Returns vs. right on capital

One of the key things that we have to do as entrepreneurs/ businessmen/ professionals are to allocate capital between our business units and teams when they ask for it. The best of us get it right intuitively, and here are a few very intuitive selection algorithms that we follow at OfBusiness. Not really prescriptive, but it has worked for us over the years, especially to keep us honest.

A. Take (capital) as much as you can – These are businesses that demonstrate a RoCE of >15%, and hence when levered, RoEs north of 25%. They are like the bellwether tech stocks (the Apples, the Alphabets, the Facebooks) or the big profit-generating FMCGs (ITC, HUL and Emami). We don’t put constraints, capital is free for them, and we just ask them to grow and dominate. No constraints. If possible, take more of the debt so that we get great overall returns and conserve the equity for the meritocratic but not yet proven. For us at OfBusiness, it’s our financing business or some select M&As that we have done.

B. Take (capital) but be efficient – These are businesses that are in the range of 9-15% RoCE and depend on leverage to juice up the RoEs to the mid-teens. They are like industrial houses (Reliance, Tata Steel, Ultratech) for us. These are businesses that generate above-average returns, but the competitive edge is not that high, and hence efficiency is key. The Key is to make sure that our returns are higher than the cost of capital. But these businesses are important for scale, growth and branding. Hence, the biggest guzzlers. For us at OfBusiness, it’s our older B2B aggregation businesses and some large M&As that we have done for synergies.

C. Ask (for capital) only if something else is working for you – These are businesses that have RoCEs in the 3-9% range and hence need equity to survive. These are like all the growth stage start-ups that have turned profitable in the last couple of years, profitable but not yet enough to be above the cost of debt. Thus, they have to have something else going for them – big market, great team, hyper-growth, winning product, right timing. For us at OfBusiness, it’s our newer B2B aggregation businesses and fee income businesses in financing.

D. Don’t ask; you will be chosen – All businesses in the RoCE of -3% to +3%. These are the start-ups of promise or pilots in our businesses, where we choose based on multiple tailwinds (just 1 is not enough): many out of the big market, hyper-growth, great team, winning product, right timing. We have some of these pilots at OfBusiness, but we operate them in this phase with a definitive timeframe in mind. Get in a pre-defined timeframe to level A/B or get grounded to E (as follows). Businesses or business units cannot stay in this phase for long.

E. Bugger off, don’t you dare ask – Businesses with RoCEs of <-3%. Nothing justifies their existence, and deservedly, they need to be shut asap.

Whenever we feel lost at OfBusiness about whether and how much capital to put in, we refer to the simple algorithm above.

Read more from CEO speaks Column:-
– Rafa’s Teachings
– The Promised Land