Moroccan Trade Routes and Lines of Credit

So your saying you never had a revolving line of credit before for disbursements?

you're

I'm not sure what would give you that impression. I've even detailed in diagram form how we structure our CCDA, which involves a specifically tailored line of credit that allows me to write checks against the account even if there is no money in there.

Generally speaking, though, I've never found lines of credit, or debt in general, to be necessary. Early in my career, I took Warren Buffett's admonishment to heart that, "you don't need to go into debt to get rich, especially if you're smart." He was my childhood hero and I figured he wouldn't say something like that if he didn't mean it. As a young college student, I treated those as words from on high; every bit as precious as Moses being handed the tablets.

My approach was to start companies with negative cash conversion cycles, high operating margins, funded entirely with equity and mostly automated so as not to require employees. It's remarkable how quickly you can grow with that combination and never have to use anyone else's capital or sell ownership. We made sure the structure was right because I spent six to twelve months reverse engineering the entire business model before we ever sold our first product. I became so efficient at managing the cash flow at one point during our startup years that there was a point at which I could collect payment from the customers four months before I had to pay the final bill, all without incurring any interest charges and still getting an early pay discount.

If I ever did need money, which was rare, and I didn't want to sell something I owned, I had one of three options:

1. Write a check against the stocks, bonds, and other assets I'd been building up my entire life, creating an instant margin loan secured by my holdings. If I wanted, say, to buy a car, I might write a check for it and then take care of the details later. It would get cashed by my custody agent and show up as a negative balance in my register. Any new dividends, interest, deposits, etc., coming in would be applied against the balance, reducing it. Given my conservatism, I'd never do this for more than 5% of the portfolio value and, even then, more than a few weeks. I believe strongly in being able to survive a Great Depression and a decline of stock values of 50% or more near instantaneously. Of all debt types, I think of margin debt as the most poisonous. Use it sparingly and only for short-term convenience when you have the funds to wipe it out available within reach.

2. I have an unlimited charge card that gives me a certain percentage rebate in cash and costs 0% if paid in full within 20-30 days.

3. There's always money being deposited somewhere, be it dividends on the stocks, sales from our retail businesses, royalty checks from 12+ years of writing, licensing income on some intellectual property I own, etc. If I ever need money, the general course of action is to wait a few days and it shows up. If it's a business day, I'm getting a deposit somewhere.

When I talk about managing things conservatively, using debt sparingly, and collecting assets that gush surplus cash (not consume it), I'm not being figurative. I mean it quite literally. Very few things require me to lay out money unless I'm buying something new or expanding. I hate businesses that have a lot of reinvestment needs or are capital intensive and those represent a majority of companies. Debt is not my style. I'd use it if I were developing real estate or something, but that's not on my agenda at the moment (I imagine it will be someday - Aaron has an interest in it.)

Personally, I only carry a fixed-rate mortgage of 3.75% on my home and student loans locked in at 3.0%. After adjusting for inflation, some tax credits (e.g., the home mortgage portion can be deducted, which is significant for my bracket), the net cost is negative so I'd rather have the funds in long-term assets that are compounding at 3x or 4x the rate. Even that drives me nuts. At least once or twice a month, I think about paying off everything even though it would cost me millions of dollars in lost future compounding and under even the most extreme scenario could not possible cause me any hardship. I loathe debt. I despise it.

This is the oddest blog ever. Fun and fluffy posts, hard-core substantive comments! I guess this ensures that only the most dedicated readers find the good stuff like the above!

If you want to start some complicated computer science venture involving automation feel free to message me. I've considered business models like this but haven't made any yet (except for investing). This is probably mostly out of laziness, because I already have a nice job that pays me to do research.

Debt is weird, and especially so in tech startups, because the equity acts like some highly risky source of debt -- try to raise equity, spend down the equity, try to survive long enough that the lack of additional equity doesn't kill the startup, try to IPO with a low cost of capital. It's like all the investing is backwards. Which sort of makes sense because the VCs are marketing to clients who are momentum investors. But it doesn't make fundamental sense because it's economically irrational.

Somehow I have a lot more respect for tech entrepreneurs who are actually able to build positive cash flows, rather than playing double-or-nothing bets for 20 times and getting lucky. Probably I am in a minority. I guess if outside investors are handing you cash to scale up some business model, it's just human nature to say, "Sure I'll take that cash. Double or nothing!"

Like most of the good blogs I follow, much of the really great stuff is in the comments. This is the interaction in good teaching/learning.

Amen

It is my belief that businessmen who use leverage to reach top rungs of society have a lot more guts than those that do not.

Why do you think it took less courage for Bill Gates to drop out of college, launch a software empire, and build his fortune debt-free during his tenure at the head of Microsoft than it did for Donald Trump to borrow enormous sums of money and build his real estate business?

Gates had no need for the cash. The business he created was so efficient that it served no purpose at all and they couldn't reinvest the profits quickly enough let alone any borrowed funds, which would have been redundant. In fact, he didn't want to sell ownership early on because they were so flush with funds, but he brought in a venture capitalist, anyway, just to have someone with experience on the board. The $30 million or so they raised in that early financing round has sat, untouched, in the corporate checking account since it was written decades ago because they've never needed the money.

What magical forces would have bestowed on him a bigger dick if he had suddenly signed some paperwork and used other people's savings in the form of an installment loan instead of internally generating the money?

Even if Gates did have less "guts" than his more leveraged contemporaries, let me ask a serious question: So what? I mean, really, who cares?

When you walk into Bergdorf, the prices are marked in dollars not "guts". When you go to build your dream home, the construction company isn't interested in how much risk you're capable of stomaching, they just want the check to clear. When you put your kids through college, the bursar doesn't want to hear that you were able to make it through years when you were juggling different banks against each other to expand a bit faster, only that your American Express says "Approved" when swiped for that semester's tuition.

This isn't the African Savannah 200,000 years ago where we're running around trying to get as close to lions as possible to demonstrate our reproductive fitness.

Excellent reply Joshua..

Maybe Guts is when without blowing up anyone's money a Bill Gates creates Billions of Dollars for its share holders and millions of opportunities globally for their employees as well as a huge philanthropy program for the deprived mankind...

Risk is good but it should always be "Calculated Risk" ..:)

This is nonsense. How does it take more guts to risk other people's money (and figure you can just declare bankruptcy and stiff them if things don't work out) than to risk your own equity?

And this is coming from a guy who once bet a quarter of my portfolio on a trade whose sole investment thesis was "moral hazard."

solid troll. 3/10

They have more appetite for risks, in the same way as people who do redneck stunts. They also have a low survival rate. I'll aim a little lower but know that I can't be destroyed by outside forces at a moment's notice.

Can you show examples of a business that has " negative cash conversion cycles, high operating margins, funded entirely with equity and mostly automated so as not to require employees."

Bill Gates used this strategy when he started Microsoft. He got paid upfront by IBM, went and bought an operating system from someone who had already done the work using the money he was paid, then pocketed the enormous difference. He never had to come up with hardly any money out of his own wallet as the business became self-funding.

Western Union is a good example. They take money upfront from customers and get to hold it for a few minutes, or a few days, until it is picked up elsewhere in the world. They don't even have to pay for their own locations in most cases as banks and grocery stores sign up for the service. Most of it is done by computers so revenue per employee is much higher than the typical business. The margins are above 20%, the returns on tangible capital infinite, and the growth unlimited. It minted a lot of money for a lot of years.

There's a question of whether or not technology will destroy it, however, so there is a danger present in the enterprise that wasn't there 20 years ago. That's how most high return businesses are; it's a sweet ride but will eventually end. It's entirely possible PayPal will make it obsolete as people no longer need to pick up physical currency at a given location but can, instead, transfer it instantly through their phones or Internet connection.

Historical Wal-Mart is a good example, too, with a slight modification in that they drove operating margins down in order to increase asset turns and drive returns on capital through the roof (you'd have to swap "high operating margins" for "high returns on capital" but the net effect is the same). On their website, you can get the annual reports going back to Sam Walton's days. Dive into the financial statements and look at what he was doing with vendor payables. He managed to sell inventory on the shelves before he paid for it so an enormous portion of the total capital at work in the business wasn't in the form of bank loans or shareholder equity. Once Sam had the initial inventory bought, he ran it so efficiently the customers were paying for the growth and the vendors were extending the capital. It played a huge role in his success and you see pictures of the data centers he was building so computers did the work rather than associates. At one point, they had the largest network database in the country besides the military and were crunching numbers in the 1980's that made NASA look simple. He launched a satellite if I remember right and used the figures to determine allocations. Walmart couldn't have happened like it did without the microprocessor.

There are plenty of others. McDonald's Corporation has an element of it on its parent company balance sheet in the franchise operations. The franchise businesses now entitle the company to royalty streams on the franchisee's capital with very minimal outlay. Returns on capital are much higher than they first appear if you glance at the balance sheet from the perspective of the owner of the franchise issuer. Coca-Cola is the same way. The core Coke business itself might be one of the best examples. It's hard to desegregate after the Coca Cola Enterprises bottling acquisition, but the core concentrate business requires almost no people, has profit margins that are astronomical - they make Microsoft look like a steel mill - and requires almost no funding. That's the interior engine hidden behind all of the numbers that explains how it's been able to increase owner wealth for 9%-11% decade after decade, generation after generation.

AutoZone did it 15 or so years ago and took the stock from $25 to almost $500 per share as they replicated Walton's system, getting the inventory on the shelves to where they hadn't paid for it until the customer bought the goods. It freed up so much money, and they used it to repurchase stock, they essentially took themselves partially private as each share represents exponentially more ownership than it did back in those days.

International import / export brokers are a fantastic variation on the same theme similar to Walmart (they swapped high operating margins for high returns on capital but the effect for owners is identical). Look at a company like C.H. Robinson Worldwide. The stockholders had to tie up very little of their money to produce each dollar of profit due to the business model. It's very economically sensitive but the profit is almost all surplus that can be sucked out of the business without harming the competitive position. The real payout ratio is actually higher than 100% of reported net earnings in some years.

Isn't Autozone a special case, it's highly leveaged, but uses that leveage to buy stock not fund day to day activites, so basically it amplifies any success or failure of it's core business.

Highly leveraged? A quick look at Google Finance shows a Market Cap of $18 billion and long-term debt of $4 billion. Admittedly, I'm not particularly familiar with the company, but unless there's a lot of off-balance sheet liabilities (or there's some hiccup with Google Finance, which is always possible), it certainly doesn't seem to be highly-levered.

Leverage is Debt/Equity which is negative (equity = -1.7B).
Market Cap is not a financial metric it's a valuation metric.

Negative equity isn't a good or bad. The balance sheet tells you if you are in a safe liquidating position (i.e. you are going to shut down the business and pay back the creditors and equity holders). But being in a safe liquidating position isn't the same as being in a safe operating position. In the case of Autozone, there is $1.7 billion of shareholders' deficit. So if Autozone went into bankruptcy, it would cost you $1.7 billion to liquidate.

However, if there is a low probability of forced liquidation, you don't care as much about the company's liquidation position. You will care much more about the strength of its operating position. For 2013, Autozone had $1.7 billion in stockholder's deficit, and generated around $1 billion in free cash flow. So it would take them less than 2 years to wipe out the deficit should that be necessary. I wouldn't feel terribly concerned with that situation provided that the operating business is still solid.

In essence, negative equity isn't an issue. Its only an issue if you think bankruptcy is a real possibility. Otherwise, you want to see if this position makes sense from an operating perspective. Negative equity is tolerable in a business like Autozone because unlike hotels, railroads, or other capital-intensive businesses, the return is so high that creditors are willing to lend to it based on the merits of the operating business alone and not on the merits of its physical assets.

(Another way you can look at it is that Autozone has a lot of intangible economic goodwill that is not shown on the books. So you are borrowing against the value of the business and not against any physical assets it possesses.)

If I had a lemonade stand with -$1000 in equity, making $500/year (basically autozones situation) I be in big trouble if I had a cold summer. It's a risk issue as compared to someone with a lemonade stand with $1000 in equity.

You certainly have to look at the downside risks. Your above scenario is the reason why I said that you care more about the operating position of the company rather than the liquidating position.

Negative equity is an indicator that you have to look deeper, but it is not necessarily an indication of excessive risk. What you are essentially asking in the above is, can you survive a downturn intact (without diluting your equity)? The answer to that question doesn't come from just looking at the balance sheet. It comes from looking at whether you can generate enough cash through a worst-case scenario to cover your fixed cash payments (leases, debt service, salaries to a certain extent, etc.). If your business is strong enough to continue to meet these payments during a downturn, then you are in a pretty good operating position. Your creditors won't be worrying that you have negative equity if you are still making the regular debt service payments. Having positive equity (especially spare cash) just means that you have a buffer should your operating business not generate enough money to cover fixed payments in a downturn.

So the question really isn't "Does this company have negative equity?" The question you should be asking is "Does this company have a strong operating position? To what extent can they meet their fixed cash payments out of operations in the event of a downturn?" Bankruptcy/liquidation risk doesn't come from negative equity, it comes from the inability of the business to meet its fixed payments in a downturn.

Yea, I guess I need to look into some other negative equity stocks, this screener is pretty good.

http://www.finviz.com/screener.ashx?v=161&f=cap_large,fa_roe_u-50&ft=4

I had the same approach to debt when I had a lot less assets. Now I've gotten ahead enough that it gives me a lot more freedom (not total independence but I could operate for several years without regard for income) and in turn that flexibility has made me more comfortable using a low level of debt relative to my assets. Especially since there are so many opportunities now to borrow cheaply and earn a higher return. At some point in the future as my capital grows I may decide that debt doesn't give me anything I don't already have. It's best used when you have enough capital to create a margin of safety but not as much as you want.

I'm actually running into some limits on borrowing since I sold the house I owned and now take only a minimal income (I don't spend very much to begin with and this maximizes some good opportunities in the local taxes and benefits). To the bank I look worthless. Even a lot of my investments are in tax-sheltered accounts where they can't act as security.

But to counter that debt I do minimize my outside obligations very rigorously. For example by renting now instead of owning a house I have 100% less capital tied up, 50% less monthly expenses, and I can move somewhere else at a moment's notice with under $1,000 in costs. In my business (a service business) I expand using contractors first and only hire permanent employees based on consistent long-term demand. 50% of the business income is pre-paid now to create a negative cash conversion cycle, and for all new customers in our core market I insist on that. The rest of the customers are back-ups that I will phase out as the core market grows and only use when we have spare capacity that is unproductive anyways.

The upside is that at the same time that I'm struggling to get the bank to approve credit (I recently got turned down for keeping a line of credit - and in the 3 weeks following that meeting I will receive more cash than the total amount of credit!), I'm also trying to figure out what I'll do with all the surplus cash that will come in over the next year. I'm planning to invest a lot of it which will allow me to borrow in a margin account if there is a need or an opportunity.

Could you show an example of a business "with negative cash conversion cycles, high operating margins, funded entirely with equity and mostly automated so as not to require employees."

Never mind - thanks for the detailed response.

I find it easier to make "perfect" cities in Civilization IV where tile yields are richer and your choice of improvement matters much more. You can build a compact closely-spaced empire where every tile can be put to maximum use. You'd likely find a great coastal city to build a massive scientist center, and maybe another couple cities to spam towns and watch as the money flows in from your banks, grocers, markets etc. Tile improvements and city specialization sadly aren't as important in Civ5 as they are in the Civ4 and somehow it doesn't feel as rewarding to me. Cultural victories are more interesting in Civ5 though.

You mentioned in another recent post that you know how to play small focused empires well but not large ones. Wide empires probably wouldn't fit your style since they are really only good for domination victories (and if you like nice religion spread). Though I'm curious, what settings do you generally use in your games?

While I'm practicing, I've been all over on settings. It's gotten to the point I can almost win 85% of the time on standard map/default everything. If I'm practicing something specific, like increasing production, I'll put myself and an AI on a huge map with no one else so I can be left alone. If I want a casual game I enjoy, I'll put a legendary start+no barbarians. There is one mod I downloaded I like to use if I'm on one of the Windows systems. It introduces additional luxuries such as coffee, tea, perfume, etc.

At this exact moment, as I type this, I have a game as Siam on in the background with all standard settings and Immortal difficulty, just to get an idea of how hard it is. I'm 73 turns in and it isn't too overwhelming, yet, but I got very lucky and ended up on my own island with the city-state Zanzibar so I don't have to worry about protecting multiple borders at this point.

What are your preferences? It's always interesting to see how others approach the game.

I also like trying different settings. For peaceful games, I'm actually liking Archipelago or island maps and focusing on sea trade/culture/science. I'm also experimenting with a mod that increases the tech cost by 50% to slow down the pace of technology relative to production. It feels like except for your capital, buildings just take too long to build relative to your tech rate. In the default settings its difficult to actually build many of the buildings you unlock, as production comes online way too slowly to be meaningful for your newer non-capital cities. The lack of compelling production options is one of the weak points in the game design, in my opinion. Sadly this is a consequence of the one unit per tile rule since production has to be kept low to avoid "carpets of doom" (making armies impossible to maneuver properly).

As for difficulty, the one game I did try on immortal I got steamrolled by unit spamming Huns. Although higher levels may be more of a challenge, I feel that the AI advantages reduce the viability of certain strategies and limit your options. I'm playing a Zulu game on Emperor right now and trying for a wide/domination strategy. Working out pretty nicely due to the strong Zulu UU and low military maintenance costs. Due to the one-unit-per-tile rule though, military strategies are pretty tedious as it is very annoying trying to micromanage armies of 20+ units 1 unit, 1 tile at a time. I'm not sure if I'm a fan of that mechanic for this reason. Building up for imperialistic conquest should be exciting, not dread-inducing.

Legendary starts are nice, I'm actually starting to favor them simply because it gets the early game going faster. Early game can be very slow especially since it is very crucial and there are a lot of decent options for you to choose from and so much to build. Not too game-breaking given that everyone will have more resources, but it does let you grow faster sooner.

Civilization is a great series, but it is such a massive time sink. I've had entire weekends pass in the blink of an eye. I finally had to uninstall the game.

My entire night was ruined last night when the Ottomans blitzed early in the game and attacked my cities with no provocations. I had told myself I would only play for an hour, but after that, the gloves came off, I fended off the Ottomans and barbarians (with some close calls of a city or 2 almost captured), then went on the offense on a vengeance, pumping out catapults and horse units and descending my Mongolian horde on the Ottoman empire and crushing them to oblivion (with a couple backstabbing peace treaties that I used to surround all the cities).

Alas, 4 hours later, I had not gotten a single thing done that I wanted to last night. But it was worth the satisfaction of crushing the Ottomans for being dicks when all I wanted was to build a couple cities and advance my civilization peacefully... until the mid-game.

What Level do you play on? I'm trying L7 but continue to fail. L6 I can beat easily. It's so addictive!

I'm still twiddling around in L4 (Prince). It is such a great game, but I need to be careful with video games or I end up getting consumed by them, wanting to master them (it doesn't help that they are incredibly entertaining).

The last time I got completely sucked into months and months of endless hours of video gaming was when I decided that I was going to get good at Starcraft II. I had to stop once I reached gold status online because my right elbow was beginning to develop kinda severe tennis elbow. It was painful and I decided that I had gone too far down the rabbit hole and didn't want to risk permanent damage to my elbow. Ceasing all video gaming for 4 months fixed it up. The problem with Starcraft was way too much APM, which really puts tremendous stress on the elbow.

So I am going slowly with Civ this time around. I also bought KOTOR II as it just released on Mac but have hardly played it. Ugh I need to keep these at bay or I won't be *productive* in real life 🙂