Your Husband Owes Me Money
My main man Morgan Housel wasn’t the only person interested in Permanent Equity’s policy of keeping 18 months of operating expenses in cash on our balance sheet. For example, I also heard from Phil who had a “quick question.” What he wanted to know is if we hold 18 months of cash only at the home office or also at each and every one of our portfolio companies.
The reason he wanted to know was because, in his experience, if you let a business become too overcapitalized, it can lead to complacency, which is the enemy of performance. So at a business he ran he adopted a policy of sweeping all cash in excess of 16 weeks of burn into a separate account invisible to the rest of the management team and that that had the effect of intensifying discussion and clarifying thinking.
And Phil is not wrong that capital constraints beget operating efficiency (and a small business might also consider putting a little debt on its balance sheets for just that reason). So this is why I told Phil that I agreed with him, and that the PE 18-month policy is at the home office and not at the portcos. Instead, at the portcos, we typically set minimum cash balances that would only support shorter dry spells and similarly sweep excess cash out regularly in order to maintain focus and discipline.
Another reason for this is that Permanent Equity, unlike our operating businesses, doesn’t generate revenue regularly – our monetization events are more intermittent. This means that our ability to be patient and take a pragmatic, long-term view on things (and always be in a position to do what makes the most sense) requires more conservative capitalization.
That said, one of my favorite examples of how a little balance sheet stress begets focus and discipline comes from a CEO we know who operates without a line of credit and only a few months of payroll on his balance sheet. By being financially lean, he believes his managers develop a healthy paranoia around money and an appreciation for the importance of earning and collecting it. They’ve got to know their unit economics and be deliberate about collecting and paying bills. It’s only then that (and this is a true story) when it becomes clear in the course of a weekly AR meeting that a particularly difficult customer isn’t paying his bills or even picking up phone calls that the CEO himself got up from the table, drove to the customer’s home inside of a gated luxury subdivision, and knocked on the door.
That knock was answered by the customer’s wife, who was otherwise going about her business preparing dinner. But she answered the door to find someone she’d never met standing there, who said, “Hi. My name is _____. Your husband owes me money. I can wait.”
Now, this isn’t necessarily how they teach working capital management in business school, but the technique proved effective in the sense that the CEO left with a check. Because imagine being on either side of that knock.
Maybe there is something to this creepy, not nice thing.
– Tim
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