MarCo
MarCo (Martech Consolidator) can start life as a fund which partners with a martech company (like Netcore). This mirrors the beginnings of Constellation Software, as outlined by Speedwell Research:
Over [his] next 11 years in VC [venture capital], Mark Leonard would solidify what he wanted to build. He would fondly recall how fulfilling it was to build something properly as a masonry, which required mastery and would be there 100 years later. (To his surprise, this was in contrast to many of the start-ups he worked with that had a “build to sell” mentality). His masonry experience, coupled with some mentorship that that exposed him to the Buffett & Munger orthodoxy, inspired his plan to construct an enduring company. This nebulous desire, however, only started to calcify after a novel insight about the success of Venture Wests’ portfolio companies. He noticed that their most successful venture investments were vertical market software companies, which to Leonard seemed to have all of the business virtues Buffett would want with a competitive “moat”. The problem though, was that each vertical market software (VMS) company was relatively unimpactful to the overall portfolio results because of their small size. His idea was to create a holding company that would just focus just on acquiring VMS companies, which he imaginatively wanted to call Software Co.
Mark’s reputation as a sharp thinker with an indisputable work ethic made many of his Venture West colleagues enthusiastic to seed his idea, which, alongside an old business school buddy who happened to work at OMERS (Ontario Municipal Employees Retirement System) pension fund, allowed him to raise a full $25mn CAD. There was one piece of feedback though; the name Leonard picked was terrible. And so Software Co. became Constellation Software, a reference to seeing a unifying picture of otherwise unconnected pieces, and officially launched in 1995.
In the early years of Constellation Software, Mark Leonard would lead the acquisition process, focusing on wholly acquiring their first VMS companies. The attraction to VMS was born from the fact that each software offering tends to be mission critical to users and each market is small enough that competition is insulated from the big players who could not rationalize spending in these small TAMs. Additionally, the recurring nature of most revenues and minimal maintenance capex makes software inherently attractive.
Recurring revenue is what SaaS companies get. The challenge for many is that the sales and marketing costs are high (remember: 11,000+ martech companies!) and this hurts their ability to generate consistent and scalable profits. What MarCo therefore needs is one or more anchor martech SaaS companies (like Netcore) which have access to a large portfolio of digital businesses.
Imagine a $100 million fund to begin with — $10 million coming from the anchor martech vendor, $40 million from investors, and $50 million in debt. Assume the debt will come in at 10%, and thus need $5 million in annual interest payments.
Next, let’s assume there is a target martech company with $5 million in revenue and about $1 million in operating losses. So, the split of the $6 million in costs would be something like this:
- $1.5 million in cloud costs (assuming 75% gross margin)
- $1.5 million in product, engineering and R&D
- $1.5 million in marketing and sales (30% of costs)
- $1.5 million in general & administration costs
Three costs can be reduced after a takeover by MarCo:
- A third of the product, engineering, and R&D costs – by shifting some operations to India
- A third of the marketing and sales, by leveraging the strengths of the anchor martech vendor and cross-sell across the growing portfolio
- A third of the G&A costs – by consolidating across the group
Together, this can bring in savings of $1.5 million, converting the $1 million loss into a 10% positive EBIDTA of $0.5 million.
Half of this would be used to service the debt on the deal, and the other half becomes the cashflow used for expansion of the business and MarCo.
Growth will also accelerate because of the benefits of cross-sell and integration into the stack, thus leading to higher profitability and more free cash generation.
So far, we have not even factored the benefits of expanding the market size by shifting the AdWaste.
Taken together, this can create a very powerful flywheel for growth – just like what Constellation Software has done.
