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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Discover one of the surest means to create personal wealth by building a profitable business Every now and then, a business book comes along that offers original insights and a fresh perspective. In The Value Equation: A Business Guide to Creating Wealth for Entrepreneurs and Investors, veteran executive, entrepreneur, and investor Chris Volk delivers an engaging, straightforward explanation about how businesses work and provide wealth for entrepreneurs and investors. The author's signature approach is centered on his award-winning wealth creation formula in a book designed to simplify complex subjects with math no more complicated than what you learned in middle school. Readers will become acquainted with the characteristics of successful business models, together with insights into how leaders can improve their own models in ways that generate personal and collective wealth. The author's framework presented in The Value Equation is the foundation upon which most of the largest personal fortunes were built. Chris Volk also provides supplemental materials including interactive Excel spreadsheets, illustrations, and sample corporate financial models on a companion website. There is even a link to an award-winning video series created by Volk that served as his inspiration for the book. Full of illustrative case studies that highlight crucial business and finance concepts The Value Equation includes: * Explorations of the true value of using OPM (Other People's Money) and capital stack variations to build and grow your company. * Advice on business assembly, growth, mergers, acquisitions, and corporate reengineering, including discussions of valuation multiples, common risks, and capital options. * Guidance on how to valuate business models, delivered with help from a variety of stories and case studies. Uniquely, the author also draws on his own background, including the introduction of three successful companies to the public markets, two of which he was instrumental in founding. The Value Equation is an indispensable addition to the libraries of anyone interested in growing wealth and capital through business, whether as a business leader, entrepreneur or investor.
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Veröffentlichungsjahr: 2022
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Table of Contents
Cover
Title Page
Copyright
Dedication
Preface
Introduction
Chapter 1: Free Enterprise and Wealth Creation
In the Beginning Is the Idea
Unicorn Likelihood
Odds of Success
The Six Variables
Notes
Chapter 2: Daymond John and the First Variable
Accountants vs. Entrepreneurs
Variable #1: Business Investment
Note
Chapter 3: The Capital Stack and Two More Variables
The Right Side
Other People's Money (OPM)
Variables #2 and #3: Amount and Cost of OPM
Cost of Capital vs. Cost of Equity
Capital Stack Assembly
Equity Sourcing
Notes
Chapter 4: Three More Variables and Voilà!
Variable #4: Sales
Variable #5: Operating Profit Margin
Variable #6: Annual Maintenance Capital Expense
Putting the Six Variables Together
Gordon Growth Model
Equity Valuation
The Miracle of Compounding
Dissecting Investment Returns
Chapter 5: The Value Equation
EVA and EMVA
Making the V-Formula Even Simpler
Solving for Other V-Formula Variables
V-Formula Data Tables
Note
Chapter 6: Business Model Evaluation
STORE Capital
The FAANGs
Notes
Chapter 7: Pulling the Corporate Efficiency Levers
Operating Efficiency (O)
Asset Efficiency (A)
Capital Efficiency (C)
Six-Shot Economics
Note
Chapter 8: Choosing from Your OPM Options
Designing Your Own OPM
Leasing
Creating a Model to Evaluate OPM Options
Real Estate as an Investment
Note
Chapter 9: Opportunity Cost
Some Opportunity Cost Illustrations
Creating a Model to Evaluate Real Estate Lease Opportunity Costs
Chapter 10: The Final Form of OPM
OPM Equity
Sustainable Growth Rate
Taking on OPM Equity
Deciding How Much OPM Equity to Use
Creating a Five-Year Model
Sweetening the Deal
OPM Equity Flavors
OPM Equity Considerations
Note
Chapter 11: A Look at Public Companies
Determining Public Stock Equity Returns
Walmart
Note
Chapter 12: Animal Spirits
Elon Musk and Tesla
Stock Exchange Differences
Restaurant Case Studies
Lone Star Steakhouse & Saloon
Boston Chicken
Value Investing
Notes
Chapter 13: Mergers and Acquisitions
OPM Capital Options
Solving for Equity and Company Valuation
EBITDA Valuation Multiples
M&A Risks and Rewards
M&A Nightmares
GE and M&A-Driven Growth
Focusing on What Matters
Notes
Chapter 14: The Essential Ingredient
The Growing Restaurant Illustration
Designed Structural Change
Planned vs. Imposed Structural Change
Blockbuster Video
Designed Revolutionary Change
Reengineering the Corporation
Notes
Chapter 15: The Art of the Possible
The Circles of Business Life
Evolving Capital Choices
Value vs. Momentum Investing
Defining a Financial Win
Some Final Thoughts
Notes
Glossary of Terms
The Value Equation Framework
Acknowledgments
About the Author
Index
End User License Agreement
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Preface
Introduction
Begin Reading
Glossary of Terms
The Value Equation
Acknowledgments
About the Author
Index
End User License Agreement
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Additional Praise forThe Value Equation: A Business Guide to Wealth Creation for Entrepreneurs, Leaders & Investors
“We're living through a historic boom in entrepreneurship. People are starting businesses at record rates. Fortunately, Chris Volk has written us all a manual for success.”
Joshua Brown, CEO of Ritholtz Wealth Management, star of CNBC's The Halftime Report
“Few people can rival Chris Volk's nuanced understanding of markets and business or match his record of success and commitment to evidence-based research. The Value Equation is comprehensive and comprehensible. Every page is grounded in practice, deep reflection, and market-tested experience. Chris achieves a lot; he has integrated modern corporate finance with in-the-trenches practice, and he does so in ways that are creative and illuminating. Buy this book!”
Randall Zisler, Ph.D., Chairman at Zisler Capital Associates, LLC, presenting Outsourced Research
“As a serial entrepreneur, I found The Value Equation offers unique insight into the process of how businesses are both created and valued. Chris leverages his years of experience and success in building three of his own businesses to provide a clear and common-sense approach to how wealth is generated. This is a must-read for every business leader.”
Kevin Shields, Chairman and CEO, Griffin Capital Company, LLC
“Chris Volk's book, The Value Equation, demystifies how wealth creation occurs in the marketplace for investors. Chapter-by-chapter he explains the intricacies of identifying and capitalizing on opportunities to build wealth. I must say my favorite chapter is the V-Formula; it is rare to see such a detailed modeling breakdown of the elements you need to consider as you create equity, borrow money, and disperse equity to would-be investors. This book is a must read.”
Alex M. Susskind, Ph.D., Associate Dean of Academic Affairs and Professor, Cornell Nolan School of Hotel Administration, SC Johnson College of Business, CORNELL UNIVERSITY
“I recommend The Value Equation for all investors, as the author, Chris Volk, provides readers with all of the ingredients for a successful and profitable business. His expertise in credit and financial underwriting is a key differentiator that makes this author outstanding in his field. As a shareholder in STORE Capital, I have followed Volk's journey for over a decade, and I can't wait to see what's in ‘store’ for him now. I have a feeling it will have something to do with creating wealth via ‘the value equation’. Well done Mr. Volk!
Brad Thomas, CEO of Wide Moat Research
The Value Equation
The Value Equation A Business Guide to Wealth Creation for Entrepreneurs, Leaders & Investors
byChristopher H. Volk
Copyright © 2022 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Names: Volk, Christopher H., author.
Title: The value equation : a business guide to wealth creation for entrepreneurs, leaders & investors / Christopher H. Volk.
Description: Hoboken, NJ : Wiley, [2022] | Includes index.
Identifiers: LCCN 2022002736 (print) | LCCN 2022002737 (ebook) | ISBN 9781119875642 (cloth) | ISBN 9781119875666 (adobe pdf) | ISBN 9781119875659 (epub)
Subjects: LCSH: Corporations—Valuation. | Business planning. | Wealth.
Classification: LCC HG4028.V3 V64 2022 (print) | LCC HG4028.V3 (ebook) | DDC 658.15—dc23/eng/20220301
LC record available at https://lccn.loc.gov/2022002736
LC ebook record available at https://lccn.loc.gov/2022002737
Cover Design and Image: © Classic Sky LLC
For my wife,
the love of my life,
who makes so much possible.
Preface
I did not initially set out to be an entrepreneur. I graduated from college in the middle of a major economic recession with a mediocre grade point average, having avoided taking a single business class. It was then that something fortunate happened to me that would guide my future choices: My applications for employment were declined by more than 300 companies.
Getting rejected by so many businesses was an accomplishment in 1979. Each letter I sent went by regular mail and was hand typed. So were the replies. For years, I kept the rejection letters as a reminder of the privilege of employment. Those letters also provided me with added motivation to succeed. With my mounting rejections, I would likely have taken any reasonable offer of employment at just about any location. Fortunately, the rejections deprived me of that opportunity and gave me time to think.
I committed to a course of action, narrowing my focus. I decided to convince a commercial bank to hire me. The idea was to maintain my career options while finding a job that would give me valuable knowledge about business and finance. I also attended night school, eventually earning an MBA. My brief banking career led me to finance and eventually to the opportunity to take three companies public on the New York Stock Exchange, two of which I co-founded. All the while, I have been a student and observer of business.
This book has been years in the making. It began with many published articles written throughout my career that eventually provided the material for an award-winning video series on business. In turn, the video series was inspired by an educational program called Schoolhouse Rock! When I was in high school, it was brilliantly conceived to make many complex subjects simple. I wanted to do something like that for business, using math you learned in middle school.
This book ultimately emerged from that effort.
Corporate business models cannot be conceived or evaluated without math. Over my career, I have found that most businesspeople are taught to look at absolute numbers. The approach within this book is intended to be broadly accessible and is centered instead on universal relative numeric relationships, beginning with investor rates of return. In taking this approach, which I have used throughout my career, complex business models can be hugely simplified. For you, the result is that a wide range of business financial fundamentals can be addressed using a single integrated approach and then condensed into a few pages.
When you are done reading this book, you should have more than just a basic understanding of how businesses create wealth. You can expect to have a good idea how companies are assembled and valued. And you will also gain insight into how business leaders work to improve corporate business models in ways that generate personal and collective wealth. These fundamentals rest at the heart of the creation of most of the largest personal fortunes ever assembled.
Businesses lie in the middle of the great river of global commerce. They are the engine of our global economy and are ultimately responsible for our collective prosperity. I have spent a career in the middle of the river and am happy to be able to share my observations with you. This book contains many illustrations of businesses, including STORE Capital, the most recent publicly traded company I co-founded.
The business case study illustrations within the book generally stop at 2019. The reasoning should be intuitive. The global pandemic that began in early 2020 created major global disruptions that resulted in near-term business performance and business model distortions. Given the timeless nature of the concepts in this book, this does not matter.
I have been fortunate to work in a time characterized by a high level of business formation and creativity, which has helped me and many others start large businesses from scratch. To my knowledge, business formation has never been more accessible. It is my hope that this book serves to inspire readers to harness the wealth creation potential of business as they contribute to, create, and run businesses that benefit us all.
Christopher Volk
Paradise Valley, Arizona
March 18, 2022
Introduction
There are many ways to get rich. Strategies for personal wealth creation often center on personal habits that encourage controlled spending, the avoidance of debt, and the accumulation of investment assets designed to make your money work for you. But there is far less written about how businesses create wealth. I went through two years of graduate business school and emerged without taking a single class on the subject. Nor have I noticed any significant change in the understanding of business students in the intervening years since.
Corporate wealth creation stands at the center of our national economic prosperity. Most of us work for businesses. And it turns out, the richest among us did more than simply control spending, avoid debt, and accumulate investment assets. The very wealthiest Americans either made their money by owning a business or by inheriting money from family members who did. The investment assets they accumulated were centered in their own business endeavors.
Any discussion of business is incomplete without a discussion of wealth creation. The two go hand in hand, like peanut butter and jelly. Most growing business enterprises need independent investor capital, and a prerequisite for attracting investors is the company's potential for wealth creation. If a business is unlikely to be worth more than it cost to create—either now or in the near future—it is equally unlikely to attract the independent investor capital it needs.
And therein is the definition of business wealth creation: Making a business worth more than it cost to create.
To make something become worth more than it cost to create involves being an active investor. Investing in public stocks or bonds can deliver returns that can make you rich over time, but those returns are generally part of the fabric of overall corporate costs of capital. Businesses are supposed to reward you for making an investment in their stocks or bonds. Every now and again, investments in public stocks are rewarded with outsized returns as some of the business wealth created by leadership is sprinkled onto shareholders. Every now and again, investments in public stocks will be rewarded with outsized returns as investors pan for gold, seeking undervalued companies having solid, but misunderstood, business models. But corporate wealth creation tends to fall disproportionately on the corporate founders and early investors who took the risk. They are the first to be rewarded for making the company worth more than the cost of its parts.
Businesses have many stakeholders, including their investors. Those many stakeholders include owners, employees, creditors, suppliers, and communities. Today, one can be overwhelmed by the flood of published books and articles that debate which stakeholders are owed the highest degree of loyalty. To analyze the relative importance of stakeholder constituencies is easiest with established businesses, especially if they have grown to be large and powerful. But no large business I can think of got to be that way without first having created massive amounts of wealth for its founding owners. Without the strong potential for wealth creation, such companies would never have existed.
People who put their money into a start-up business typically have other investment choices. Those choices generally come with investment return expectations. In turn, such expectations effectively create a hurdle rate to attract investor capital to a new business. If you can meet or exceed that hurdle rate, then you have a chance to accomplish more than simply earning and saving money. You can create wealth from thin air by making your business worth more than it cost to put in place.
Here is a simple illustration: Since it was first created in 1926, investors in the S&P 500 stock index have earned, on average, 10% annually. That might make 10% the institutional investor benchmark hurdle rate, though I would note that I have generally seen more aggressive investor targets for newly minted companies. The hurdle rate, in this case 10%, is the starting point for wealth creation. Should your business produce a total investor rate of return of 10%, then your company will be simply worth what it cost to create. Raise that delivered return to 20% and your investment doubles in value. In business, it is the excess return, and not the appreciation of underlying business assets, which creates value from thin air. Likewise, a business can easily be worth less than what it cost to create. In this case, should your company's total rate of return be a mere 5%, then your investment value would stand to fall in half.
People commonly confuse investment returns with wealth creation. They are not the same. Think of it: A company could provide its shareholders with a meaty annual rate of return of 10%, yet still have created no value above what it cost to create. In turn, if you accumulate enough investable assets capable of delivering 10% annual rates of return over time, you can personally become rich. But keep in mind that without the potential to deliver annual returns greater than 10%, the company in our example would likely never have been able to attract sophisticated outside investor capital. The independent investors would likely have elected to invest their money elsewhere, possibly into the S&P 500 Index, which is backed by a portfolio of the nation's largest seasoned companies having far greater investment liquidity and far less execution risk.
Most established businesses realize rates of return that are not attractive for outside investors and yet still allow their owners to make a decent living and save some money. But wealth that is created out of thin air can only be achieved in business by producing annual rates of return above applicable return benchmarks. If you can achieve this, then you and your leadership team have realized an enormous accomplishment. If you can achieve this while also satisfying your many other stakeholders, then you can say you have attained a truly rare level of business success.
Shareholder wealth creation is the single most important corporate financial performance metric. It's not that hard to figure out. Just calculate what a company cost to create, then subtract what it owes to creditors, and you get a number equal to what owners have invested at cost. Now, compare that owner investment to its current valuation—this is obviously easiest with a public company—and you arrive at the amount of shareholder wealth creation. This number is called equity market value added, or EMVA, which is simply the amount by which a company's shareholder equity is worth more than it cost to create.
Once you know the amount of value creation, you can compute the annual compound growth rate of your EMVA. Key to this computation is knowing the weighted average age of company equity at cost, which will almost always be younger than a company's chronological age. That is because most companies reinvest some or all their free cash flows back into the business, rather than distribute that free cash flow to shareholders. The result is that the cost basis of a company's equity rises each year as company management reinvests shareholder cash flows into the business. In the case of the companies I have helped lead, we have also raised new shareholder capital annually, which has served to further reduce the effective age of our business. Financially speaking, the higher the annual compound EMVA growth you can realize, the better you are.
EMVA growth is a far better long-term business evaluation metric than compound earnings growth. Between 2015 and 2019, Walmart, amongst the most valuable publicly traded companies and the single largest retailer and corporate employer in the US, threw off close to $30 billion annually in free cash flow from operations. The company paid out only about 20% of that in shareholder dividends, which means that about 80% of annual shareholder cash flows were available for reinvestment into the company each year. Assuming Walmart reinvested the money profitably into its business, how could earnings per share fail to go up? Really, the company could have lit on fire half of its annual retained cash flow, reinvested the other half into earnings-producing investments, and net income per share would be expected to rise.
The reinvestment of cash flows is the main reason that broad stock market indices rise over the long term. They have to. Yet, for shareholders, the paramount issue should be whether companies are able to retain and reinvest their free cash flows without losing any of the value of that reinvested cash. And while not losing any wealth would be great, creating added EMVA would be even better.
Regrettably, too few Americans understand the power and dynamics of business wealth creation. Many of us believe that wealth is beyond our reach and that our market economy is somehow rigged to favor an elite few. I have never believed this. At its heart, America aspires to be a meritocracy. If you are fortunate enough to live in America, your potential should be limited only by your imagination, dedication, and discipline.
My experience is that good ideas, solid business models, and qualified leadership teams are scarcer than the investor capital needed to support and sponsor them. In my career, this has become increasingly true. If you are considering an idea having the potential for wealth creation, America is as good a place as I can think of to execute it. For one, the US, with approximately 4% of the world's population, has more small- and middle-market companies than any other country in the world. According to the US Small Business Administration and the US Census Bureau, as of 2018, there were approximately 26 million small businesses having no paid employees other than the owner, and more than 6 million small businesses with fewer than 500 paid employees. Those small businesses collectively employed nearly half of all working Americans.
The growth of capital availability to fund business ideas is equally impressive. When I graduated from college in 1979, there were scarcely any private equity investment companies. Forty years on, there are no fewer than 10,000 private equity and venture capital firms investing in every kind of company imaginable. Add them all together and you have an abundance of capital unheard of in American history. With a highly open economy and a strong legal framework, both of which are essential to encourage business formation, the US has a veritable conga line of lenders and equity investors in search of solid ideas having wealth creation potential. I learned this personally—access to investment capital enabled me to co-found companies in 2003 and 2011 that would both go on to be listed on the New York Stock Exchange.
Among the greatest gifts my parents gave me were an education and an example. In 1980, with nothing but a college degree in history and French, $500, and a box of hundreds of rejection letters from prospective employers, I loaded up my 1970 Volkswagen in New York and drove to Atlanta, Georgia. I landed a job selling clothing, and then started attending night school to learn about business. A few months later, I was hired by a regional bank—my goal was to work for a bank—where I would spend the next six years. For most of those years, I was engaged analyzing businesses and evaluating their ability to repay loans. I also spent many of my evenings in night school, earning my MBA. Along the way, I learned something that seems obvious: Not all businesses are created equal. Some businesses simply have superior business models that enable greater wealth creation.
Once a year since 1982, Forbes magazine has published its list of the 400 richest Americans. With few exceptions, members of this elite listing owe their fortunes to the wealth creation engines of some of the world's finest businesses. The fortunate self-made members of the list followed personal interests, often had luck shine on them, and found themselves owning stakes in groundbreaking businesses they helped create that became worth billions of dollars. In turn, the businesses they created were endowed with some of the finest business models capable of producing gargantuan rates of return that so exceeded any rational investor return expectation that they literally created geysers of wealth from thin air. Often, the wealth created was so abundant that it's common to see multiple members of the Forbes 400 who owe their vast collective net worth to the same singular corporate successes. Importantly, the geysers of created wealth often rained down broadly on employees and investors.
After I started to work at the bank, I became interested in business models. From my earliest days in banking, I began to model out businesses and create projections, which helped me to develop an expertise in business model evaluation. I cut my teeth on Visicalc (the first spreadsheet software for personal computers), graduated to Lotus 123, and later moved on to Excel, which is the prevalent spreadsheet software in use today. My earliest financial models can be described as long and weighty.
The thing about most business models and projections is that they are bound to be wrong. In fact, I commonly saw companies put together “base case,” “best case,” and “worst case” financial model scenarios, which simply gave the model authors the opportunity to be wrong three times. In truth, with just one or two variable changes, business model outcomes can vary by great degrees. Given this high level of variability, I became wedded to sensitivity tables (or “data tables” in Excel), which allowed me to see potential outcomes given a range of values for any two key model inputs. If you created many sensitivity tables, you could incorporate numerous variables, which provided better insight into key model variables and margins for error. The best business models tend to have ample room to make mistakes and yet still create wealth through outsized investor returns.
When we raised the investor money to start STORE Capital in 2011, the financial model I prepared was important. (STORE is an acronym for Single Tenant Operational Real Estate, inspired by our dedication to investment real estate that serves as profit center locations for our many customers.) At the time, I figured that the worst we could likely do was to realize an annual rate of shareholder return of around 9%, with an expected annual rate of return closer to 20%. By the time our original founding institutional shareholders sold their shares in the first quarter of 2016, they had realized a compound annual rate of return of approximately 26%.
With many founding corporate investments, the downside is a complete loss of all invested funds. In our case, we believed we could at least produce an annual rate of return that exceeded the aggregate return requirements of the pension fund capital that seeded our new business, with substantial upside. In 2011, our plan and an excellent leadership team allowed us to garner an investor commitment of $500 million to launch STORE Capital. At the time, there were just five founders with a vision, no offices, no assets, and many virtual meetings. Two years later, with the company on track, we accepted another $530 million in investor commitments. Another year and a half later, we listed STORE Capital on the New York Stock Exchange. By the end of 2019, STORE had an enterprise valuation approaching $12 billion. More importantly, we had created more than $3 billion in equity market value added.
Over the years, my approach to financial modeling became simpler. Complex models are neat, but they can be prone to greater error. If I did a complex model, it was always wise to have a simple model just to see if the results approximated one another. In a way, financial models are like computer programs: the fewer lines of code you write, the faster and more dependable the result is. For Investor Day demonstrations at STORE Capital, I would reduce the corporate financial model inputs to just 14 key variables. Take that in for a moment: We had a company having over $9 billion in assets, annual revenues greater than $600 million, and 95 employees, and it was possible to whittle our entire enterprise down to 14 variables.
You may be wondering why a discussion of corporate financial modeling approaches is so important. Well, it turns out that you can create a basic corporate financial model with as few as six variables that drive investor rates of return. At a high level, this means that corporate leaders have just these Six Variables—as I've named them—under their control, all working in concert with one another to deliver investor rates of return. And, as you should know by now, potent business models having investor rates of return that exceed investor return requirements lie at the heart of business wealth creation. So, the Six Variables work collectively to form a framework for understanding the essentials of how businesses work to create wealth.
Understanding that framework may make you more interested in business.
Understanding that framework may influence your employment decisions.
Understanding that framework may help you to lead a business.
Understanding that framework might inspire you to start a business.
Understanding this framework will make you a better business investor.
Understanding that framework will improve your personal wealth opportunities.
That's what this book is all about.
Chapter 1Free Enterprise and Wealth Creation
In the United States, businesses—large and small, public and private—create the beating heart of individual and national wealth creation. At the end of 2018, our nation boasted more than 32 million enterprises, of which just over 6 million had paid employees.1 The latter equated to a business for every 55 Americans, or, better still, a business having paid employees for roughly every 30 Americans in the labor force.
Given those statistics, if one were to look at the total number of businesses, there would be a business for every five Americans in the labor force, which is astounding.
How has this been made possible?
The abundance of businesses in America owes itself to three factors: An educated workforce, a ready supply of capital, and a strong rule of law. The United States is not alone in this; in no small way, these contributors to business formation lie at the foundation of the economy of every highly developed nation.
In the Beginning Is the Idea
Most businesses start with an idea, which usually takes the form of a solution to a problem. The key question is how to build a profitable business model around the idea.
In 1995 Larry Page and Sergey Brin, who had met as graduate students at Stanford, saw that searching the internet for relevant information was a cumbersome process. Their idea was to make internet searches efficient, productive, and user-driven, applying the technology they created to drive a high level of search demand.
They didn't know how this idea could translate into a profitable business model. No one could have foreseen how dominant and profitable Google, the company they created, was to become. Certainly not Page and Brin, who in 1999 briefly entertained selling Google to Excite, a more established search engine company, for $750,000, which would have allowed them to turn a tidy profit and return to their graduate studies. No one could have blamed them for unloading their money-losing venture; that year, Google had posted a $3.1 million loss on revenues of just $220,000.
Sergey Brin, left, and Larry Page posing in a messy office setting in October 2002
Credit: © Michael Grecco Productions, Inc./Grecco.com, ALL RIGHTS RESERVED.
Just two years later, the company would produce its first profit of $32 million on revenues of $86.4 million, and it would never look back. Three years after that, they took Google public. Between 2004 and 2019, Page and Brin sold over $10 billion of Google shares apiece, and yet still held onto corporate shares valued at more than $25 billion for each of them.
Over the next two years, the company they founded continued to prosper. By the end of 2021, with a net worth estimated by Forbes of $123 billion, Larry Page ranked as the fifth-richest person in the world. His former partner, Sergey Brin, was effectively tied at number six, with a reported net worth of $118.5 billion.
Unicorn Likelihood
This brings up the interesting topic of the likelihood of anyone—including you or me—becoming a billionaire. Looking to the richest among us makes an interesting study, because these subjects provide insight into the most compelling business models in each generation.
As of the end of 2020, there were over 3,200 billionaires in the world, of which over a quarter resided in the United States.2 The odds of an American being a billionaire are roughly 1 in 355,000, or far better than the extremely long odds of winning a Powerball lottery, which is approximately 1 in 300 million.
Of course, many of the world's richest inherited their wealth, and so might be excluded from the competition to become billionaires. A better question might be this: What are the odds of being a self-made billionaire? Not too bad, actually; of the global population of billionaires surveyed at the end of 2020, 60% were self-made, which is an astonishing statistic.3 The amount of wealth created in the 50 years between 1970 and 2020 is indeed almost without precedent. One would have to look to the same period a hundred years earlier for a comparative period of productivity and creativity. Instead of names like Bezos, Musk, Gates, and Buffett, one might have spoken of Rockefeller, Carnegie, and Morgan. Still, the numbers of the world's most affluent today dwarf those of the Gilded Age, or what is also called the Age of the Second Industrial Revolution.
Of course, much of the difference in the magnitude of today's superrich lies in population growth. Much is also owed to enhancements in capital formation, including resources such as the Small Business Administration, venture capital, and pervasive private equity firms. These resources, together with technological advances, gave rise to what is today called the Third Industrial Revolution, with economic and productivity growth propelled by digital and technology advances.
The numbers show that being a billionaire is statistically easier than winning the Powerball. It is also statistically easier than making a living on the PGA Tour. There were an estimated 927 billionaires in the US at the end of 2020. Meanwhile, the career earnings of the active golfer ranked 927 on the PGA Tour amounted to less than $25,000.4 There are more self-made billionaires in America than there are PGA Tour pros who can earn a good living playing the game.
Getting into the NBA is nearly equally hard, with just 450 players scattered across 30 teams, and each earning a median salary of approximately $3.5 million in 2019.5 Getting into the NFL is a little easier, with about 1,900 players and a far lower median salary under $850,000.6 Yet, you would be right to say that all these people are virtual “unicorns,” or mythical creatures, which is also a term used today for start-up businesses having valuations of a billion dollars and up.
Odds of Success
To my way of thinking, the real action in business lies in the middle markets, which I would characterize as companies having from $10 million to $1 billion in revenues. This is where most of the job growth and business creativity is in the United States. This is the most common fertile ground for growing businesses that have the best chances for material wealth creation.
To be among the broad group of thousands of middle market businesses is broadly attainable.
By contrast, smaller companies often serve as vehicles for independent employment, which can be personally rewarding but generally lessen the chances for wealth creation.
The bottom line is this: If you can harness an idea and transform it into a business model, what are the odds of success?
It turns out that the odds of having a business that survives at least five years are about the same as the odds of consistently breaking 100 at golf. The odds of business survival for longer than 10 years are somewhat better than regularly posting golf scores under 90.
Golf vs. Business
Golf
1
Business
2
50% Can't Break 100
20% Don't survive a year
25% Shoot between 90 and 100
50% Survive at least five years
20% Shoot between 80 and 90
33% Survive more than 10 years
5% Shoot below 80
?? Survive and create MVA
1 Data from National Golf Foundation
2 US Small Business Administration Office of Advocacy June 2016
Actually, the odds may be about the same, since golf statistics are based up players who report their scores. Of course, many golfers elect not to report their scores, while among those who do report their scores, there are well-founded suspicions of score embellishment.
In business, there are generally no free mulligans, and statistics are not compiled from self-reporting, which makes reported business survival rates more reliable.
Businesses that survive 10 or more years are apt to have better business models than those who do not. The outliers in business are the companies that do two things: They survive; and then having survived, they become worth more than they cost to create. These lie at the heart of wealth creation. The aggregate creation of value beyond the cost to create a company is called market value added (MVA). A company's owners tend to be the prime beneficiaries of MVA, though creditors also typically benefit. The principal driver of MVA creation is centered in the ability of a business to realize rates of return that exceed the overall cost of capital, which includes both equity and interest-costing proceeds from other people and institutions. At an extreme level, outlier businesses can enable their shareholders to become unicorns. I expect that most of the founders of such rarified companies end up as surprised as Sergey Brin and Larry Page. But there are thousands of MVA-creating businesses that individually and collectively lie at the center of our economy and the prosperity of our communities.
The Six Variables
While there is a limitless supply of ideas that might be applicable to business formation, there is not, at a high level, a limitless supply of business models. When viewed abstractly, just Six Variables combine to deliver equity returns and create equity market value added. They are:
Sales
Business investment
Operating profit margin
Amount of interest costing proceeds (other people's money)
Cost of other people's money
Annual maintenance capital expense
This is not to say that buried within the Six Variables lie far more diverse operational fundamentals. Henry Ford created the first scalable automotive assembly line, and Albert P. Sloan was an administrative and marketing genius who grew General Motors to surpass Ford and become the largest company in the world. These and other operationally minded business leaders are illustrative of the immense creativity that can be harnessed to enhance business models. Still, behind all this effort and operational creativity lie Six Variables, which demand the attention of—and can help—every business leader.
Notes
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