Most public companies are led by seasoned executives who have long since replaced their respective businesses’ original founders. But while they may be able help move a business from one phase to the next, studies show that having the original entrepreneur run a business is better for stock prices and overall performance.
In 2016, Bain & Company put together an index of founder-led companies and found that these businesses outperformed S&P 500 companies led by hired guns by a factor of 3.1, on a total-return basis, between 1990 and 2014. Even if you remove all tech companies from the equation, these businesses still outperformed by a factor of 1.8. Founder-led operations also generated 31 per cent more patents than their non-entrepreneur-led counterpa rts.
Why do founder-led businesses do so much better? Because, as the study found out, entrepreneurs are more obsessed with their company and more innovative than someone who hasn’t spent their life inside the business.
With more evidence showing that these kinds of companies do outperform, some investment firms are now creating funds that invest in founder-led operations.
“It’s a really exciting place to be, because you’re investing in some of the most innovative, bold visionaries out there in the marketplace,” says Daniel Kelley, who oversees the newly launched Fidelity Founders Class fund, a mutual fund that invests primarily in founder-led companies.
To create the fund, Mr. Kelley studied more than 2,000 founder-led companies both in the United States and globally, and then picked 115 companies to buy into. The fund only launched on April 18, so the breakdown of his holdings isn’t yet publicly available. However, he’s most interested in companies where the founder has a strong vision for the future.
“Not every founder is created equal, so my bet size grows with my conviction in the founder and my analysis of that founder’s ability to execute on the vision,” says Mr. Kelley.
Not just a CEO
What’s interesting about his approach is that the founder doesn’t have to occupy the top spot in a company. They can be involved in a business in other ways, too, such as a chief creative officer, chair of the board or even just a major, but vocal, shareholder. They must have influence on the business’s vision, but they don’t have to be running the day-to-day operations.
“Some of these founders could be great visionaries, but not great at operating the business,” he says.
One thing all the businesses he owns have in common is an obsessive focus on the customer. That’s critical, he says. He wants to hold companies with founders who are trying to make their customers’ lives better.
“Better value, better service and better products usually lead to disruption of how things were done historically, which leads to market-share gains and growth,” says Mr. Kelley.
Founder-led companies also tend to have a deeply ingrained culture of innovation, as they constantly look for ways to solve problems. That’s especially true among newer tech companies.
As well, founders tend to have a lot of skin in the game.
“I look for founders whose interests are fully aligned with those of the shareholders and have the bulk of their net worth in their business,” says Mr. Kelley. “Sometimes, professional CEOs don’t have the same alignment of interest, so they don’t have as much ownership in the company.”
Not just technology
As the Bain study found, even non-tech companies outperform if their founder is still in charge. Mr. Kelley has found that, too. While 40 per cent of the companies in his fund are tech-related, the rest are not.
“It’s important to mention that there are great founders and great innovations across industries, not just technology,” he says. “This is not a tech fund.”
Some of the other companies he holds are in sectors like water purification, apparel – where some of them are leveraging 3D technologies – biotech and education.
“With the right founders, you’re getting exposed to a lot of trends that the market doesn’t really appreciate,” he explains. “These are emerging or disruptive trends, so the founders are seeing something that the markets haven’t yet noticed.”
Picking the right companies
Mr. Kelley wants to own businesses that are innovative and disruptive, and the best way to do that, he says, is to own small and mid-cap companies that can grow larger over time. If they’re meeting their short-term goals, then they will become large companies or could be acquired by industry behemoths – and a takeover can be “tremendously rewarding” for shareholders, he says.
It’s not all about growth, though. He also wants to buy companies that are attractively valued. There can be times during a growth phase when a business experiences a short-term weakness in performance. It’s during these downturns that Mr. Kelley buys in.
“These drawdowns are often short-lived, which means I’m getting these growth stocks at a discount,” he says. “They can appear expensive on short-term revenue and earnings metrics, [causing] price dislocations, and that’s the best time to buy these visionaries and founder-led companies.”
The recent sell-off and increase in market volatility has presented this kind of buying opportunity.
“I tend to find opportunities when the market is freaking out over something that is noise,” he says. “I focus on the long-term value of a company.”
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