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Highest Use of Capital [Finance
Posted on January 22, 2016 @ 07:02:00 AM by Paul Meagher

In my last blog on the principle of highest use, I wondered whether we might apply the highest use principle to investment capital. The basic idea is that we would want investment capital to serve its highest use first but also subsequently enjoy other uses that our investment capital might have. The purposes of this blog is simply to explore how we might apply the highest use principle to investment capital. I think it is an idea worth exploring and hope this blog encourages you to come up with your own views on the highest use of capital.

We might begin by listing all the uses of investment capital. When I googled "uses of capital" one result that was helpful was the Uses of Capital page on the Virginia Capital Partners' website. They list 8 uses for their investment capital. These uses are listed below (visit this page for details on each use):

  • Growth Capital
  • Acquisition Capital
  • Geographic Expansion
  • Startup Capital
  • Public Company Assistance
  • Restructuring
  • Shareholder Liquidity
  • Recapitalizations
  • Management Buyouts

This is a good list of uses for a venture capital firm's investment capital. Many of the businesses that use this website to raise capital seek capital for one or more of these these reasons. Unfortunately it is difficult to order this list and say that one use is higher than the rest. It is also difficult to see how employing capital for one use leaves you with the ability to enjoy other uses for the capital unless you derive a return on your investment that leaves you free to invest in other desired uses. For example, if you invest in helping a company grow, the return from that investment might in turn be sufficient to finance the acquisition of a company or geographical expansion for the company. The highest use principle might suggest the best initial use for your investment capital.

Another way to think about the highest use of capital is to reflect upon your own experiences investing in your business. You definitely want your capital to satisfy as may uses as possible. If you had the choice between purchasing a tractor or a piece of land, what is the highest use of capital? That might be determined by the number of uses I have for the purchased object and whether those uses can return capital that would allow me to re-invest into other uses. The highest use of capital in this case might be a tractor because having the land alone without a machine to work it is not likely to return capital back to me as quickly as having a tractor that can be used for many revenue generating activities and also to develop the land. The revenue generated from using the tractor might allow me to subsequently buy the land and have a tractor to work it which preserves my wealth and potentially allows me to re-invest my capital again. So the highest use principle might help us figure out which of several potential investments is the best use of our capital based on whether one of those investments is more likely to allow us to invest in the other uses for our capital.

Another way to think about the highest use of capital is in terms of maximizing positive impact while preserving wealth. Some call this social impact investing. In this case you look beyond just the monetary returns of you investment to how the investment impacts the lives of workers, the community, and the environment. Henry Ford, for example, said "The highest use of capital is not to make more money, but to make money do more for the betterment of life." Henry Ford may not have been totally philanthropic when he used his capital to raise workers wages as it lead to his workers being able to afford to buy the cars he was producing. Using capital for "the betterment of life" can feedback and create a virtuous cycle of investing that ensures your money enjoys many uses in other hands before it is finally exported from the community for some commodity that cannot be purchased locally. Ford's capital investments had significant social impact while also preserving his wealth. Some might say the preservation of capital is not required in social impact investing. If not, then we have to ask whether this is the highest use for our capital because once it is used up there may no longer be capital available for other uses.

Anytime we invest money we are concerned with making the best use of our investment capital. The highest use principle encourages us to look beyond the initial use of investment capital to anticipate how the investment might lead to other uses of capital either in your hands or in the hands of others. Ideally you want your investment capital to be preserved so it can be used again for the next best use of capital.

Social impact investing is another way to frame the highest use of capital and the highest use principle might be even more applicable to this form of investing. If you are an investor considering a social impact investment you might want to invest in a project that represents the highest positive use of your capital while also ensuring that your capital will be preserved for the next highest use in the future. Entrepreneurs receiving such funds should realize that the objective of the investor may not be to simply to spend their money on a good cause, but to create enough revenue from their investment to preserve their wealth for the next best use and to create the maximum number of uses in the community where the money is being invested.

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