Perspective

A Letter to Starters

Further insights from Tom Cowan on TDM's operating model and investing philosophy.

The following letter was written by Tom Cowan (TC) to new starters on behalf of the three founding TDM Investment Team members: Ben Gisz, Tom Cowan, and Hamish Corlett.

TDM was founded on the idea that long-term ownership of great companies could create world-class, enduring returns. This letter delves into the details of TDM's unique structure and how we operate, and importantly how our foundational beliefs on investing are intertwined into each of these. Thank you to Tom for agreeing to share this publicly.
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Welcome to TDM

As part of your onboarding, I thought it would be useful to write a note to provide our view (Ben, Tom and Hamish) of what we do and why we do it.

No doubt from the interview process you would have picked up we do things differently around here. We believe deeply understanding this is very important – it is such a critical part of why the team are so passionate and love what they do every day. Hopefully by the end of this and our session together everything will start to become clearer. If not – always feel free to grab one of us to have a chat.

This business was started on the floor of my one-bedroom apartment when I was 26. I’ve known Hamish nearly my whole life and we both then connected with Ben during Uni (in fact he was the first person I met on day one). In those days, we often discussed that if ever given the chance, we would build an investing business from a blank sheet of paper with the vision of being true long-term investors. After Uni, we went our separate ways, and it would take us a few years in other professional investing jobs before we formed what is today TDM Growth Partners.

We began TDM with one objective in mind – to really love what we do for a long period of time. For that to happen, we believed we needed to focus on two things: 1/ investing for the best outcomes for our clients and companies, and 2/ the people we work with and how we operate together.

Since the start, we’ve operated with intentional constraints that are counter to 99% of funds management businesses. These constraints are largely what make us unique and what have enabled us to have the best chance of compounding capital at high rates of return. Starting with almost a million dollars and only one client, today we have 20 trusted long-term clients and about $2 billion of funds under management. We have been fortunate to compound our clients capital at over 25% per annum for almost 18 years – which means our original clients have made approx. 61x their money. We hope to continue compounding at this rate for many years to come. This is our north star – not asset accumulation (but more on that later).

We always appreciated the power of the team. When we came together, we knew that the three of us would get better outcomes than anyone of us individually. And for us to succeed together we needed to share the same values and beliefs. As you will get to see overtime, the three of us have different skills and work in many respects differently but the shared values bind us together to allow us to get great outcomes. As the team has grown exponentially this has only become more important. Without the right people and culture at TDM, we won’t love what we do or achieve our goals.

How we describe what we do

When trying to describe TDM, I’d say it’s difficult to put us in one typical investor category. We don’t fit neatly.

While we have similarities to listed equities, Venture Capital, Private Equity, or cross-over investors, none accurately describe what we do as an investment firm.

In our simple terms, we use the words “growth partners” (hence the name). As growth partners, we invest in a highly concentrated global portfolio of fast growing private and public businesses for long periods of time where we can be a trusted partner to the management team. Our partnership with management can have many flavours from being active Board members to long-term supportive shareholders. Our returns come primarily from the growth of the businesses we’re invested in.

And when we say long term, we really do mean it. We’ve owned one portfolio company since our inception and their public listing 17 years ago. And we hope to remain invested in that business for many more years to come. It has brought incredible joy to see that business go from a $120 million micro-cap business to now an ASX top 25 giant worth over $17 billion.

To further crystalise who and what we are, it is worth explaining what we’re not. How we partner and how we make investment decisions means that there are and will be successful companies and talented investors who will never be a part of TDM.

We don’t make many investments, typically between one to four per year across both private and public markets. We say no to great founders 99 times out of 100. That is not to say these businesses aren’t or won’t be successful, but rather an acknowledgment that we have such limited punch cards given our concentrated approach. Beyond passing a high bar for quality of business, for a business to be right for TDM they need to be aligned to our active approach to true partnership. This approach can be a turnoff to founders and executives who might just want a ‘source of capital’.

This “fit mindset” applies equally to team members. We view investing as a total, all in, team sport. This is rare, given anyone can fulfill the function of allocating capital as an individual and most do. Our team mindset can mean that we’ll miss many talented investors and some great ones will probably leave. We want to be clear about this belief upfront.

Our north star is compounding at 25% p.a.

Guiding every decision is a mission to compound returns north of 25% p.a. for decades to come; we have successfully done so for almost two decades. This is what inspires us.

Peering back over the last 100 years, there are only a handful of investors who have seen the multi-decade success we are chasing, most famously Buffet and Munger compounding at 20.1% from ’65-’21 which is just bonkers. *Berkshire Hathaway 2021 Annual Report 

We’ve set out to achieve this using a different type of business model with the unwavering commitment of fully aligning the interests between our clients, our portfolio companies and the TDM team. The belief that the investment industry operates on fundamentally misaligned incentives is at the heart of how we operate.

To be true long-term investors and achieve high returns over a long period, we needed to rethink the funds management business model and operate differently from the rest of the industry – we re-considered how we approach everything from client relationships, portfolio company support, internal team structures, and investment approach.

Let’s start with our client relationships and structures

Unique client relationships allow us to operate and invest how we do. It is at the core of our competitive advantage. The four elements that form our unique client relationships are:

1 / Shared values

2 / A single pool of evergreen capital across private and public businesses

3 / Transparent individual accounts

4 / Performance-only fees

Element 1: Shared values.

Since 2004, we have been careful to accept only clients who aligned with our values and shared our long-term philosophy to investing. Many of them have built large business themselves as owners or operators, so they understand that businesses don’t move in a straight line. They also understand that excellent management can create immense value over time. We could not operate if our clients’ trust was not unwavering. This is something that we’ve developed over years and focus on building every year.

Element 2: Investing out of a single pool of capital.

The TDM fund has no ‘end’ – you may hear some refer to this as an ‘evergreen fund’. The pool size grows with investment returns, meaning that TDM doesn’t ever have to fundraise, and is closed to new clients.

Our clients have entrusted us with their hard-earned money – and assuming we are holding up our end of the bargain and producing great long-term returns – their capital is with us indefinitely. The practical flow on of this is dramatic. From an investing view point (and we will come to the impact this has for our portfolio companies in a moment), it allows us to actively allocate capital when there is fear in the market and typically other investors are forced sellers as their clients start asking for their money back. It allows us to have a high cash balance to the portfolio for long periods of time when we think the market is over excited – the moments in the cycle when you are getting stock market tips from your Uber driver or your Grandparents want to buy shares in Afterpay – these are the moments when our future expected return hurdles aren’t being met, and a high cash balance can put us in poll position for when the sentiment changes. This flexibility has been our secret sauce – we set up our portfolio in times of market weakness, and can sit on the sideline when things get a little crazy and heated. It also allows us to invest in a private business, support them through their IPO transition and remain invested for many years after they go public.

And importantly, we are never forced to sell any shares. This would not be possible under a more typical structure; many venture funds are forced to distribute shares to their clients once a company goes public within a certain time frame, private equity funds typically sell their portfolio companies (to the public or other companies) irrespective if it is best for the company in order to lock in their returns, and public market investors often turn over their entire portfolio many times a year to align with market-required benchmarking.

Aside from fundraising and increased client management being an incredible distraction to investment firms, it is not the reason why we set up TDM with a reduced client number. We did so to allow us to be true long partners to the businesses we own. Note I use the word ‘own’, because fundamental to our investment philosophy is that we view ourselves as business owners – irrespective if we own a small portion of a large US listed business, or if we own a large minority stake of a private business that we are active on the board, our mentality and actions are identical in both circumstances. Despite many self-imposed constraints, the paradox is that it allows us to invest without restraint; no defined investment horizon, no geographic or sector mandate, agnostic to the private or public markets. We just want to find and own 10-15 great companies for long periods of time.

Element 3: Every client has their own individually managed account (held by a custodian).

Practically while this has created some complexity to operating TDM, the benefit of full transparency to the client base has proved worth it. At any given time, a client can see the exact number of shares they hold in any given portfolio company. This has fully charged our trust battery with them, and as you can imagine only enhances the likelihood of maintaining their capital with us. Despite this, every single portfolio looks the same – there is no picking and choosing in regards to portfolio construction – and this goes to employees as well (more on this later).

Element 4: Performance-only fee structure.

We do not charge – on a net basis – any management fees. Ben has written a full blog on this that is a must read, so I will keep this brief. We bill our clients a straight 15% of fund growth over and above a high-water mark – that is, if the fund is not growing (our clients are not making money), we don’t get paid. This is the ultimate tool to align incentives between us and our clients. Many managers are incentivised to accumulate assets under management to receive their portion of this as a management fee irrespective of performance – this has never and will never make any sense to us. To be clear, some managers raise large funds, earn huge profits from charging 1 or 2% management fee, and produce market or below market returns (e.g. the vast majority of public fund managers fail to outperform the market indices over the medium to long term). It’s akin to doctors being paid based on the amount of pills they prescribe! This is totally flawed and indicative of a broken industry.

We always wanted to do things differently, and we know this performance-only fee structure keeps us incredibly hungry, focused and humble – sharing in the ups and downs with both our clients and portfolio companies.

How our structure creates value for our Portfolio Companies

By investing in a hyper concentrated manner, we’re able to spend a disproportionate amount of time helping our portfolio companies. While we actively manage our liquid public market positions, we don’t make many ‘investment decisions’ as such every year in comparison to other professional investors. The constraint on the number of companies in the portfolio was purposeful – by holding fewer investments for longer, we’re able to know our portfolio companies inside out.

Most investment firms are structured to either create more deal flow (companies to invest in) or more clients (more money to managed to increase fees). So, what we do is actually counter-intuitive in the investment industry.

The depth of our work allows us to not just make good investing decisions, but to offer better support to all of our portfolio companies as they see fit, ultimately giving them the best chance for success. Hands on support is not for everyone, but we do know that when we find the right management team who want to be true partners, the outcomes for both parties speak for themselves. I would estimate 80% of investment team hours are spent in this bucket of ‘portfolio support’.

Our portfolio support is both wide and deep when it comes to alleviating the friction points to a sustainable growth journey – from bespoke hands-on expertise on issues like executive remuneration strategy, IPO preparation, board construction and reporting, strategic advice and benchmarking.

Consider it a cross between the services of a management consulting firm and an investment bank, but with totally aligned incentives and, of course, free of charge to the company. Most fast-growing businesses need arms and legs, and we love providing them, as well as an outside in view that often management teams deeply appreciate. What we do know is our focus on people and culture and helping management teams effectively scale this horizontal function across their business is one of the biggest unlocks we can help provide. All our portfolio companies are culture first and understand for them to scale effectively, it hinges on scaling their talent and culture first and foremost.

We back and support existing leadership teams. But we do know that the journey to $50 million in revenue is different than the journey from $100 million to $500 million and again to $1 billion. While there are very rare talents who can succeed across the entire journey, there tends to be a natural turnover as key players begin losing interest in running big businesses at scale. We spend a huge amount of time helping portfolio companies, in Jim Collins parlance, ‘finding the right people for the right seats on the bus’, and this includes board members.

Our general attitude towards boards is they should be heavily weighted with operators. Not investors. Hamish has written a great blog on “What a great Non-Executive Director” looks like – a must read. As businesses scale, the benefit of deep domain expertise from those who have seen these problems before significantly enhances the outcomes.

This portfolio support is supplemented and often delivered through our investment team members with operating capability – this is made up of former world class executives (usually people we have known for a long time and invested behind at some point) who have now chosen to be part of the TDM journey. This too is a massive source of competitive advantage for us and one we do not take lightly – it has been a strategic priority to build this team out over the last few years and continues to be. This will come to light further in your onboarding journey.

Aligning the TDM team values and incentives to clients and Portfolio Companies

Key to our team DNA is the belief in acting like owners: owners of our business (TDM) and of our Portfolio Companies. We want to hire people who love investing, or love working in a high performing team and want to support those that do, and want to be part of owning great businesses over their lifetimes (TDM included).

Beyond TDM managing clients’ portfolios, there is deliberate alignment of the entire TDM team’s individual investments to match the portfolio. It means that we’re eating the food we serve. We’ve always found it strange that an Investment Manager could buy their clients one company but then have a personal account where they buy another. At TDM, everyone is in it together. Our team can only invest in TDM portfolio companies, with the same weightings as clients. This ensures the individuals on our team are always bringing their best investment ideas to the table as well as making and committing to decisions as a team. It’s a fundamental pillar that builds trust between us as a team and between us and our clients. This constraint exemplifies our values of ‘Hunt as a Pack’ and ‘We are Owners’.

Tied closely to ownership is our mission of investing in businesses we are proud of. Management teams doing their life’s work, fostering cultures that we want to be a part of. Life is too short to do business with people who you don’t love spending time with.

Beyond fund and personal investment alignment, we have clear short-term and long-term incentive programs based on TDM business profits. This further aligns our team to behave like owners of the TDM business. Our model is clear and transparent – client fees are 15% of fund growth, and a TDM team member is given a set percentage of TDM’s net profit. We over-incentivise our staff on true performance for the business as a whole – maybe at surface salary level our team are typically underpaid on a base salary with what they could make elsewhere, but we know it keeps us hungry. When you factor this in, as well as the ability to compound capital at high rates by investing in the fund, I am yet to hear of an employee who feels like our compensation philosophy is not fair and generous.

Finally, let’s discuss what all these constraints and structures mean to how we actually invest

We invest without restrictions. This means we can allocate capital to fast-growing private or public companies, globally, in any sector. By fast-growing, we mean at least 20% – after all we are trying to compound the fund at 25%, and this comes from our companies growing their top line revenue around this rate. None of our businesses have burdensome debt, and usually none – over time, we have come to understand the value of capital flexibility within the portfolio. Nothing can kill a company quicker than leverage.

With our current fund size, and high conviction approach, generally we are targeting allocations between $50 million and $300 million per investment.

What hasn’t changed over the years is our investment philosophy and how we assess the opportunity for potential investments and the portfolio as it relates to expected returns. We call it our Four Pillars investment framework: Growth Opportunity, Structural Competitive Advantage, People & Culture and Valuation. Each has various subheadings, and if you are joining the investment team, this will become second nature to you over time.

To reiterate, the most important part of any investment thesis is our belief in People and Culture. Public and private executives are often surprised by just how much time we spend understanding (and contributing to) this part of their business and strategy.

Introducing the TDM Foundation, critical to our mark on society

As a team, while we skip to work on behalf of our clients, we don’t feel as though it is enough to simply try to compound capital without a higher purpose. This inspired the TDM Foundation, which has expressed its goal of donating $100 million in the next ten years. Part of your onboarding will be sessions with Roly, who leads our Foundation, and what will become apparent is that the Foundation’s philosophy in many ways mirrors that of the investing side of the business – supporting passionate and high-performing people, in a concentrated way, who have a long-term and lasting impact on the community as they grow.

From hands-on help in delivering the Day of AI in Australia, to vetting cutting edge cancer-fighting research (with Hearts and Minds, HM1), the Foundation is active in making sure our partners achieve their missions. We strive to grow a world-class foundation who do more than just give capital grants – we want to maximise social impact.

To wrap, and to welcome

I hope this has given you a little more colour and filled in some potential missing pieces from the interview process. The first few months will be a bit of a blur – the pace of play here is fast and intense – but we are here to support you to be a high performing team member over the long term. If we want to be one of the best investment firms of all time, we need to recruit, foster and develop the best talent. People and Culture has to be our competitive advantage as well.

Welcome to TDM – no doubt you will contribute to TDM the best you can in the coming days, weeks, years and decades.

TC

 

About the author

Tom founded TDM Growth Partners from his one-bedroom apartment in 2005, driven by his admiration for investing philosophies like those of Phillip Fisher and Warren Buffett. Eighteen years and nearly 40 employees later, Tom leads the team alongside his co-founders and best mates, Hamish and Ben.

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