Long Term Clients and the Principal/Agent Problem
Nomad Investment Partnerships was one of the best investment firm most people have never heard of. They returned over 21% in a 12 year timespan from 2001–2013, trouncing the S&P 500 4.6% return in that same time frame. Nomad wrote the most compelling shareholder letters since Berkshire because they combined a philosophical model of investing (“scale economics shared”), self deprecating humor, let their performance do the talking, and had an unusually high ethical bar (sorry finance world). They have published their letters for free here. But this post isn’t about their investment prowess, but about their approach to building their investment firm and better aligning their interests with that of their clients.
What is the principal/agent problem? I’m a tech advisor and fractional CTO, so it’s when my incentives (stacking up work on an hourly basis) as an agent aren’t aligned with that of the CEO as the principle (CEO that wants the best long term, cost effective solutions for the business). Are consultants unethical? Not necessarily. But, it takes a routine amount of cognitive load to say “is this best for the business vs what’s best for me?”. That’s the yardstick to measure by. If the story was that simple, I wouldn’t be writing a blog post. What happens when consulting runs thin and clients are cutting back or dropping you? What happens if your spouse loses their job? When shit happens, that’s when character shows up.
After 2 decades of working for many SaaS and tech companies, I’ve decided to be my own boss and run an LLC of 1. It’s a long awaited step for me and I intend to be doing it for some time. Using Bezos' ‘regret minimization framework’ I imagine working backwards from 5 years from now. In that time, I’d like to have a small (3 — 6) number of clients that I’ve been working with for a number of years. Ideally their businesses are successful, I feel like a part of the team, and I share in the successes (or failures) with them. My approach to align our interests is accomplished through equity, a discounted retainer, and patience to establish a relationship to get there.
Back to our Nomad friends. “There are two ways to approach (the principle/agent problem): 1. maximise the conflict for the sake of maximising short-term agent revenues (standard industry practice), or 2. set about minimising the difference through behaving and thinking like principals.” Sleep and Zakaria were keenly aware of getting paid performance management fees, regardless of results. So they put their money where their mouth was. “each new year has a hurdle of 6%, and the hypothetical pass-book return goes unrewarded…But I simply do not want to earn a ‘performance fee’ if future returns are below 6% each year, that is not what we are about, and I want to be able to shave in peace in the morning!” My version of skin in the game is discounting my rate for equity, which isn’t popular with consultants. I’ve been told numerous times not to take equity by my peers. It’s probably good advice, but perhaps for a different model than mine.
I can’t say I have the structure 100% nailed, and each case will be specific, but I believe it works because: a) I want to build long term relationships and can afford the patience to get there b) I know more about investing than virtually anyone else in my role. For some, a consulting practice is a bridge until they find something more permanent. I can assure you I have no interest in doing anything other than what’s stated above: handful of clients, for a long time, sharing in the success. I like being my own boss and having the freedom to build my business the way I want. But work is is most fulfilling when you build long term relationships over time. I believe this gives me a better shot at doing that.
This does mean I need to know how to reasonably value a business and how to discount my rate accordingly. Working in my favor is a capital environment that’s saner now then 2 years ago, steering away from highly speculative tech startups (looking at you crypto/blockchain/NFT) and preferring companies post product-market-fit. It also means that I need an initial period of time (~3 months) to build a relationship with a new client. I like to start with a modest commitment on a focused project at my normal hourly rate with the understanding this could turn into a long term engagement. Lots of things may come up on both sides of the relationship that influence whether this is long or short term: raising capital, traction in market, or “gelling” with founders to name a few.
Admittedly this is a bit of an experiment for me. It may fail, but I like the idea a lot (thanks Nomad) and hopefully my clients will too.
