The Rebel Allocator

by Jacob Taylor

  He continued, “The money you borrowed from your parents--you had to pay them back eventually, right?” I nodded. “Since that money was only borrowed, they didn’t own the lemonade stand with you. They weren’t entitled to any profits. That borrowed money is called ‘debt financing.’ It accounts for about twenty percent of the external money businesses use if you look at the long term average in the United States,” Mr. X said.

  “What could I have done other than borrow money from them?” I asked.

  “You could have brought your parents in as fellow owners. They give you money. You don’t have to pay it back, but now they’re in line with you when it comes time to pay owners. They become your business partner. That’s called ‘equity financing,’” he said.

  “I’ve never heard those terms described so simply,” I said. The old man had a knack for distilling concepts that tangled my brain at work and school. “So if my lemonade stand was a typical U.S. business, I’d put up eighty dollars of equity and my parents would put up twenty dollars of debt?” I asked.

  “That’s about right,” he said. “Equity goes by different names depending on when it happens in the life of a business. They call it seed funding, angel investing, venture capital, IPOs, stock options, private equity. But the concept is the same: equity is ownership,” he said.

  “That finally makes sense,” I said.

  “There are a few other external sources of money for a business,” he said as we walked. “You can borrow money from your vendors for short periods of time. Here’s how that works: you get the lemons you need now, but don’t have to pay for them for thirty days. Vendor financing is usually short-lived, but it can be an important source of cash for some companies,” he said. His gait was slow, but his mind was still firing on all cylinders.

  “I imagine that can work against you as well. Having to pay vendors before you get paid by your customers? Growing out of business,” I said. Whenever I could, I tied back to our past conversations to validate he wasn’t wasting his time with me.

  “You’re exactly right,” he said. “There’s another side of the coin. You can get money from your customers before you deliver your product or service to them. Are you old enough to remember layaway?”

  “It sounds familiar,” I said.

  “It mostly went away when credit cards became popular. Back in the day, if you didn’t have enough money to buy what you wanted, you could put money down as a deposit. You’d save up the rest, and when you could pay the difference, you got the product,” he said.

  “People must have been better at delaying gratification back in the olden days,” I said.

  “Clearly,” he said. “There are other examples. Think about an insurance company. They take your money as premiums up front. Then if you later file a claim, they pay you out to cover whatever was insured. But in the meantime, they get to keep that money and invest it. It’s called float. As in the customer is floating the insurance company money up front. When a good investor like Warren Buffett gets access to float, it can be a special combination. But most people aren’t Warren Buffett...” he said.

  “I just thought of another one,” I said. “I saw on the counter that you have gift cards for Cootie Burger. The customer gives you the cash up front, then redeems it for food later. But in the meantime, you get to do whatever you want with the cash. Would that be considered float?”

  Mr. X beamed, “Very clever! Yes, that is absolutely float. We’re always interested in ways of taking in more cash before we have to pay it out. Gift cards are one way that makes sense for our business,” he said. Was I actually starting to understand business? Gasp, the horror! Quick, someone get me an antidote copy of “Das Capital.”

  “I think I have another one,” I said. “Are you familiar with crowdfunding? Basically, an entrepreneur pitches the idea for a product. Usually they have some kind of prototype, like an ice chest with a radio built into it or something. If people like it, they can make a small deposit as a commitment to buy. This gives the entrepreneur the money needed to at least get started in building the product. They get a built-in customer before they have to take the risk of large-scale production. Isn’t that a form of borrowing from your customer?”

  He stopped shuffling for a moment to think. “Hmm… it sounds an awful lot like layaway, but what you’re describing could be considered float, sure. Once you understand the concept, you start to see it all over. That’s what I love about business. There’s always something new to learn,” he said.

  “Tell me about your proudest moment,” I said. It was my turn to steer the conversation for a while.

  “There have been so many over the years,” he said. “So many business deals and breakthroughs. I’ve had a very fortunate run.”

  “How about the proudest moment in your personal life?”

  “That’d be a three way tie: the day my wife and I tied the knot and the birth of each of my children.”

  “I’ve only heard you mention the one daughter,” I said.

  “I had a son as well, but that’s a story for another time,” he said coldly. Hint taken: no trespassing.

  “What was your wife like?” I asked.

  “‘Lovely’ is the only word that gets close,” he said. “Kind and patient, with a quiet inner strength. She gave me a feeling that as long as she was in my corner, we’d be able to get through anything together.”

  “She sounds like a great life partner,” I said. “How’d you know she was the one?” I had been regularly asking myself that age-old question as my relationship with Stephanie was evolving. I was curious to get the old man’s thoughts.

  “That’s a question so unique to the individual, it can’t be answered. But when you know, you just know.” That wasn’t very helpful, Mr. X.

  We had completed a small loop around campus and arrived back where we’d first met. We found Cathy there, taking a phone call. She smiled and waved when she saw us.

  “How was your walk, boys?” Cathy asked after hanging up. “The campus looks beautiful from what I’ve seen.”

  “He had a hard time keeping up,” Mr. X said. “He kept asking to borrow my cane. It was sad.”

  “He’s too fast for me,” I said. “So we’ll see both of you for dinner tonight, right?”

  “If you’re lucky,” Mr. X said. The walk and the sunshine must have put him in a feisty mood.

  “Looking forward to it!” Cathy said.

  Maybe it was the fresh air or the California sun. Maybe I was excited for them to meet Stephanie. Whatever it was, I was feeling pretty damn good.

  CHAPTER 27

  Operation Impress-Steph-with-My-Billionaire-Friend was a go. See, I wasn’t lying. I do hang out with the rich and famous, babe. Plus maybe she’d like Mr. X so much that she’d find my neglecting her for Wichita trips to be a worthy sacrifice.

  I made a reservation for four at a nicer Mexican food place. The great thing about Mexican food is you can pick the best place in town and you won’t need to sell a kidney if you get stuck paying the bill. Beans, rice, and tortillas can only cost so much. It didn’t hurt that we have the home court advantage on Mexican food in California. I was being a good culinary capital allocator.

  No surprise, Stephanie looked great. A nice sweater, jeans, fashionable boots, her hair pulled back in a ponytail. I loved how versatile she was. It could be a fancy corporate soiree, a nature hike in the middle of nowhere, or a dressed-down dinner with a billionaire. She had the range to handle it.

  We arrived first and were taken to our seats. We chatted about nothing while we waited. I saw Mr. X turn the corner first and scoot along with Cathy in tow. We got up to greet them and received our customary hugs from Cathy.

  “How did you land this one?” Mr. X asked me as he shook Stephanie’s hand.

  “I’m not sure,” I said. “Don’t remind her.” The waitress came around and took our drink orders after we’d settled into our seats.

  “So how did you two meet?” Cathy asked.
/>   “She was my drug dealer,” I said with no affect. A concerned look spread around the table.

  “Caffeine, being the drug,” Steph broke in with a mock frown. “I served him his coffee every morning. After months, he finally got up the courage to ask me out,” she said. “I thought I was going to have to do it for him.”

  “Oh, how sweet,” Cathy said. Mr. X added a playful wink.

  Stephanie blushed as she smiled and said thank you.

  “I hope you don’t mind,” I said. “I took the liberty of ordering us chips and guacamole to start. Have you ever had fresh California guacamole?”

  “I don’t believe I have,” said Cathy.

  Mr. X just shook his head like he couldn’t care less. “Not my thing,” he said.

  “Fun fact, everybody,” I said. “California grows about ninety percent of the nation’s avocados. And this place does it right. You’re in for a treat.”

  “What are you studying in school?” Mr. X asked Stephanie. Sorry to bore you with my guac talk, Gramps.

  “I’m working toward my Ph.D. in social psychology,” she replied. “More specifically, I’m studying decision-making biases and heuristics. I also teach undergraduate psychology classes.”

  “Interesting,” Mr. X nodded. “There is no shortage of human folly in this world. You don’t have to look far to find bad decision-making abound.”

  “It is quite humbling to study all the different ways we fool ourselves,” she said. “The crazy part is how it happens right under our noses without us knowing. We always assume it only impacts others--that we’re the exception. It must be part of human nature.”

  “This may surprise you,” Mr. X said to Stephanie. “But I’ve studied a fair amount of psychology.”

  “Really?” she said. “For what?”

  “Well, I realized there were some quite useful ideas in there. Ideas that could help with both life and business. If I’ve been successful, it’s because I’ve never been afraid to reach over the fence to grab helpful ideas, no matter the source. I would never have made it in the siloed world of academia.”

  “You’re right,” she said. “The incentives in academia are set up to find your little niche and drill deeply, almost to the point of absurdity. The pressure to publish is extreme. It’s no wonder you hear stories about data being twisted to support a hypothesis and a crisis of reproducibility.”

  “Does it seem like your professors get obsessed over one idea?” Mr. X asked. “Like they are a man with a hammer, and every problem in the world looks like a nail?” He already knew the answer.

  “Yes!” she said. “They identify one useful or interesting phenomenon and then they view the whole world through that one lens. That’s how it feels anyway.”

  “I bet,” Mr. X said.

  Our server arrived with our chips and the ingredients to make our guacamole. Part of the charm of this restaurant was they made the guacamole right in front of you. The ingredients arrive in small bowls ready to be mixed. With flair, our server added the avocados, salt and pepper, lime juice, minced onions, tomatoes, cilantro, and serrano chiles to a large mortar and ground it with a pestle into a perfect paste.

  “You go first, Mr. X,” I said.

  He wrinkled his nose at the thought as he reached for a chip and dipped it tentatively into the guac. We all watched as he bit off the corner and chewed. He added the rest of the chip to his mouth and continued chewing. His head slowly started to nod. “You know what? That isn’t half bad. I’d better have a little more to make sure that first bite wasn’t a fluke,” he said, reaching for more. We all laughed at his little show. Mikey likes it!

  I was relieved after all the selling I had done. We all dug in and it wasn’t long before we were scraping the bowl clean. The rest of our meal was filled with great food and laughter. Cathy shared hilarious stories, many of them where Mr. X was the butt of the joke. He took his ribbing good-naturedly. Mr. X shared a few of his own stories, interesting characters he’d met over his decades of business dealings. The check came and Cathy responded like a territorial bulldog when I offered to pay. She wasn’t having it, but I at least had to try.

  As we walked out, Mr. X seemed to be leaning especially hard on his cane. I got close to help keep him steady. He quietly whispered only to me, “Don’t let this one get away, Nick,” and nodded toward Stephanie. “She reminds me of my wife. She’s a keeper.” The little gleam in his eyes took ten years off.

  I nodded back. And with that, he stood a little straighter and shuffled his way out of the restaurant with a new vigor. Keyser Soze.

  CHAPTER 28

  Having been able to avoid travel for a few weeks, I felt rejuvenated and excited for my next trip to Wichita. On the plane, I studied the week’s Warren Buffett installment, hoping to anticipate the lesson plan. No surprise, I was in the dark.

  -- “Businesses in industries with both substantial over-capacity and a ‘commodity’ product are prime candidates for profit troubles. Over-capacity may eventually self-correct, either as capacity shrinks or demand expands. Unfortunately for the participants, such corrections often are long delayed. When they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates over-capacity and a new profitless environment. In other words, nothing fails like success.”

  -- “We do have a few advantages, perhaps the greatest being that we don't have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners. In doing that, we always mentally compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison--acquisitions against passive investments--is a discipline that managers focused simply on expansion seldom use.”

  My taxi driver gave me a skeptical look when I gave him the address where I was to meet Mr. X. I understood why when we arrived at the empty lot in a rundown part of town. Was that a clue? Who knows--I was used to showing up dreadfully confused. Mr. X was already there. I immediately noticed he had upgraded (downgraded?) his cane for a walker, one with a built-in seat. I found him sitting patiently with a blanket over his legs. He looked like he’d aged seven years in the few weeks since I’d seen him, but he managed a smile when he saw me approaching.

  “Hi, Mr. X,” I said.

  “Welcome to the future site of a Cootie Burger restaurant,” he said with a surprising energy. Maybe there was still some juice left in him yet?

  I looked around the empty lot and the grey blight that surrounded it. It was a rough part of town. “This is an... interesting place for an Cootie Burger, isn’t it?” I asked.

  “Poor fool,” he said with a smile. “You can only see two inches in front of your face.”

  “What do you mean?” I said.

  “Maybe a story will help.”

  “Lay it on me,” I said.

  “I was hiking in the woods one day as a much younger man and went through a section of forest where there had been a fire. I couldn’t help but notice the only thing growing were pine tree saplings. That got me wondering why these green pine trees were the first thing to make a comeback after a fire. I asked a botanist friend of mine and it turns out conifer trees have evolved a very clever strategy. Do you have any idea what it might be?”

  “No clue, Mr. X,” I said.

  “As you probably know, pine trees release cones that fall to the ground, tumble a bit, and then just sit there. Sometimes for years and years. Big deal, right? But here’s where nature gets interesting. Eventually a fire comes along. The flames introduce a new environmental dynamic. The soil becomes richly fertilized by the fire’s ashes. Sunlight is suddenly plentiful as trees and brush are burned away. After years of sitting dormant on the forest floor, the patient pine cone springs into action. The heat from the fi
re opens up the seed pods and releases into the fertile environment where the fledgling pines quickly take hold. Their usual competition has been wiped out--it’s a whole new ecological ball game. The pine cones on the forest floor wait to take advantage of the eventual disruption, and it’s proven a very effective survival strategy. But it requires extreme patience,” he said. I’ll admit, I was mesmerized whenever he’d spool up into teaching mode like this.

  “I’ll probably never look at a pine cone the same way,” I said. “ But I still don’t see how this relates to an empty lot in a rundown part of town?”

  “Imagine being patient like the pine cone,” he said, “waiting... ready to take advantage of disruptions in the system. Change is unavoidable, but we can use it to our advantage. One strategy that’s been successful for us at Cootie has been buying plots of land in areas of urban blight where we believe there’s a good chance of revitalization. Everything moves in cycles: growth, eventual decay, cleansing tear down, repeat. The forest and the city aren’t so different. When an area is particularly rough, we’re able to acquire properties for very low prices. The buildings and services like water and electricity are often still in decent shape.”

  “Really?” I said.

  “The low price today makes sense,” he replied. “Who wants to buy in this shabby state? You couldn’t get much cash flow from this property as it exists right now. So there’s not much to support the asset’s price. But that’s very short-sighted in my view.”

  “So you’re saying that someday this will be a nice part of town?” I looked around and tried to imagine new buildings, new families moving in, and new energy injected into the area. Maybe it’s possible. “I guess it’s not that hard to picture. Anything would be improvement, right?” I said.

  “Here’s the hard part of the strategy,” he said. “We have to wait. And wait. And wait. In some cases, it’s taken over ten years of just sitting on the property doing nothing but paying property taxes. When most CEOs are measured by the quarter, it’s very difficult to be that patient. The wheels of progress turn imperceptibly slowly. But eventually a rough neighborhood gets cleaned up. We then have a location in a hot area, and we paid a favorable price for the real estate. Now we have a material advantage over our competitors for a long stretch. Just like the pine cone, we have a head start after the fire.”