Specialty Capital
This is the gold standard. There are a few sources of capital that have
almost no economic cost and can take the limits off of growth. They include
things such as a negative cash conversion cycle (vendor financing), insurance
float, etc.
Negative Cash Conversion (Vendor Financing)
Imagine you own a retail store. To expand your business, you need $1
million in capital to open a new location. Most of this is the result of
needing to go out, buy your inventory, and stock your shelves with merchandise.
You wait and hope that one day customers come in and pay you. In the meantime,
you have capital (either debt or equity capital) tied up in the business in the
form of inventory.
Now, imagine if you could get your customers to pay you before you had to
pay for your merchandise. This would allow you to carry far more merchandise
than your capitalization structure would otherwise allow.
AutoZone
is a great example; it has convinced its vendors to put their products on its
shelves and retain ownership until the moment that a customer walks up to the
front of one of AutoZone’s stores and pays for the goods. At that precise
second, the vendor sells it to AutoZone which in turn sells it to the customer.
This allows them to expand far more rapidly and return more money to the owners
of the business in the form of share repurchases (cash dividends would also be
an option) because they don’t have to tie up hundreds of millions of dollars in
inventory.
In the meantime, the increased cash in the business as a result of more
favorable vendor terms and / or getting your customers to pay you sooner allows
you to generate more income than your equity or debt alone would permit.
Typically, vendor financing can be measured in part by looking at the
percentage of inventories to accounts payable (the higher the percentage, the
better), and analyzing the cash conversion cycle; the more days “negative”, the
better.
Dell Computer was famous for its nearly two or three week
negative cash conversion cycle which
Float
As Buffett describes it, float is money that a company holds but does not
own. It has all of the benefits of debt but none of the drawbacks; the most
important consideration is the cost of
capital – that is, how much money it costs the owners of a business to
generate float.
In exceptional cases, the cost can
actually be negative; that is, you are paid to invest other people’s money plus
you get to keep the income from the investments. Other businesses can develop
forms of float but it can be very difficult.
Insurance companies are a good example that collect money and can
generate income by investing the funds before paying it them out in the future
in the form of policyholder payouts when a car is damaged.
Sweat Equity
There is also a form of capital known as sweat equity which is when an
owner bootstraps operations by putting in long hours at a low rate of pay per
hour making up for the lack of capital necessary to hire sufficient employees
to do the job well and let them work an ordinarily forty hour workweek.
Although it is largely intangible and does not count as financial capital,
it can be estimated as the cost of payroll saved as a result of excess hours
worked by the owners.
The hope is that the business will grow fast enough to compensate the owner
for the low-pay, long-hour sweat equity infused into the enterprise.
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