The 8 Capital Allocation Decisions CEOs Face

While I was visiting our office in Riga, Latvia a few weeks ago some folks asked me how my job has changed as CEO on the journey over the last five years.

I tried to explain that when a company gets bigger, the CEO job boils down to three big things:  1) Vision 2) People and 3) Resources.

The past 18 months I’ve been focusing a ton of energy on the People part of the equation.

However,  as I start to look hard at the next three to five years of FullContact, I find that I’m naturally starting to focus more of my energy on Resources.

More specifically – I’ve been looking closer at Capital Allocation.

There was a recent very lightweight HBR post titled CEOs Don’t Care Enough About Capital Allocation.  While the post doesn’t go nearly deep enough analyzing the subject, I think the punchline is – in large part – very  true.

This weekend,  I read The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success – which Warren Buffet listed in his 2012 Berkshire Hathaway Annual Shareholder letter as #1 on his recommended reading list.

I then re-read Benjamin Graham’s seminal work – The Intelligent Investor.

Both books are outstanding and I recommend them to anyone that wants to understand investing and capital allocation at a deeper level.

Warren Buffet once said – “Being a CEO has made me a better investor and vice versa.”

I think this statement is great and it makes perfect sense to me.

One of the notes in The Outsider that I highlighted on my Kindle referenced the ‘toolbox’ of 8 tools that CEOs have at their disposal when allocating capital.

For deploying capital, there are five tools:

  1. Investing in Existing Operations
  2. Acquiring Other Businesses
  3. Issuing Dividends
  4. Paying down debt
  5. Repurchasing stock

For raising capital, there are three tools:

  1. Tapping internal cash flow (including selling assets)
  2. Issuing debt
  3. Raising equity

The gist is that every CEO has these 8 tools at their disposal.  How effectively each CEO uses these tools will determine the results.  Some of these tools are appropriate to use at different times, depending on market conditions and the hand that each company is dealt.   Each tool will have a different impact on shareholder value and it’s important to actually do the math and evaluate the impact on shareholder value of each tool before using one.

To help guide their decisions on their use of these eight tools, here are the twelve traits that I noticed each of The Outsider CEOs shared:

  1. Rational (and extremely ruthless) capital allocation decisions
  2. Hyper focus on value per share – not traditional metrics like revenue, market capitalization, growth, or net income
  3. A strong #2 that managed day to day operations freeing up the CEO to focus on capital allocation
  4. Decentralization of operations and delegation down to the lowest possible managerial level – to release entrepreneurial energy – bordering, in some cases, on anarchy.
  5. Centralization of capital allocation decisions – bordering, in most cases, on a dictatorship.
  6. A focus on hiring great people and holding them brutally accountable for results, but for the most part, leaving them alone as long as they hit their numbers.
  7. Willingness to strike their own path while their peers and the rest of the industry followed another path (what Buffet coined the institutional imperative).
  8. Willingness to completely change strategic direction when the market conditions changed (for example, fluctuate between being acquisitive when the market conditions were favorable and divesting assets when the market conditions were favorable)
  9. Extreme confidence in their own decision making abilities without relying on a team of external advisors and consultants
  10. Ability to make capital allocation decisions quickly without spreadsheets, but through back of the envelope calculations and simple analysis of the most important variables.
  11. Focus on the long view rather than quarter to quarter results.
  12. Ability to tune out the external noise (media, press, pundits, analysts, etc) and just focus on creating shareholder value for the business.

As we enter what looks like a period when everyone is pronouncing things like Winter Is Coming for Unicorns or RIP Summer, I think these eight tools and twelve traits are worth pondering and thinking deeply about if you are a CEO of any sized company.

I know I will continue to ponder these points as I continue to be on the other side of the world, away from all the noise, and working remote from Denmark.

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