The Value Equation. Christopher H. Volk

The amount of wealth created in the 50 years between 1970 and 2020 is indeed almost without precedent. One would have to look to the same period a hundred years earlier for a comparative period of productivity and creativity. Instead of names like Bezos, Musk, Gates, and Buffett, one might have spoken of Rockefeller, Carnegie, and Morgan. Still, the numbers of the world's most affluent today dwarf those of the Gilded Age, or what is also called the Age of the Second Industrial Revolution.

      Of course, much of the difference in the magnitude of today's superrich lies in population growth. Much is also owed to enhancements in capital formation, including resources such as the Small Business Administration, venture capital, and pervasive private equity firms. These resources, together with technological advances, gave rise to what is today called the Third Industrial Revolution, with economic and productivity growth propelled by digital and technology advances.

The numbers show that being a billionaire is statistically easier than winning the Powerball. It is also statistically easier than making a living on the PGA Tour. There were an estimated 927 billionaires in the US at the end of 2020. Meanwhile, the career earnings of the active golfer ranked 927 on the PGA Tour amounted to less than $25,000.⁴ There are more self-made billionaires in America than there are PGA Tour pros who can earn a good living playing the game.

Getting into the NBA is nearly equally hard, with just 450 players scattered across 30 teams, and each earning a median salary of approximately $3.5 million in 2019.⁵ Getting into the NFL is a little easier, with about 1,900 players and a far lower median salary under $850,000.⁶ Yet, you would be right to say that all these people are virtual “unicorns,” or mythical creatures, which is also a term used today for start-up businesses having valuations of a billion dollars and up.

Odds of Success

      To my way of thinking, the real action in business lies in the middle markets, which I would characterize as companies having from $10 million to $1 billion in revenues. This is where most of the job growth and business creativity is in the United States. This is the most common fertile ground for growing businesses that have the best chances for material wealth creation.

To be among the broad group of thousands of middle market businesses is broadly attainable.

      By contrast, smaller companies often serve as vehicles for independent employment, which can be personally rewarding but generally lessen the chances for wealth creation.

      The bottom line is this: If you can harness an idea and transform it into a business model, what are the odds of success?

      It turns out that the odds of having a business that survives at least five years are about the same as the odds of consistently breaking 100 at golf. The odds of business survival for longer than 10 years are somewhat better than regularly posting golf scores under 90.

       Golf vs. Business

Golf1	Business2
50% Can't Break 100	20% Don't survive a year
25% Shoot between 90 and 100	50% Survive at least five years
20% Shoot between 80 and 90	33% Survive more than 10 years
5% Shoot below 80	?? Survive and create MVA

      ¹ Data from National Golf Foundation

      ² US Small Business Administration Office of Advocacy June 2016

      Actually, the odds may be about the same, since golf statistics are based up players who report their scores. Of course, many golfers elect not to report their scores, while among those who do report their scores, there are well-founded suspicions of score embellishment.

      In business, there are generally no free mulligans, and statistics are not compiled from self-reporting, which makes reported business survival rates more reliable.

Businesses that survive 10 or more years are apt to have better business models than those who do not. The outliers in business are the companies that do two things: They survive; and then having survived, they become worth more than they cost to create. These lie at the heart of wealth creation. The aggregate creation of value beyond the cost to create a company is called market value added (MVA). A company's owners tend to be the prime beneficiaries of MVA, though creditors also typically benefit. The principal driver of MVA creation is centered in the ability of a business to realize rates of return that exceed the overall cost of capital, which includes both equity and interest-costing proceeds from other people and institutions. At an extreme level, outlier businesses can enable their shareholders to become unicorns. I expect that most of the founders of such rarified companies end up as surprised as Sergey Brin and Larry Page. But there are thousands of MVA-creating businesses that individually and collectively lie at the center of our economy and the prosperity of our communities.

The Six Variables

      While there is a limitless supply of ideas that might be applicable to business formation, there is not, at a high level, a limitless supply of business models. When viewed abstractly, just Six Variables combine to deliver equity returns and create equity market value added. They are:

      1 Sales

      2 Business investment

      3 Operating profit margin

      4 Amount of interest costing proceeds (other people's money)

      5 Cost of other people's money

      6 Annual maintenance capital expense

      This is not to say that buried within the Six Variables lie far more diverse operational fundamentals. Henry Ford created the first scalable automotive assembly line, and Albert P. Sloan was an administrative and marketing genius who grew General Motors to surpass Ford and become the largest company in the world. These and other operationally minded business leaders are illustrative of the immense creativity that can be harnessed to enhance business models. Still, behind all this effort and operational creativity lie Six Variables, which demand the attention of—and can help—every business leader.

Notes

      1 1. 2021 Small Business Profile, US Small Business Administration Office of Advocacy.

      2 2. Wealth-X's Billionaire Census 2021.

      3 3. Wealth-X's Billionaire Census 2021.

      4 4. Career money leaders list through February 2021, Professional Golf Association.

      5 5. Dimitrije Curcic, “The Ultimate Analysis of NBA Salaries [1991–2019],” August 6, 2021, https://runrepeat.com/salary-analysis-in-the-nba-1991-2019.

      6 6. 2020 Player Salaries, https://www.pro-football-reference.com/.