NEW PODCAST! HOW TO RUN SHARED SERVICES IN PE & VC
Colin and Brent discuss problems with a startup studio, setting up internal services in PE, and different value-add structures
Join Colin's Micro-PE Course & Community at IndiePE.com.
Colin Keeley: [00:00:00] Hello, and welcome back. This is Colin Keeley here,
Brent Sanders: [00:00:03] And I'm Brent Sanders.
Colin Keeley: [00:00:05] and we are two guys buying and building wonderful internet companies.
Brent Sanders: [00:00:08] Yes, we are in and does it sound like I have a cold? I just noticed that it sounds a little congested.
Colin Keeley: [00:00:14] a lot better than you have been for the last week and a half.
Brent Sanders: [00:00:18] No, you asked me when I first got this. If I got a COVID, COVID test, I'm vaccinated. I actually got COVID a long time ago, so I'm like, I shouldn't be, I got it from all the rug, rats, all the kids running around and they had sniffles like two weeks ago and I ended up getting hit with a pretty hard cold, which was worse than COVID.
So maybe I got the Delta Varian. I don't know. All the testing places near me are closed. Like once the vaccine started rolling out, they all just picked up. And, but I bet I could get it anyway. I'm a little congested, but feeling wonderful.
Colin Keeley: [00:00:48] Anecdotally, it seems like there's a number of people that have both had, Delta after the vaccine or they got tested, they didn't have Delta, but they came down with something like that was a pretty serious flu. So it does seem to be roaring back in some sense, even if it is not COVID.
Brent Sanders: [00:01:03] Yeah. I think it might be who knows? I can definitely taste and smell though. So that was the one thing I definitely lost when I go.
So who knows, hopefully I'm building that immunity, getting my immune system back to where it needs to be. But, this week we wanted to talk a little bit about what services, how we work on these mini, private equity businesses, micro, private equity business.
Colin Keeley: [00:01:24] Yeah, I think services in general, everyone plays it a little differently, the private equity world or the holding company world. So we can talk about that. And then I know you have pretty strong opinions of services in the startup studio model. Cause you ran that for us. So I think that would be interesting for people to hear the history and how we think about it today.
Brent Sanders: [00:01:42] Yeah. And it's an evolution. I think, we talked to, we were guests on a podcast in, with, I think it was Andrew piano. And he was in a startup studio that was based in California and they were doing something similar, one of the things that I think I learned, and I'm just going to dive right into a little bit of history.
So I ran. I started a software development agency, probably what 17 years ago, something like that long time ago, it was just myself and hired a couple of employees. And over time I had about 10 employees and wanted to get out of that business because it sucked, it was a, just a people business.
It was like, you're constantly feeding the bees, trying to get more work in. And it was just a merry-go-round. Profitable, who is a good business from that respect, but it just got boring, frankly. And so we had started doing our, I had started doing, convertible notes with clients so that they were startups.
And, I would do some work at a discounted rate. We were at the time charging, I don't know anyone for one 50 to two 50 an hour. And so we'd go down to $75 an hour and forever, every hour we worked, we earned. It was essentially like convertible debt. So we would still cover our costs and make a little bit of margin.
And so we did that with a couple of clients and they were not great startups. And so I thought a lot about that in, I got connected somehow with Paul Lee. And he was, he had started Ronin, which was this, basically studio model incubator, where they were going around and, spinning up new businesses from scratch, raising a little bit of money or drawing money down from an existing fund and spinning up a startup and internally, building the product, designing it, getting, testing it, going to market and all these things basically going from zero to one, finding a CEO, not too different.
I guess what we're up to in a way, except we're not going from zero to one, we're taking a business and trying to install a CEO and an operator and then set it off and let it do its thing. Recap though, it was a little bit different of a model where, the reason for joining with them was I was bad at picking companies and I actually didn't really know anything about, I didn't really know what a comfortable in it was.
I knew. There would be some potential upside for me, or I was getting some form of equity. I had no idea net what I know now, which is, after four years of spending time in the venture capital world is like all the nuances around it. And, the experience that I have now. So that was really the goal of joining that group.
And I would say to that end, it's been super successful. I've learned venture capital. I've learned fundraising helped raised $175,000,575 million fund and gotten tons of experience. Looking at deals, evaluating deals, how fundraising from LPs works to deploy capital in that whole scene.
And so it's been like, I don't want to offend your MBA, but it's been a form of an MBA, right? I didn't go to business well, but it was, it rubbed off enough to learn something about a very specific, space. But then came, the question is once I brought my company into this, Basically like a VC fund, how does it work?
What are the mechanics around? And we didn't know. We knew that some people were doing this thing. And so when I say a studio model, just to add a definition, there was, we have a set of resources. There was a marketing capacity. So there was another company that was run by other, other co-founders.
That did performance marketing ad spend. And then my group, which was, Hey, we'll design build, support your product. So get it out the door and write code and all that good stuff. So these two services are available to you or, you don't have to use us, but that was the whole thing.
And so we were pitching to CEOs that had done it once before. So we were definitely marketing to folks that had tried to. Start a business from scratch, raise money, find a co-founder or find a technical co-founder find, find a marketing co-founder, whatever it is. They realize the value of having some help.
And So that's what, who we would pair up with and it worked really well. We had a couple of wins. We have a couple of businesses that are still in the running and growing and raising it significant marks, but we have a few, venture that just fell on their face. The
Colin Keeley: [00:05:52] brag a little bit for you. Paro just raised at $120 million valuation, something like that. They just raised a series B $25 million. So that's, it's the most successful one, out of the fund so far.
Brent Sanders: [00:06:04] out of the fund so far. Yeah. And so what did we do for power in the beginning? Not much. We made decks fundraising decks for them. We did a lot of we, I think, we made their brand, which I think they're still using, We built a bunch of prototypes of product and whatever else, but they, they were smart in the sense that they were quick to hire a seat, a CTO and, get their own tech team up and running.
And what we saw is, in the failure cases and over-reliance on the studio, it's like, they knew they would never hire, they would wait too long to make these internal hires. And, we still invoice these people, it was definitely, it was a cost plus model. So this is the topic I really want to dive into.
So the long and short of it is like, how do you keep talent around? So when I talk about talent, on the studio side and how do you incentivize them to work on projects where, They're not getting their full, they don't really know that they're necessarily, they know they're working at a discount to an extent, but like they're also knocking necessarily getting that equity.
And, when it comes time for bonuses and whatever else, it's it's a little bit tighter of a belt to work with. It was like burning the candle at both ends. Which, but I think our model works really well. Cause I've heard of, like the Andreessen model where they have, a bunch of experts.
And what I've heard of the challenges there is getting people interested in enough in your business to work on it. So there's a scarcity of resources. There's no real incentive for them to work on one thing than other than their belief that you're going to turn into the next unicorn.
So if you're like a, an ugly company in that portfolio, good luck getting anybody to help you from, the fund side,
Colin Keeley: [00:07:39] And way too much demanded, like not nearly enough supply of people to help out. So like they over promise and then it's just oh, good luck actually accessing any of that talent that we promised you.
Brent Sanders: [00:07:49] Yeah. So then on the flip side is if you.
can't just have a bunch of people kicking around, waiting for the next idea to start, which is, if you've ever run an agency, timing is everything, being able to ramp people off of a long running project in the ramp up onto the next one, there's an art to that.
And I got pretty good at that. And that was one of the things that as we raised the fund. I was getting in front of LPs and talking a lot about, and that was one of the, you could tell, like the sophisticated LPs were understand like, Okay.
You have 10 people, you have 20 people. Like, how do you pay for them?
Is that my fees that are paying for them? And, never was because we were really disciplined and that's, I think, to both our detriment and. Our benefit, like the benefit was definitely to the LP is we were way more, nobody got a salary that didn't earn it, if like we're never upside down on people.
But then again, we also had to charge for costs. So it was like a very difficult exercise and keeping everybody busy all the time. There was very little bench time. And that put a ton of stress on me of Hey, I'm running this P and L I've got a, three people working on one project, three people working on another.
And that was always the thing is trying to structure small three person teams to work for a six to eight to 12 week period on a project and try to, run agile, do all these things where. Costs runaways or rabbit holes weren't in going down, which was super challenging. But the thing that we stuck with that I would say, looking at Vernon and if we wanted to do a similar model, which I think you and I have been kicking around the idea of who's going to work on these things.
Do we build that back to the company? How does it, how is that structured? Does it come out of fees as a paid for by the fund? We were still in this like early stage, figuring it out. I think the best way is to keep it, how it was done at builder's, which was, you can't lose money on the studio.
That can't be a thing. That's like a source of where all the fees are going and not actually benefiting the businesses. And so it was like a market model. Whether if the portfolio companies didn't use. The studio, then it was the market saying these people aren't adding value. And it was a really hard conversation where, we had some people that are super talented that, the portfolio companies loved and, in some cases we actually let them move over and ocean say, let them, but they were in, that's why they were there is to get involved with early stage startups.
Getting access to that and then going and working for them and getting off my P and L and onto theirs. The hard question there is like, why is that sustainable? And it definitely wasn't. It was like super hard to manage. There was no, I didn't have any, float, I should say, like from the fund, like there was zero.
If my PNL was negative yeah. I was negative and that was not a place that we wanted to be, and it was stressful. The question is like how much is subsidized by the fund through fees or carry or whatever, will fees in this case. And then how much is actually coming from these companies and you don't really want to be like profitable on these companies, but you also want to be able to compensate people and get good talent.
Those are the two that's the long version of getting it. Those are the two decisions to find yourself at when you have a studio or sort of internal services servicing these cases.
Colin Keeley: [00:11:01] So I've been talking to other people in our position that are setting up funds and, on their way, it, some people want way more stuff housed in the head office. So like a lot of marketing, some products back office finance operations. And then some people will want nothing. They want it like a radically slim front office, everything pushed down to the portfolio companies.
And so if you look at how other people that are doing this while do it, they, they go on all different directions. So Andrew Wilkinson and tiny. They, push everything down to the companies. And it's just capital allocation has happened at the head office and like acquiring new businesses.
And so their only job basically is to hire and fire CEOs. And then if they want any, like centralized activity, they'll spin out a new, agent. A new agency focused on that. So like a growth agency or something, and then all the companies will charge full freights. So all the agencies will charge full freight to the companies.
And so it's like the companies could go with any agency, but we have this one agency that's maybe knows your business already. And it's like a pre-approved as like a solid agency.
Brent Sanders: [00:12:10] Yeah. And the other part of it, the other part of it, that is a huge benefit is we were always in-house in the same building as all you're in the same office with all these people. And So there was. Huge benefit to that, But, the full freight thing on startups for VC, it just wouldn't fly. It's just every CEO we talked to, they want a deal.
They want, they really don't want to, touch that cash as much as they'd like to. But then again, it probably is a better motivator to, to not be relying on the agency and just know it's an agency. And I think for these more established businesses, Painful freight makes a lot more sense.
Cause what are your alternatives? Like you can either hire. And I think to me, the question is if you have a playbook that involves like a heavy front-loaded lift where it's like, Hey, every business we buy, we redo that front end of their web app. Or we, brush up their marketing. If that's your playbook, I think it likely makes a ton of sense to have the studio, but, if it's not, and I love the idea of looking at constellation where it's like, Hey, by the business allocate capital, that's it we're w we're not involved.
Colin Keeley: [00:13:20] So Mark Leonard is very similar to Andrew and the way it's structured. So they have a lot of learnings across their whole portfolio, but those learnings exist is mostly. No conversion rate on the. Yeah, top of funnel should be this. And if it's not, it's probably because of these things and that exists is like a document.
And then as in people that can talk to other people at other companies, not as like a, I dunno, a seal team or something that just dives in and fixes it all out. If you acquire a new company. So on the opposite end of the spectrum, I've been spending a lot of time looking at Robert Smith and Vista and they operate very differently.
They have a VC. So Vista consulting group, which is I don't know, McKinsey or something like, a high-end agency that has this 110 point playbook that they use. And this is definitely what they pitch LPs. I don't know if it's 110 points, it's just, good marketing, but they have this big list of things that they go through.
And they deploy in every new company that they acquired and they are Uber confident that any company they acquire, they can make significantly more profitable, but these like standard operating procedures. So they are known to pay much higher, amounts and even to buy like, high growth, very large multi-billion dollar tech companies, because they're so confident that they could improve them pretty dramatically.
Brent Sanders: [00:14:40] There are, I've spoken to other people that work in proper private equity and there's a lot of, management or. The front office or whatever you want the head office, that's making decision that, Hey, you got to go with a McKinsey or a Deloitte in there. Actually they get plugged into every single project.
So if you're of that mindset, you might as well own that business and know you're taking some of that with you or, reaping some of that margin. But, I. Don't have a conclusion here, but I would err, on the side of, the Wilkinsons and the mark, Leonard's where, let them make their own decisions.
Not to say, I don't want to work on these projects and at the scale we're at like with blink sale, like I'm working a lot on it. We're doing the work ourselves. It's a first deal. We want to show the most gains on it, which probably is a little artificial. It's I'm not, we're not paying ourselves.
We allocated cash. People helping us. Sure. We have contractors here and there, we're going to be able to show a little bit more, I think, progress for our capital allocation because we're actually putting that sweat into it, which I don't really think we plan on doing on future deals.
Colin Keeley: [00:15:46] Yeah. As far as lifestyle goes, like it would be way nicer to just focus on buying great companies and then putting in great CEOs in place. And then you're making one decision to make hundreds of decisions because it's the CEO's job to recruit and hire and make all the more minor decisions around the company running.
Brent Sanders: [00:16:04] Yeah, that is definitely the most leveraged position you could be in. But yeah, in the short term, we are in such an early phase to me. I think there's a well-worth even if it's lower leverage, it's well worth showing, Hey, we're going to be able to show gains and a better track record, which will allow us to unlock, where does that get us?
What does that unlock by, by taking these lower leverage things? So it's always stepwise. You gotta be patient. I don't feel like we are in a position to necessarily do that just yet, but we're getting close. You know that's where I think the fundraise kind of question comes in, right?
It's if you can raise that capital now that great, put a fund together, do it. The feedback we're getting is people really want to see track record. People want to see a couple of deals where it's been, these guys know what they're doing. They're not, ask clowns and, actually can put up good numbers.
Colin Keeley: [00:16:59] Yeah, it certainly helps. And it really doesn't matter a ton. If the goal is pay yourselves, like there's all different ways you can do it. You can take a management fee from independent sponsor deal. You can take a closing fee, like a percent of the closing price to pay yourself for the searching period.
The two and 20 is just nice because it's it's consistent. You're getting that too. It's like a consistent salary, even if it equals roughly whatever the closing and management fee would be. It's just a less lumpy.
Brent Sanders: [00:17:25] Yeah. Yeah. There's a lot of different ways. We were going back to the studio model. We were, we had a general like concept of fairness. And I think I learned that was probably one of the best things I learned from the GP. Was there was no subsidy, right? There was no free lunch.
There was no like, oh, you're just going to take these fees and put them in help you like, keep people on your staff and keep yourself on payroll for even to that point where it's like, Hey, this has to make sense. This is this is a real business. This is not just because it's a fund. And sure.
We raised a lot of money. That's for deployment of capital. It's. To, subsidize things that people aren't using or we're seeing value of. And that comes down to a week by week, month by month basis. So I think it's when you look at the world that exists, when you have all these services, it has to be a little cut.
You have to still treat it like a real business, like a cash business, not like a fun that's floating around and, living on fees and whatever else there has to be. No fluff there because I think it's, that's the right way to. Keep it in check. Cause could you imagine keeping, I don't know, two to three people, four to five people, however many are along that aren't really adding value and it's just dead weight.
And so I think that's the one thing is you look at a services model. If you do it, you've got to be super diligent around how you manage it. And, almost do it in not a ruthless way, but a, you have to be realistic with yourself. Are these things actually adding real value to the portfolio?
Cut it, it's gotta go and you can always kind of reboot that stuff,
Colin Keeley: [00:18:56] That's what I think Andrew's model is so clever because every business has to stand on its own and you control demand to a certain extent. Like you could almost stand up an agency with all the demand that you control and then it has to be self-sufficient. So you give, some kind of entrepreneurial head of the agency, maybe a few months salary to get going, and then it's you will, you kill, you got to stand up your own business.
You got to find your own. And then I was asking people in a similar position to us that are standing up funds is have you looked at just, acquiring a growth agency? It would be pretty nice to have one kind of attached to you. And so I don't know if it ever makes sense to go down that path probably only if they are pretty profitable, otherwise you should just build your own and steal the people away and stand it up yourself.
Brent Sanders: [00:19:41] Yeah, the thing is like you buy this business and then you say, Hey, work with my portfolio. And again, if they don't pay full freight, you're going to crater. That agency that's exactly what happened with we might do, which I knew it was going to happen. That was part of the plan is Hey, I'm going to just stop treating.
The cash for future, portfolio like equity value. And that's what I wanted. I wanted to, the cash is great and all, but, it just, it's just a, merry-go-round, it keeps going around and you work and you work and it's is there a way to get a higher multiple, and just that one-to-one hour or two time, or, it's still have employees doing it.
And I was also participating in the work, but, that is the part where I think Andrew has it, is you can't do a, a lesser amount. And then if the agency you acquire decides, Hey, all of your portfolio companies suck. I don't want to work with them. They don't pay my rates. Then you still at least have a profitable business there.
And you don't impact their ability to be profitable with all your pet products.
Colin Keeley: [00:20:34] Yeah, it's a clever model solution to a problem that a lot of people are encountering.
Brent Sanders: [00:20:39] Yeah. Yeah, I think it's right. It goes back to that fairness sort of doctrine of Hey, if it has value, you pay what it's worth. And so for startups, I think that's where you run into a lot of problems because there's just so many constraints and startups really shouldn't be using agencies, right?
If you just started a business, you're the CEO and you have no one on your team. Your job should be recruiting, good people to help you out. It should not be going to, the red antlers of the world and doing a hundred thousand dollars branding exercise. Maybe if you have a candle company, I don't know, but that'd be a weird startup.
Colin Keeley: [00:21:11] Yeah, it's a red handler is a lot more than a hundred thousand dollars. I think it's like a few hundred thousand dollars to get a brand. Done with them and they have to be like, you have to be one of the chosen ones. Cause they turn down like all the work they get approached with.
Brent Sanders: [00:21:24] Yeah, we hired, we had a portfolio companies and it was a hundred thousand
Colin Keeley: [00:21:27] Oh, it was.
Brent Sanders: [00:21:28] just a brand. Yeah.
And the companies aren't around anymore. So go figure that being said, not to the detriment of the founders, they were right. It was just a very hard space. It was something in the, aftercare space and the death space, which is, implicitly difficult.
But Yeah. They wanted to, they did a great job, but they just, it was like, not quite the right thing.
Colin Keeley: [00:21:48] The one that I know that paid are they paid more, it's a different company, him as well, but their dead as well. So it didn't save them. Their beautiful brand did not save them in the long run.
Brent Sanders: [00:21:58] Yeah, no, you never know what can be resuscitated in that world, but yeah. Yeah, I dunno. That's the world like that's the world I've come from though is like that New York agency world, where things are cycling through at a pretty fast clip. And, if you compare work for a startup versus Hey, you're doing brand work for at and T through some giant agency, it's it runs at a similar pace.
There are a lot of similarities, but there's a vastly different business behind it when you're working for a, some massive global company that, has no problem dropping a hundred thousand dollars a month or whatever it is for these agencies at least a hundred thousand a month.
Colin Keeley: [00:22:35] Yeah. Hey, anything else you wanted to talk about?
Brent Sanders: [00:22:38] No, I just think that, that's something we're working through as, as we're working on. The business we do have, and then as we look at sort of these future deals, it's like, where does the fund get involved? Because part of me thinks a studio is a huge value.
Add part of me thinks it's a huge pain in the ass. So it's like, where do we net out on the idea I'm of the mindset. As of right now, you can quote me on this is like the hands-off approach. Let the CEO decide. And if they want to work with somebody. As internal or if we even have internal resources, having that, that Wilkinson model, that full freight model is the way to be
Colin Keeley: [00:23:10] Yeah, I think for starting, it doesn't make sense to start up a investment fund investment firm and an agency at the same time. So I want this shared playbook which we'll develop and share. But mostly it'll be in the form of connecting the right people together, connecting the CMOs together, the head of paid marketing's together.
Then standing up your own separate thing that you have to manage, but, yeah, at some point you get big enough, maybe it makes more sense to have those shared services.
Brent Sanders: [00:23:37] Cool. Until next time we'll chat about something else. Fun related. Okay.
Colin Keeley: [00:23:42] Yeah. Next week I will talk about Robert Smith. I've done a bunch of research on this. I just got to clean up all my notes. So there'll be a fun, deep dive, very different than a constellation, the complete opposite.
Brent Sanders: [00:23:54] I'm looking forward to it and we'll hopefully elaborate more on the software. Smells or tastes like chicken
Colin Keeley: [00:23:59] Exactly. I've said it so much. I had to research it a little bit more, but yeah.
Brent Sanders: [00:24:05] Cool. Thanks for listening.
Colin Keeley: [00:24:07] Yeah, take care, everyone. Bye-bye.