Mark Leonard launched Constellation Software in 1995 when he left the VC world with $25 million in capital. Since then, he has quietly been building and compounding one of the biggest and most successful software firms in the world, all without fanfare.
I’ve been interested in business and entrepreneurs all my life, but it was only about a year ago that I first heard about Leonard on an episode of Founders. I was blown away by the story of this entrepreneur who led a vast software firm, but who I had never heard of during the Dotcom Bubble, the rise of social media, or the blockchain/AI crazes.
Here was a business genius who had started with $25 million and turned it into a massive publicly listed company with a market cap of over $90 billion. I had to find out more, so I started reading Mark Leonard’s shareholder letters and discovering all I could about this near-mythical Canadian entrepreneur.
I will likely spend several more years studying Mark Leonard’s business career, but even based on what I’ve learned so far, I’ve learned several important lessons.
The Power of Decentralization
Being into blockchain technology, I already know about decentralization and its benefits. Leonard has taken this approach to business. When Constellation acquires a software firm, he doesn’t take over and dictate how things should go. He trusts the team to keep growing and lets them get on with it. The aim is to preserve expertise and allow those who know best — those who took the business this far — to keep growing it.
Everybody talks about the importance of delegation in business, but few master it. While Constellation does support its acquisitions with capital for growth and with strategic support, it lets those who know best grow the firm at the grassroots level. The management team is often kept in place, the existing culture is preserved, and the company is given a lot of autonomy.
That said, Constellation does ask its companies to share data and best practices with each other. So, while autonomous, they’re constantly learning from each other, accelerating growth and creating a positive feedback loop.
Focus on Niche Markets
Constellation doesn’t acquire what you’d call mainstream software firms — that’s probably part of the reason it stays relatively under the radar. It acquires Vertical Market Software (VMS) companies that dominate niches and have steady cash flows. For example, in 2022, it acquired Allscripts Hospital EHR business for $700 million.
If you’ve never heard of Allscripts’, you’re not alone. I hadn’t either, and that’s not a surprise because it is explicitly focused on healthcare and helping medical facilities manage their operations: it provides Electronic Health Record (EHR) systems, among other such programs.
These are the kinds of companies Mark Leonard buys. They dominate their niches and would be difficult to replace, so they also have a moat and are somewhat protected from competition. That said, he does buy in diverse industries so that they aren’t overexposed to one market or the other.
Long-Term Thinking
This comes up again and again when studying great Founders and CEOs. They almost always think in decades rather than years, although they push on as if time is running out!
While some companies think only of the next quarter or a few years out, Leonard thinks about long-term value creation and sustainable compound growth.
Leonard and all great Founders are thinking years down the road and are willing to wait patiently and add value slowly and steadily so their acquisitions grow. If only vulture capitalists and asset strippers would take the same approach!
Conservative Deployment With High ROIs
One of the most important metrics a company should have if Constellation Software is going to buy it is strong cash flows and solid returns on investment. This serves two purposes.
First, Constellation has made many acquisitions without debt. It uses existing companies’ cash flows and profits to acquire more, creating a self-perpetuating money-printing machine.
Second, the ROI is high, and minimal spending is required. Constellation isn’t buying distressed companies and trying to turn them around. It’s buying ones that already have juicy margins and growing them.
Note: Leonard did use debt strategically a few times. During the zero-interest rate environment after the financial crisis, he used what he called “free capital” to make multiple acquisitions.
Alignment of Incentives
Leonard makes sure executives and managers have skin in the game by giving them equity stakes.
Who’s going to do a better job, the guy who gets paid $100k plus a bonus or the guy who watches his net worth grow as the company he oversees does? That’s an easy one to answer, and it shows up clearly in Constellation’s stock price over the long run.
Leonard considers incentives before making any significant moves. It’s well known that he resisted taking the company public for a long time for this very reason. He was worried that the short-term focus in the public markets, the loss of autonomy and extra public scrutiny, and the potential cultural impact on the firm could all take a toll.
Nevertheless, taking the firm public worked out. Just scroll back up and take a look at the stock chart if you have any doubts about that!
Leonard does not do public interviews, so these quotes have been pulled from his shareholder letters and other sources. Like Warren Buffet’s letters, these have developed somewhat of a cult following.
- “I’ve traditionally traveled on economy tickets and stayed at modest hotels because I wasn’t happy freeloading on the CSI shareholders and I wanted to set a good example for the thousands of CSI employees who travel every month.”
- His vision was to create a “permanent capital vehicle for the vertical market software industry, where you didn’t have to buy & sell a company you could keep it forever and build real businesses that last a lifetime.”
- “Typically, Constellation’s acquisitions are small — in the $2-million to $4-million range — but add them all up, slip in a dose of Constellation’s financial and operational discipline, and you have a company with a market cap of $18 billion.”
- “We work hard to keep the early burn rate of initiatives down until we have a proof of concept and market acceptance, sometimes even getting clients to pay for the early development; we triaged initiatives earlier if our key assumptions proved wrong.”
- “We believe in small teams outperforming large teams, and so given the choice of taking a 200-person business and buffing it up into two smaller ones, we would much prefer to do that and believe that the benefits are there as opposed to ramming businesses together, firing a bunch of people and moving a bunch of work offshore.”