Last month we closed on our evergreen “fund,” TDV Acquisitions (“TDVA”). TDVA isn’t a fund, per se. Initially, it’s actually a “blank check” company with permanent capital raised from private investors. TDVA will acquire software and digital media businesses. While in some ways it sounds a lot like a fund there are some meaningful differences. The purpose of this post is to explain why we took this approach as opposed to raising a traditional private equity fund.
First, let’s define the anti-hero (no offense to our PE friends). A private equity fund is a pool of committed capital invested by a professional manager. The manager typically invests this capital in a selection of businesses over a period of 5-7 years, at which time investors can expect her money back (plus a handsome return, hopefully). Managers collect an annual management fee based on the total size of the fund and a portion of the profits. While performance is a key objective, managers are also incentivized to raise and deploy as much capital as possible and as quickly as possible. This is a tried and true traditional model. But it doesn’t align with our vision.
What’s our vision? Our vision is that TDVA can, over time, acquire and operate a collection of profitable software and digital media businesses. We will use the initial investment capital to build a base of businesses, and then leverage those assets to buy more businesses. Some will be high growth. Some will be high yield. Some will be sold and some will fail. Our ambition is that within 10 years is to develop a portfolio that, in aggregate, produces $100M in annual revenue. TDVA could then IPO, sell, or simply hold.
That approach isn’t compatible with a traditional fund structure. So we went a different route.
In TDVA we essentially started a company and sold shares to our investors. We’re going to keep the dollar figures confidential, so let’s use some round numbers. Let’s assume we sold 1,000,000 units at $1 per unit. That gives us $1M to invest. We will enhance that equity capital with debt to further extend our buying power. Follow on capital, if needed, can be raised at (hopefully) ever-increasing valuations as we acquire more and more businesses. Investors can exercise their pro-rata (or more), liquidate, or get diluted along the way.
Why go this way?
1) We want to de-couple capital raised from returns
This is a biggie. One of the problematic elements of the traditional PE model is that fund managers are incentivized to accumulate assets under management (“AUM”). A typical 2% management fee on $1B of assets is $20M a year - whether the performance is good or bad. That’s a stunning amount of money to collect in fees for making investments that might or might not be successful. In our experience, great returns are generated by great performance - not by deploying large amounts of capital. This may seem obvious, but for many PE investors whose business becomes raising and deploying capital, it can be easy to forget. With TDVA wanted our north star to be outsized returns even if that means relatively small AUM. Anyone can put capital to work; getting back more than you put out is the hard part.
2) We want flexibility
A traditional fund structure typically has a defined hold period. We don’t want to be forced to buy a business when the market is too hot just for the sake of deploying capital and maximizing our AUM by raising more capital. On the flip side, we don’t want to sell perfectly good, dividend-yielding businesses because of an arbitrary hold period of X number of years. Sometimes it will make sense to buy; sometimes to sell; sometimes to hold. Let’s let the opportunity and our returns guide us.
3) Our investors don’t need their money back for a long time
Our capital providers are focused on long-term success rather than generating institutional gains necessary for career advancement or another motive. It's money that, if we do our jobs well, will develop into generational wealth. As managers, that’s a huge responsibility; we treat our investors’ money as our own. That’s not a metaphor. We (Jordan and Mo) each have 7-figure commitments in the same security as our investors.
4) We want to build and leverage strong back-office operations
There is leverage in scale. With fixed costs like accounting, finance, HR, and some technology services we are able to develop efficiencies and centers of excellence that can benefit the entire organization. We frequently acquire sub-scale businesses that would otherwise be unable to afford - as an example - sophisticated analytics. By grouping these businesses and developing a shared-service model we are able to invest in a bench of high-level talent that can provide our portfolio businesses with an unfair advantage in the marketplace. This only comes with scale.
5) We want consolidated borrowing
Much like #4, with increasing scale credit becomes cheaper and easier to obtain. Cheap credit will help drive our equity returns. A company with a larger P&L can usually borrow at cheaper rates than smaller businesses where the perceived risk of default is higher. In a traditional fund structure, one portfolio business usually can’t leverage the borrowing capacity of another business. In a holding company, it can. We want to be able to use debt for follow on acquisitions or investments in growth. By consolidating the balance sheets of our portcos under one entity we can borrow more money at less cost. Further, it opens up opportunities that would otherwise be closed if we had to use all equity for acquisitions because the return profile does not make sense.
6) We want consolidated liquidity options
Candidly, we have no idea how this story ends. There are publicly traded analogs in the space such as Constellation Software, Upland and J2 (now Consensus Cloud Solutions). There are privately held analogs (too many to mention) generating steady cashflow for their owners, and others still that choose to sell off all or some of their businesses in time. A capital company structure gives us maximum flexibility to set the right course for TDVA portfolio companies.