A coworker previously proposed the concept of the “ideal business.” I was doubtful at first, but I listened to the rest of the explanation. A perfect business takes no more capital, generates functionally limitless returns, and lasts an indefinite amount of time. One disadvantage of a business with no cash is the lack of internal reinvestment options. As a result, the owner of such a company must possess abilities that go beyond managerial wisdom, such as capital allocation expertise and management recruiting smart.
A perfect business is rare, and a competent executive with all of the necessary talents to lead it is even rarer. As a result, stock analysts are wary, apply valuation discounts, and expect that any outperformance will be short-lived. Complexity arises from the desire to reinvest revenues in new and varied firms. Maintaining the firms as autonomous and decentralized units is the best method to deal with this. However, this structure has another disadvantage: opacity, which reduces investor confidence. Those involved in establishing and working for such great enterprises, on the other hand, are willing to put their own money into the company – legions of its executives do so. The resulting group of self-made millionaires who are loyal stewards minimizes turnover, adds stability, and keeps the culture alive. Long-term outlooks are likewise crucial parts of an autonomous and decentralized organization, and such managers are trustworthy with them. As a result, a virtuous circle emerges. When you add in the fact that their capital is at risk of being taxed, you have a corporation that is operated for similarly taxable owners rather than non-taxable institutions. Apart from the tragic point at which they can no longer reinvest revenues successfully, the ultimate difficulty for such ideal enterprises is to avoid breaking the virtuous loop. To overcome that challenge, you must first provide an appealing investment idea to owner/operators that fits three criteria: (1) create above-average returns, (2) be understandable and direct (not through intermediaries), and (3) be subject to the operator’s control. As a result, such people will be keen to expand their firm and broaden their competitive advantage, or moat, as well as take a long-term perspective. The ideal business would be able to accommodate the owner/operators it attracts on a regular basis if it had a well-developed investment or acquisition apparatus. Second, the ideal company must preserve both decentralization and its corporate culture, which raises a fundamental challenge regarding how directors and management should handle these issues. In general, directors lead and managers manage in corporate governance. Is structure and culture more important for the board of directors, management, or both? The answer is almost certainly that both concerns are shared duties in the ideal organization. Decentralization is critical for attracting and maintaining business sellers who want to be successful as business owners. Ironically, their senior executives are one of the biggest roadblocks to decentralization, as they generally believe in their own management. However, once they are in charge of a huge number of firms, their team is unable to comprehend anything. Grouping people into groups can help, especially if group presidents are well-equipped with administrative tools. Culture is also strongly ingrained in the perfect business strategy. True, managers have main responsibility, and the board need a clear succession plan, but who intervenes when successor CEOs deviate? The board of directors and management are in sync at the ideal organization. Tom Peters, a management guru, argues for what I call “intelligent autonomy”: flexibly delegate and decentralize around tight performance standards. It is necessary to have a strong organizational culture. There’s much to be said about making a formal declaration or set of commandments, with someone garnering consensus and writing them down. Ironclad rules, on the other hand, suffocate adaptability, which is another necessity of the ideal firm. It’s preferable to keep any written code fluid and adaptable. When it comes to operational risks, it’s “people issues,” not “business difficulties,” that could derail this virtuous cycle. The ability of the ideal business to produce group leaders, for example, mitigates CEO succession. Their departure would be a major setback because they are the epitome of company culture. However, given leaders’ loyalty to the culture, the possibility is limited – the ideal company’s culture would have to change dramatically to force serial departures. The most serious danger is board succession: Defection risk would arise if the board produced an unfriendly managerial environment. Strong directors are desirable, but only if they are aligned with the company’s culture – a strong contrarian director is a nightmare. As a result, the ideal company’s “help wanted” sign for directors reads as follows: We’re looking for a capable, hardworking, long-term director who understands the company’s business, model, and principles. This position appears to be ideal. Lawrence A. Cunningham is a George Washington University professor, the founder of the Quality Shareholders Group, and the publisher of The Essays of Warren Buffett: Lessons for Corporate America, which he has published since 1997. Sign up here to receive updates on his research on quality shareholders. More: Here are some companies that know how to spend money so you can make some money. Plus, why have high-quality, trustworthy companies outperformed the S&P 500 by 30% to 50%?/n
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