Capital allocation

Factual definition

Deciding where a business commits its capital, including reinvestment, acquisitions, debt repayment and distributions. Responsibility may be shared among management, the board and owners.

Capital allocation in round numbers

Hypothetical: a company has US$10m of free cash to allocate over the next year. It compares a new facility, an acquisition, debt repayment and a distribution, considering expected returns, risk, liquidity needs and obligations.

Shayne Fitz-Coy’s definition of Capital allocation

The frameworks are borrowed (Buffett’s canonical menu, the owner-earnings discipline) and Fitz-Coy’s contribution is the insistence that the practice is unavoidable and daily. Capital allocation is not a annual strategy exercise.

It is whatever the owner does with this month’s cash, including nothing. His teaching separates two acts that look like one decision: buying ownership and funding growth.

Both are capital allocation, both are judged by the same required return, and confusing them is how owners pay growth prices for businesses that have not grown yet.

How Shayne Fitz-Coy uses Capital allocation

His day-one worked example: a buyer with $5.6 million splits it. $4.2 million to buy the founder’s ownership and $1.4 million to fund five new locations.

Two different acts with the same dollars, and both must clear the hurdle, because $5.6 million has to become roughly $17.1 million in five years to compound at 25%. The leveraged buyout (LBO) calculator’s rule generalizes to the whole practice: work backwards from the required return to the walk-away price before looking at the asking price.

The framework is borrowed. This week’s allocation decisions are not.

Why Shayne Fitz-Coy’s perspective on Capital allocation matters

The multiple is paid at entry, but the allocation decisions create the exit. A student who can value a business but cannot rank its uses of cash can analyze the past and cannot operate the future.