While it has not changed things dramatically yet, this legislation signals society’s interest in helping young companies get going and broaden the sources of financing available.
  • Peer to peer lending.  Lending Club, Prosper, and even On Deck, all seem to be creating more options for smaller or younger companies to find financing.
  • Enterpreneurship is part of popular culture.  Maybe because consumer Internet companies play such a large role in so many lives today, popular culture is influenced by the explosive growth and creative services developed by Internet companies.

Counter Point: Entrepreneurial Companies are Declining As a Percentage of the Whole

Firm Entry and Exit RatesAt the same time, there is data to suggest the dynamism of the American economy, including entrepreneurship, has been declining since the 1970’s.  In a study by Ian Hathaway of Ennsyte Economics and Robert Litan of the Brookings Institute, they explore the decline of “dynamism” in the US economy.  This chart shows that firms that are less than one year old are a declining percentage of the overall total, suggesting that the churn of business in America is declining.

This decline is difficult for me to reconcile with what I see every day.  I suppose it could be that the absolute number of young companies reaching lift-off point is increasing, while it is still a declining percentage of the whole.  It is also may be that the companies that survive are living longer and the overall base has gotten so large that there is an inevitable decline of start-ups compared to the whole.  Or, it may be that micro businesses like restaurants and dry cleaners are no longer being started as they once were (not sure this is a bad thing) as those businesses are historically very difficult.

Old Firms Living LongerAnother chart from this study shows the distribution of total firms by age.

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Three More Lessons from Warren Buffett and Berkshire Hathaway

Two recent items helped me draw lessons for how I want to manage my investment firm, Greybull Stewardship.  The first is Warren Buffet’s memo that he sent last month to the managers of the 80 businesses of Berkshire, and the other is in the book, Berkshire Beyond Buffett, by Lawrence Cunningham.  The lessons are not new, but they are so central to the success of Berkshire that they are worth thinking about again.  These are also ideas and strategies that we have implemented at Greybull Stewardship.Berkshire Beyond Buffett

The first observation is a reminder about how reputation is more important than money and profits, particularly given the decentralized manner in which Berkshire Hathaway operates.  Warren Buffett spent over half of his memo to his managers (five paragraphs) reminding his managers to stay well “in the center of the court.”  He continues, “If it’s questionable whether some action is close to the line, just assume it is outside and forget it.”  He also included again his quote that, “We can afford to lose money — even a lot of money.  But we can’t afford to lose reputation — even a shred of reputation.”

Culture of Mutually Deserved Trust

The second observation is about the autonomy that Buffett gives his managers.  Autonomy is one of the two primary themes of the Cunningham book.  Buffett writes in his memo to his managers to “talk to me about what is going on as little or as much as you wish.  The only items you need to clear with me are any changes in post-retirement benefits, acquisitions, and any unusually large capital expenditures.  But I like to read, so send along anything that you think I may find interesting.”  At Greybull Stewardship, the CEOs and management teams of our portfolio companies do an excellent job and you can see it in their excellent track record.  I enjoy discussing things with them, while I believe in letting them manage their businesses.  Many private equity investors over estimate their own ability to manage companies, and I work hard not to fall into that trap. As has been explored by Charlie Munger and others, there is something about a trusting culture that brings out the best in people.

Munger said this at the Berkshire annual meeting in 2011, “The greatest institutions . . . select very trustworthy people, and they trust them a lot.  There’s so much self-respect you get from [being] trusted and [being] worthy of the trust that the best compliance cultures are the ones which have this attitude of trust.  [Some corporate cultures] with the biggest compliance departments, like Wall Street, have the most scandals.  So it’s not so simple that you can make your behavior better automatically just by making the compliance department bigger.  This general culture of trust is what works.”

Fickle foster parents

And, the third lesson comes from the Berkshire Beyond Buffett book about the idea of permanence that Berkshire can offer to people who may want to sell their business to Buffett.  Some private equity investors may consider this not to be important — which suggests they do not appreciate the significance of this permanence.  Some other private equity investors understand the significance — yet they do not have a fund structure or an investor base that will allow them to pursue this strategy.  As Cunningham writes, “private equity firms are short term by design, as they create funds with ten-year lives (five to sow then five to reap). Iinvestors start looking for their payback in year six.”  Cunningham continues by writing that the permanence of Berkshire really helps its subsidiaries because “Management can concentrate without interference and invest in the brand, assuming a fifty-year time horizon rather than focusing on meeting the short-term needs of fickle foster parents.”

While not new, these are important and essential components of Berkshire Hathaway and what I am doing at Greybull Stewardship.  Cunningham’s book is a good overview of most of the subsidiaries of Berkshire.  That part may be tedious if you are already familiar with Berkshire.  Cunningham’s conclusion is that Berkshire’s culture and strategy are so strong that it will remain strong well after Buffett retires.  I tend to agree with that.  As I have written before, Buffett deserves more credit as a business strategist and how he arranges the culture of Berkshire than for investing acumen.  His strengths are putting himself and Berkshire in a place to be the perfect home for great businesses. Then saying yes to invest in great businesses is the easy part.

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Companies and Founders Deserve Better Financing Options

Business financing and capital raising are full of contradictions.  The world is awash in capital, but the availability of capital to businesses is often binary.  For some, too much capital is stalking them.  For others, the switch to turn on capital flow remains hidden.  Size can be a determining factor.  Debt providers, in particular, seem to believe that larger means safer, even if they are lending money at minuscule rates of return.  For small businesses, nothing is more fickle than bank financing.
Fickle Bank Financing

A financing carousel?

For equity capital, even if the capital flow is turned on for their company, founders face options that are limited.  There are the “strategic” providers of capital, otherwise known as competitors or semi or potential competitors who will inevitably attempt to shape the company strategy to suit their other interests.  Then there are the capital providers (traditional venture capital or private equity) that are all about exiting as soon as they enter.  The industry of traditional equity financing is set-up to trade-in and to trade-out of companies.  This constant carousel of investors is sub optimal for a company and its ability to earn outsize returns by building long-term competitive advantages. It is explained that this system developed because it is best for the investors.  It seems contradictory to me to require a company to be on a constant treadmill — turning over its equity investors — if the exact opposite is the optimal method for long-term value creation (in my opinion).  There must be a better way.

How Would You Like This Guy as Your Financing Partner?

A private equity fund manager had some unbelievable quotes in the Wall Street Journal last week in talking about his fund, Charterhouse Capital.  He spoke about how his priority was current profits with no regard for his successor colleagues (and by implication, his portfolio company management teams and stakeholders).  His focus is all about profit maximization for the here and now.
“The absolute intention is to maximise the value of [Charterhouse] to the people who are there today,” Gordon Bonnyman, then chief executive and now chairman, wrote in a 2001 letter made public.  “In other words, no one is particularly concerned with the financial well being of those who will succeed us.”  As the Wall Street Journal reporter interviewed him in his office, he emphasized his short-term orientation. “I enjoy it. It’s good at the time,” he said. “That’s it.”
There is nothing wrong with that strategy.  Company founders and owners just need to understand that guys like this exist in private equity.  If that is what you want, great.  If it is not what you want, be wise in picking a partner.  If a private equity guy treats his own firm and colleagues that way, how do you suppose he treats the management teams at his portfolio companies?  Not to mention, how do you suppose he treats the customers, employers, and other stakeholders of the portfolio companies?  There is a place for this type of strategy in the world, but founders and management teams deserve an option to choose this financing strategy — or something else.

Greybull Stewardship is An Alternative Financing Option, But Not for Everyone

I set-out to solve this problem for founders and management teams with my investment firm, Greybull Stewardship.  I selected the word Stewardship to convey that we are in this to be good stewards of capital and to be good stewards for the companies that trust us to be partners with them.  Greybull is not the optimal choice for someone who wants to treat their company as a short-term trading opportunity.  There are many other capital options that are better than us at that strategy.  Greybull is a better choice for management teams who want flexibility of if/when to sell their company, how to grow their company, and the ability to pursue unique strategies that create long-term competitive advantages.