Author Christopher Volk: 5 Things Every CEO Should Know About Navigating The World Of Finance
Business models are not created equal, but the dynamics of return delivery rest on just six variables that can be attended to by leadership to elevate value creation potential.
As part of my series about the “How to Navigate and Succeed in the Modern World of Finance”, I had the pleasure of interviewing Christopher Volk.
Christopher Volk, author of THE VALUE EQUATION, has been instrumental in leading and publicly listing three successful companies, two of which he co-founded. The most recent is STORE Capital (NYSE: “STOR”) where he served as founding chief executive officer and then as executive chairman. Volk, who has written about corporate finance since early in his career and has created an award-winning video series about the topic, is a regional winner of EYs’ Entrepreneur of the Year award. He resides in Paradise Valley, Arizona, and Huntsville, Alabama.
Thank you so much for your time! I know that you are a very busy person. Our readers would love to “get to know you” a bit better. Can you tell us a bit about your ‘backstory’ and how you got started?
I graduated from a small university in Virginia with a degree in European History in the middle of an economic recession. With few job prospects, I went to work selling clothing for a retail chain store in Atlanta, Georgia, while taking evening accounting classes. Soon I was hired by a regional bank, where I started to learn about financial statement analysis. I have been a “credit geek” ever since. After years of commercial credit work, lending and night graduate business school, I departed banking to work with an Arizona-based customer engaged in long-term real estate lease arrangements with chain restaurant operators. There, I became involved in raising institutional equity and eventually suggested that we publicly list the business on the New York Stock Exchange. I guided that effort, eventually becoming President of the public company. We would go on to sell that business seven years later. I was instrumental in founding two similar public companies after that. The three public New York Stock Exchange companies were listed ten years apart, in 1994, 2004 and 2014 and all three were successful as measured by absolute returns and performance relative to benchmarks. Throughout my career, I have taken the time to write articles, with most centered on credit analysis, commercial real estate evaluation and business model evaluation. Taking the time to write has been important, helping me become a better business strategist.
Can you share a story about the funniest mistake you made when you were first starting? Can you tell us what lessons or ‘take aways’ you learned from that?
I have made any number of mistakes in my career. For instance, early on as a credit analyst, I evaluated a loan opportunity with a seasoned stuffed animal manufacturing company that went bad within the first year. I determined I had made a mistake in the credit evaluation and volunteered to personally help collect the loan and liquidate the enterprise, which I did. The loss ended up being negligible and the bank threw a fancy dinner in my honor. On a personal level, the amusement lay in the fact that I never had dinners offered to me in subsequent years for the many performing loans I made. I made note of this and have been mindful of praising the efforts of our investment origination staff ever since. I also learned a good deal about loan collections. To this day, I have a cast bronze boot mold used to make one of the company’s iconic stuffed animals (Zip the Chimp) that sits on my desk. The machine that this was a part of was the company’s single biggest piece of equipment and yet yielded virtually no value. We had to give the machine away in exchange for its scrap metal value.
As an analyst, I learned the importance of how to ask questions and write findings. It is easy for personal bias to find its way into credit evaluations that demand an objective, but critical viewpoint. On one occasion, meeting with a potential bank customer, my youth and personal bias got the better of me. I basically asked whether, given the financial performance of an apartment complex, the customer was paying too high a price. The volcanic response can’t be printed here, but basically, the customer wondered who I was and noted that he had personally led the state real estate appraisal society. The lesson is one I have never forgotten. There are many ways to ask questions and most do not require an interjection of opinion. I should simply have asked about the negotiation process for the apartment complex and how he and the seller arrived at the agreed price. Ever since, I have advised credit analysts to begin customer interviews by simply asking them to talk about their companies. The answers are often long and can both eliminate prepared questions and open up new lines of questioning.
Is there a particular book that you read, or podcast you listened to that really helped you in your career? Can you explain?
I have been an avid reader of business books that have helped shape my views over the years. When writing “The Value Equation”, I made a point of including the observations of many economists and authors, often including pictures of them. The book’s central business modeling theme comes from work I have done over thirty years, but I wanted to incorporate business stories as well as observations from such important contributors. The economists noted in the book include (alphabetically) Eugene Fama, John Maynard Keynes, Myron Gordon, Merton Miller and Franco Modigliani. Other economists I have been fond of mentioning in my work include Harry Markowitz, Daniel Kahneman and Amos Tversky. Most of these individuals were honored for their work with Nobel Prizes and all have had an impact on me, adding contours to my business views over the years. In the book, I also give some nods to various business writers, including James Champy, Thomas Davenport, Peter Drucker, Michael Hammer, Henry Hazlitt and G. Bennett Stewart. Their timeless, important work has also influenced me.
Are you working on any exciting new projects now? How do you think that will help people?
Getting “The Value Equation” launched has been the biggest of my recent projects. The central theme relates to simplified business modeling and how that determines current equity returns, which rest at the heart of business wealth creation possibilities. I should have a related website that will be launched and you can anticipate ongoing contributions as I continue to write. My approach to business modeling, which I have employed as a business leader, is universal and I hope will make understanding business more widely accessible. I believe this to be important because business is the greatest driver of wealth creation, delivering huge societal benefits and is demonstrative of why free enterprise is destined to be superior to other alternatives. Beyond writing, I have various projects in mind, but will look to help guide more than just do.
Do you have a “number one principle” that guides you through the ups and downs of running a business?
My number one principle in business and life is to do my best to treat others as I would like to be treated. If one can successfully do this, then creating a business becomes a win-win proposition. Those that start businesses and are fortunate to accumulate personal wealth as a result should not be the only beneficiaries. True success involves benefitting a wide array of stakeholders.
Not far behind my first principle is a second: You either make things happen or allow things to happen to you. This is universal, but especially so for people who choose careers in business, where there are so many possibilities. In my own career, there have been moments where I took decisive personal action that impacted my future. Likewise, I have employed this maxim in business. It is important to be anticipatory and not just reactive.
If a fellow business leader would ask you for advice about whether to bootstrap or to look for VC capital, how would you help them weigh the pros and cons of that decision?
Bootstrapping has definite advantages. Foremost is being able to retain a higher degree of business ownership. The downside is that it can be riskier and delay your ability to address your target market. When we started STORE Capital in 2014, we needed a lot of money because making real estate investments is so capital intensive. So, we did not really have the choice to “bootstrap” the firm in the traditional sense. However, we could have elected to raise the capital ourselves from pension funds, family offices and the like, which would have improved our personal economics. But doing so could have taken years, risking early mover advantages and putting at risk our ability to keep our cohesive, experienced leadership team. So, we instead raised the equity we needed largely through a private equity firm (Oaktree Capital), which allowed us to raise $500 million and start our company in just a few months. In doing so, we traded off greater ownership for certainty and the chance to rapidly create a large, market-leading company. We chose to limit our risk and to own a smaller piece of a bigger pie.
What measure do you use to determine the value of a company? What advice would you give to other leaders about how to get an optimal evaluation of their business?
When I started my career, I had a lot of interest in learning how to value a company. In fact, it’s easier than you might think. In my forthcoming book, valuing a business starts with the Value Equation, or V-Formula. Once you know the fundamentals of the equation, together with capital stack assembly using OPM (other people’s money), valuing a company can be done in three simple steps as follows:
Wealth is created by designing a company capable of producing investor returns sufficient to make it worth more than the cost of its parts. Business models are not created equal, but the dynamics of return delivery rest on just six variables that can be attended to by leadership to elevate value creation potential.
What would you advise to a founder who initially went through years of successive growth, but has now reached a standstill. From your experience do you have any general advice about how to boost growth and “restart their engines”?
As a general rule, growth companies cannot remain so forever. Markets become competitive, compressing margins and limiting opportunity. Balance sheets and equity investments become large, creating a “denominator effect”, where it becomes hard to deliver historic growth on an enlarged corporate valuation. A once growth company can become instead a “cash cow”, which is not the worst of fates! Such businesses often transition from cash flow reinvested into corporate growth to cash flows paid out as dividends. Other companies instead elect to buy in shares, which has the benefit of avoiding the implicit commitment to pay consistent and gradually growing dividends.
The other choices typically lie in M&A activity or cash reinvested into expansion in new business lines. Both can pose elevated risks, often entailing fundamental business model changes. Many companies have faltered employing such strategies, but there have also been notable successes.
At the time Steve Jobs returned to Apple in 1997, the company was a money-losing niche computer business. Four years later, Apple introduced the iPod, an MP3 player that would revolutionize the digitized music industry, together with the first version of iTunes and the Apple Store. Collectively, these moves set the foundation for Apple’s eventual leadership in establishing an integrated entertainment environment and set the stage for the 2007 introduction of its pioneering, feature-laden iPhone. These seminal events would be followed by the compatible iPad, Apple TV, and wearable technology initiatives that completely transformed the historic company business model. Apple could no longer be viewed as a personal computer company, with the sales of Mac computers amounting to scarcely more than 10% of corporate revenues. In its unprecedented creative process and corporate reinvention, Apple became the world’s most highly valued public company.
What are the most common finance mistakes you have seen other businesses make? What should one keep in mind to avoid that?
As I describe in “The Value Equation,” companies don’t go out of business because they lose money. They go out of business because they run out of cash. For business leaders and their shareholders to sleep well at night requires a business model having sufficient margins for error together with a corporate capital stack that enables reliable capital access.
I can offer an illustration:
The company was large and publicly traded, having a balance sheet funded with a mix of equity and asset-backed commercial paper. For the uninitiated, commercial paper is the single most cost-efficient way to borrow short-term money. Doing so requires that the issuer have banks willing to step in and buy back the overnight paper if there is no market. However, the market for commercial paper had historically been so dependable that this particular company used it to fund long-term, fixed rate loans. It then appropriately hedged the interest rate risk. But then the unthinkable happened. In its rapid growth, the company suffered an unfortunate accounting restatement, which became a catalyst for the election by some of its banks to not renew their back-up credit lines. The resultant credit rating loss would cause all the company’s commercial paper to become instantly due, requiring the immediate refinancing of an entire large asset base. In this process of liquidity evaporation, the business, which had not reported any historic losses, was compelled to seek bankruptcy protection. The business did not survive this catastrophic risk and was purchased by a consortium of investors that liquidated its assets.
At the time, I was President of our first public company and we had been approached by several banks suggesting that we likewise adopt this commercial paper funding strategy. To do so would have materially elevated our profitability. When we inquired about what would happen if our banking group did not renew its back-up commercial paper credit lines, we were told that such an event had never happened. So, we asked that the banks support this assertion with credit facilities of long duration. They declined and we passed.
In case you are thinking this is an exceptional story, we had a good customer having an exceptional vertically integrated oil business. In their growth, they funded much of their borrowings with highly efficient, asset-based credit facilities, essentially short-term borrowings backed chiefly by massive oil inventories. Unfortunately, the company elected to not hedge sufficiently against the price of oil. The near-term result of this oversight was elevated profitability. However, after reaching an all-time high of more than $140 per barrel in June 2008, the price of oil plummeted to around $40 by the end of the year. With oil worth less than 30% of what it had been, the available borrowing base under the company’s credit lines likewise fell by 70%, resulting in a large margin call that could have been avoided through oil hedging contracts. In this process, the business, which had been a consistent performer, ran out of cash and filed for bankruptcy protection. Unlike the prior illustration, this company found a buyer. However, the similarity is striking. Sacrificing a prudent capital stack and liquidity access for short-term earnings proved fatal.
Ok, here is the main question of our discussion. Based on your experience and success, what are the five most important things one should know in order to succeed in the modern finance industry? Please share a story or an example for each.
Number one is defining a market that stands to benefit from your ability to provide capital. Finding lending or financing niches is not simple in our highly refined lending markets. In this vein, we have historically limited the scope of our financing products and the markets to be addressed. Specialty lenders have an edge where it comes to risk quantification.
Second is the maintenance of credit quality. Potent credit cultures are difficult to maintain, which has resulted in the demise of more than one finance company.
Number three is diversity. The study of the importance of diversity garnered Harry Markowitz a Nobel Prize in Economics. All finance companies will make mistakes. The issue is to not place too many eggs in one basket. Essentially, Dr, Markowitz posited that investment diversity provided a free lunch, raising the likelihood that a non-correlated pool of loans to average companies could behave, in aggregate, like an investment-grade rated pool.
Number four is portfolio monitoring. Our companies benefitted greatly from customer financial reporting which enabled us to be proactive on the comparatively small portion of the portfolio that was underperforming.
Number five is a prudent capital stack. Capital stacks should be put together intelligently. They need to match fund corporate cash flows to avoid liability sensitivity, which is the adverse impact that can happen when interest rates rise and maturing borrowings need to be refinanced at elevated costs. The borrowings should ideally be long-term and not subject to risks of call, like commercial paper. The amount borrowed should also be less than the amount that could be borrowed, providing an added liquidity cushion.
Of course, none of this is possible without a quality team and a corporate culture willing to critically address each of the above five ingredients.
You are a person of great influence. If you could start a movement that would bring the most amount of good to the most amount of people, what would that be? You never know what your idea can trigger. :-)
“The Value Equation” is a potential start and I am looking forward to the response to the material. Original business books offering fresh perspectives on finance are rare. I wrote my inaugural article on the V-Formula in 1999, have been adding to it since then and have applied the findings to our own companies. The result is a novel integrated financial framework for how understand business and its potential to create wealth. Globally, we are in need of greater financial literacy. If I can help deliver a simpler way of understanding business and promoting its virtues, then I believe that has the ability to help many people as they evaluate their personal goals.
How can our readers follow you online?
My website is www.thevalueequation.com. I also occasionally publish on Seeking Alpha and other publications.
This was very inspiring. Thank you so much for joining us!