My evolution as an entrepreneur and investor has been marked by two distinct phases. I may be entering into a third phase. Phase 1 began at age 19, when I got my first true line of credit. My father co-signed my first note, set me up with a sweetheart deal that was almost guaranteed to make a small profit. I was in business for real. Prior to this act of generosity, I had been entrepreneurial, hustling to scratch out a small profit on this or that project from age 13, but nothing of any serious substance. This bank loan was real. And, so began phase 1.
I compounded my equity very fast thanks to this leverage. I was hooked. This phase ran for 10 years. Get assets on my balance sheet to manage. Compound tangible book value. Lever up again. Repeat. All is going well. I began diversifying a bit… and snap. Around year 10 I incurred my first major financial setback. And, making matters worse, the size of the loss relative to my net worth was accelerated thanks to my leverage.
So began phase 2 –age 29. I trimmed, cut and rearranged things as best I could but it was not enough to make it back from the losses from the business that had lost it. I had to generate cash some other way. I had a profitable second business but this company was not as optimized for cash production as it could have been. I set about optimizing it –to the extreme. I further determined to generate goodwill after generating cash. I wanted to make my business transferrable. I had purchased two companies for very cheap and soon thereafter realized that they were cheap for a reason and if I didn’t change them they would be cheap (relative to earnings) when I went to sell them. I was determined to reshape them. And so, I wanted to generate cash and grow the valuation. Plus, I would do it without debt. I’d use my brain instead. Profit first, but not just profit, cash profit. I had to have cash to stave off the losses elsewhere within my world.
I liquidated the poor performing company, surged performance in the performing company, and wound up selling it earlier than I expected. I had accumulated far more than I (or my wife) would spend in our lives. I began volunteering a lot more with our church and associated non-profits, and goofing around on the lake. By age 36 I was bored and felt selfish not working. I should do something more with my talents. But what? I launched Little Engine Ventures, and brought in a handful of limited partners.
We invested across a diverse swath of assets types, focusing on control companies that I could understand. My primary concern was driving intrinsic business value for my partners. I didn’t care where it came from, just that it had good probabilities of working out within a 3-5 year time frame. We invested in control companies, startups and marketable securities, going wherever the deals were. The partners have been great. I’ve been extended a long leash. If you’re reading, thank you. Wow.
Returns for the initial partners have been exceptional. We acquired control of 12 companies, invested in 6 startups and maintained a portfolio of 10-20 marketable securities (bulk concentrated in top 5 ideas.) We had (and still have) almost no debt. We’ve tried to use our brains.
In fact, I think we’ve tried to do things that were really smart and –maybe as a result– were occasionally foolish. Somewhere around year 3, after control acquisition #12, I realized that I was not free from involvement post-acquisition. Our companies were simply too small, and my thesis usually had some form of “grow intrinsic business value” written into it. This is not enough guidance for a General Manager. I did a little more than this, but not much more.
I’ll skip over the work done on Playbooks (worthy of another blog post) and get to the point of this note. We must generate profits in the form of cash. Something above 85% of our assets must be producing meaningful cash on cash returns, available for centralized allocation, in a reasonable time frame. The real magic of my second phase is that I was committed to generating huge cash on revenue, and huge cash on tangible assets. And I was confident that I could and would invest this cash into exceptional projects with absurd returns that were available to no one else on the planet. If I could make 50% ROA, in the form of cash, and then invest a portion of that cash into 100x situations, and then rinse and recycle the back into more >50% ROA situations, the results would compound in faster and faster time increments. The results could be astounding, and attractive to myself and outsiders. The real magic is actually stupid simple. Generate cash. Invest it where the returns are exciting. Brace for some failures. Don’t over think it.
In phase 3, we are prioritizing cash generation. And not just cash in 5 years after the sale of a company. We don’t want to be forced to sell companies to generate cash. We have cash and we want cash dividends from cash generative control companies. Otherwise, we have to consider liquidating them. And before adding new ones, we can stay in our marketable securities ideas, that produce cash, can be turned to cash, and can be traded to cash for an all-cash control situation that we understand, like and will produce cash promptly. I am also going to hold cash so I can pounce when the market takes another nose dive. The math works. Cash is king.
If cash is king, then intrinsic business value growth is the king’s special forces. The normal forces are rent collected on tangible assets. And if we’re going illiquid to acquire permanent assets, we demand >50% returns on tangible assets, in the form of annual cash dividends to the Fund. So enters phase 3.