There is a lot of theory-crafting when it comes to running a portfolio of businesses, and it did not take a long time for us to see that until you spend time running one… you won’t know exactly what your challenges are going to be, or what practices are best for you.
Every time we thought we’d figured it all out – what about a roll-up? A Berkshire Hathaway-style portfolio? – it was never as simple as it seemed. The integration and operations of acquired businesses required a lot more strategy and thought.
A major operational conundrum that kept coming up for us was – should we have one central team running all of our properties, or should we fully decentralize.
It isn’t a simple question. There are a lot of pros and cons to both in theory, which is why we could only truly decide once we’d had thousands of hours of operations under our belt.
A portfolio usually starts when one company expands by acquiring or building a similar or complementary business, where it uses its existing team to fulfill the offering of the second business. It tracks then, that the general starting point for most portfolios is to have a centralized team that runs a couple of different properties.
It could look something like this:
A digital marketing agency owner is great at growing brands for others, and they want to diversify their income, so they decide to launch or acquire a brand or two of their own.
Why would they do this? They theorize that by utilizing their agency’s team to not only fulfill their clients’ digital marketing needs but also the needs of the new brands they’ve acquired, they can keep costs lower, benefitting from their existing expertise.
The premise is that the company can fill up any excess bandwidth team members have with a side-project or additional acquisition’s operations.
Many internet businesses are sold as asset sales, so the founder does not continue with the business post-exit, nor is their time typically accounted for in the P&L – so adding a new “CEO” to the business post-acquisition often eats into the margin substantially. Having an existing team who could fill the roles left by the seller for no (or an incremental) increase in cost seems hugely beneficial.
By using an existing team to take over the business, a portfolio can achieve operating leverage and see their expenses reduce relative to revenues as they keep making acquisitions.
This is how almost every portfolio manager I’ve spoken to in the space starts, and it’s where we were back in 2019.
Onfolio started life as a bootstrapped company, so looking for operating leverage was a key way to scale.
We started out operating much smaller assets that typically couldn’t afford a full-time CEO or SME to run them. By hiring 4 or 5 experts and spreading them across 10-20 similar businesses, we could get the expertise needed for those sites, pay the experts accordingly, and still turn a profit.
Only, there are considerations other than just costs…and getting this next one wrong is the most costly of all.
Let’s talk about focus.
Sure, hiring experts and spreading them across multiple businesses seemed to allow the businesses to “get the expertise they need” but here’s the reality: without focus, it’s only part-time expertise, and part-time expertise is a lot harder to transfer to action.
The online business world moves fast, there are a lot of distractions, and most growth comes from a combination of momentum, quick action, and constant attention.
We learned that, no matter how appealing it seems to have one operator focusing on multiple properties, no matter how much of an A-player you think you have, no matter how many “synergies” you think you see between the companies… every business needs someone to focus on it, and that person needs to only focus on one business. Otherwise, the business will fall behind competitors who do only focus on one business, and it will start to deteriorate. Small things add up to big issues with shocking consistency.
Going All In On Decentralization
Even after this realization, we did not immediately go fully all-in on decentralization.
While it seemed clear that a lack of focus was hurting some of our businesses, it wasn’t obvious whether the solution was a full decentralization, or instead, narrowing the scope of our holdings (so-called “niching down”).
It also wasn’t clear to what extent we should decentralize. Was it okay to have a single, separate CEO running each business, but share central resources among businesses such as marketing, HR, content creation, and graphic design? Was it okay to have all the different companies inside one central Slack workspace in separate channels?
Could we achieve some operating leverage if we still had one central team, but acted more as a roll-up and only bought businesses in the same vertical, such as SEO agencies, for example?
To answer these questions, we looked at other successful holdcos we admire, and what we found was that most holding companies evolved to a fully decentralized model:
- Tiny (fully decentralized)
- Constellation Software (fully decentralized but share best practices)
- Berkshire Hathaway (fully decentralized)
Andrew Wilkinson of Tiny, after having dinner with Charlie Munger and other value investors:
“I think that synergy is how conglomerates die… almost all our businesses are digital, and they all use Amazon S3 and EC2 for hosting. We started going, oh, we should take all the businesses and we should run a procurement process where we negotiate with Amazon directly because it’s a large expense line item, same with stripe, same with cellphone providers… When we asked Munger, he said, “Look, if I could be dictator for a day, I could jump into any one of our businesses and I could probably increase free cash flow by hundreds of millions of dollars with one fell swoop, with simple things. But I don’t because then your CEOs lose trust.” The most important thing when you’re running a conglomerate is having your CEO’s trust. Believing they have full autonomy, believing they can make their own mistakes, and trusting you’re only there when asked. After we had that conversation, we spoke to many other people who run conglomerates. We’ve moved away from that.”
Mark Leonard of Constellation Software on smaller, decentralized Business Unit Managers and teams:
We seek out vertical market software businesses where motivated small teams composed of good people, can produce superior results in tiny markets. What we offer our [Business Unit] Managers is autonomy, an environment that supports them in mastering vertical market software management skills, and the chance to build an enduring and competent team in a ‘human-scale’ business. While we have developed some techniques and best practices for fostering organic growth, I think our most powerful tool is using humanscale [Business Unit]’s.
When a VMS business is small… if the business leader is smart, energetic and has integrity, these tend to be halcyon days. All the employees know each other, and if a team member isn’t trusted and pulling his weight, he tends to get weeded-out. … Priorities are clear, systems haven’t had time to metastasise, rules are few, trust and communication are high, and the focus tends to be on how to increase the size of the pie, not how it gets divided. That’s how I remember my favourite venture investments when I was a venture capitalist, and it’s how I remember many of the early CSI acquisitions.
The larger a business gets, the more difficult it becomes to manage and the more policies, procedures, systems, rules and regulations are generated to handle the growing complexity. Talented people get frustrated, innovation suffers, and the focus shifts from customers and markets to internal communication, cost control, and rule enforcement. The quirky but talented rarely survive in this environment. A huge body of academic research confirms that complexity and co-ordination effort increase at a much faster rate than headcount in a growing organisation.
David Landry of Demesne Investments has also done some excellent research into the different types of holdcos and how they operate:
Committing to a model of human-scale business units means that there will be many people with the same job function across the organization. One of the main reasons we so rarely see companies with hundreds of autonomous business units is the allure of the quick cost synergies that can be harvested by eliminating these supposedly duplicative roles and combining operations.
For many acquisitive companies, these kinds of cost savings are the most important driver of their M&A underwriting. Decentralized businesses, especially those that acquire already-robust businesses, know that in the long run, this can kill the golden goose.
Every acquisition requires some degree of integration. In decentralized businesses, the most invasive integrations happen with the smallest acquisitions at the lowest levels of the organization. At smaller sizes, a more invasive integration is more manageable because the acquired business is simpler and there are fewer people involved (i.e. human-scale). The risk to the broader enterprise is also more limited if it goes awry. The C-suite does not get involved at this level unless asked because the manager who will have responsibility for the acquired business going forward should have the primary say over how it is molded into his existing operations. As the size of the acquisition increases and becomes more complex, the lighter the integration is likely to be.
This approach to integration and synergies is a total inversion of typical corporate behavior. It is all too common to see self-important (and poorly incentivized) CEOs push for large, splashy acquisitions for all the wrong reasons. Tantalizingly huge synergy estimates are dangled in front of analysts while the integration costs are relegated to the footnotes. Yet it always seems to be the synergies that are overestimated, and the integration costs that are underestimated.
Ultimately, we concluded that the solution to a lack of focus was indeed to decentralize – and to go all in on it. This meant:
- One CEO per business (unless the businesses were extremely similar, so much so that one could be run as a division of the other)
- Setting up unique finance and operational accounts, eg. bank accounts, QuickBooks, ClickUp, payroll processing, HR management software for every acquisition
- Of particular importance: Setting up a unique Slack workspace for every business.
A further note on moving teams to dedicated Slack workspaces.
We already had separate, dedicated channels for each business and we kept these channels under the Holdings Slack workspace – but as we grew and stopped sharing internal services, we found it was starting to become disingenuous when people who would never work together had to welcome newcomers to the company and wish each other happy birthday, among other things.
One thing that we grappled with was the idea that it can be tricky to build a team culture when you’re fully decentralized. We realized, though, that our company was already a conglomerate of different teams, and each team had its own culture. These teams worked so well within their own sub-cultures that it didn’t make sense for us to force our culture on them – but rather to lean in by letting each team build their own culture and bond further. This is only helped by decentralization.
Admittedly, some existing team members were used to being in one big Onfolio Slack and needed to adapt as we implemented this, but they soon saw the benefits of smaller groups and tighter teams.
It greatly benefits new members who come into an already decentralized company. For example, if Contentellect hires somebody, that person should feel part of the Contentellect team – instead of feeling lost as part of the Onfolio team where they “interact” on Slack with people who work on totally different businesses, who they’ll probably never meet.
Keeping teams in their own Slack allows them to thrive better and unlock their own creativity.
The CEO of each company does remain in the central Onfolio Slack with the C-Suite and holding company team so that we can facilitate knowledge sharing and accountability.
We decided some time ago that the best way forward was to fully decentralize, but waited until we had some bigger assets in our portfolio. The smaller assets still benefited from shared HR and other services, but after making our latest acquisitions post-IPO, we’ve leaned fully into decentralization and that process is nearly complete.
As mentioned, many of the businesses we come across in our deal flow are being sold by solo founders. Many times the founder does not account for their own time in the P&L, so it’s up to us to negotiate the price based on what we think the cash flows will be with a new CEO in place of the seller. For example, we acquired Contentellect for a much lower multiple than usual, but we were pricing in the cost of hiring a dedicated CEO.
Contentellect makes an excellent case study as it is the first business we’ve acquired that we had fully decentralized from Day One. A dedicated entity with a dedicated CEO, everything is 100% separate from the holding company, and has no one working on it who also works on other businesses.
Granted, it’s a bit early to declare victory after just one month – but based on February’s performance, we are confident this model is the way to go.
Will This Make Acquisitions Less Profitable?
Yes and no. Since we’re now hiring a dedicated, hungry, experienced CEO for each business, rather than sharing that cost across businesses, there will be an instant hit to the bottom line that we didn’t necessarily have before.
However, we price this into our acquisition valuation and purchase price. The DCF modeling we perform includes realistic costs of a CEO, and we bid accordingly.
Does this mean we will miss out on some deals because we aren’t willing to pay as high as others? Possibly. But that buyer will either need to work for free or they will not see the margins they were expecting after they install their own CEO. For us, it is much more important to know there will be an increased expense for the incoming CEO, factor that into our NPV calculations, and be disciplined with our bidding. And the reality is, so far, factoring the cost of a CEO into our modeling hasn’t given us any headwinds when it comes to winning deals over competitors.
Crucially, hiring an excellent CEO only impacts the business’ profitability in the short term. Long term, the focus they bring will lead to vastly improved results and increased profits.
Will CEOs receive equity in the businesses?
We could write a whole other article on this topic, and one day we probably will. It’s complicated to decide whether CEOs should receive equity in the businesses they run, or stock options in Onfolio, or other compensation arrangements such as bonuses and phantom equity.
Giving equity in a specific business increases the CEO’s sense of ownership and directly rewards them for their efforts. Giving equity in Onfolio means there is liquidity (eventually) for CEOs, and a sense of all CEOs rowing together.
A sense of ownership, a direct reward for success, liquidity, and a shared direction can all be achieved with different structures though, and we aren’t yet married to a single structure. What we do know is that we are looking for a balance between rewarding CEOs for performance, unlocking their entrepreneurialism, and keeping Onfolio and our shareholder interests at the forefront.
So now that we’ve fully decentralized, what does Onfolio look like right now from an organizational structure perspective?
But What About The Benefits Of Centralization?
One of the main advantages of a roll-up is the ability to cross-pollinate and cross-promote between brands. We’ve found we can still achieve this with our companies, and we can even have some companies form clusters of close relationships, while keeping their operations completely decentralized.
We think it’s important to make these optional for CEOs though. If it makes sense for both businesses to work together to grow both their own companies and the larger Onfolio pie, then they’ll do so. Our job is to facilitate that through introductions, sharing of best practices, knowledge sharing, case studies, and in-person meetings. The key difference is that we are not forcing it on the companies, which brings a lot of potential issues.
Essentially, we’re looking to capture the upside of a roll-up (shared knowledge, potential JVs, business relationships) by way of suggestion and facilitation, whilst mitigating the downsides by fully decentralizing the teams and letting synergies happen organically rather than systemically. It’s the best of both worlds, and believe that we can achieve this.
To summarize, after initially wanting to centralize our operations to capture more “synergies” and cost savings, we have learned that fully separating businesses is the way to go, as it allows focus and entrepreneurial freedom.
We are already seeing benefits here, and will continue to lean in on full decentralization