I am going to explain how we have segregated the capital allocation and operating functions of our businesses, plus how we choose when to reinvest and when to buy a new company.
Michael Girdley recently covered the difference between a typical CEO and a HoldCo CEO in his newsletter. (Unpaid advertising - subscribe if you haven’t already). He breaks down the Operator CEO and Allocator CEO:
“I think of it as the “allocator” mindset vs the “operator” mindset. An operator-CEO is the person in the arena. An allocator has to be comfortable sitting in the stands, only occasionally getting involved. Instead of being involved in the play, you’re constantly scanning for opportunities.”
In my experience, no CEO is 100% one or the other, but they do lean to one side. I enjoy getting in the weeds occasionally but am a much better allocator. In his book, The Outsiders, William Thorndike discusses what sets great CEOs apart from good CEOs. Their ability to allocate capital; To invest.
Unfortunately, most CEOs reach the position without ever having to prove their capital allocation skills. Most arrive because they are either very good at operations or at sales. They sit in the CEO chair and are now tasked with making capital allocation decisions that will drive the future of the business.
Part of our success has been the separation of these functions. We hire great Operator CEOs. People who love the nitty-gritty of running a business. People who thrive in making the machine work. We then have them pass all excess capital from that business to the HoldCo. Our CEOs can present plans for capital allocation to us, and we compare them with all available options before choosing where to invest.
99% of the time we will reinvest in one of our businesses before buying a new company. Why?
The success of an investment depends mainly on who is driving the outcome. It is a much higher probability to bet on one of our CEOs than to trust someone completely new.
We need to motivate and retain our CEOs. They are paid a percentage of profits. If we veto all their ideas, they will soon be looking for greener pastures.
However, we do have certain companies and CEOs where there are few opportunities to reinvest. In those instances, rather than forcing money into a less-than-ideal situation, the HoldCo structure allows us to look at all possibilities and choose the most attractive.