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Founder Led Business - Part 1
Founder-Led Companies Outperform the Rest — Here’s Why
As both a founder and an investor, I've long wanted to share my perspective on why "founder-led" businesses often outshine their counterparts. It's important to acknowledge my inherent bias in this regard. Instead of imposing my biases on you, my aim is to shed light on what the data reveals about businesses led by founders.
In the spirit of making this exploration engaging and insightful, let's kick off with a couple of stories. No lengthy preamble – let's dive straight in.
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Is this just a ‘Jobs’ for you?
On a sunny day in 1996, Steve Jobs struck a what appeared like the deal of lifetime. For him, it was only the beginning. Apple would buy NeXT for $400 million.
At the time, Apple was run by Gil Amelio. Having recently overseen Apple's worst-ever financial quarter, Amelio wasn’t particularly loved at Apple, so it seemed sensical that he should leave. With Amelio gone, Jobs offered to help Apple locate a new leader. The idea was that he would step into the role of CEO until someone suitable could be found.
This is where the founder mindset comes in. Let’s pay attention to how Jobs' return to Apple serves as a powerful example of how founders' distinctive thinking and actions can yield remarkable results.
At the time of his comeback, the prevailing wisdom held that Apple was losing ground due to "PC Economics" and that the winning formula was to separate the operating system from the hardware. The conventional belief was that Apple had to adopt a more horizontal approach, allowing commodity hardware manufacturers to compete while Apple focused solely on the operating system. The previous CEO, Gil Amelio, embraced this notion, even fostering an ecosystem of Mac cloners to supply hardware alongside Apple's renowned OS. Jobs did the opposite.
He challenged the status quo upon his return, a move that confounded nearly everyone in the industry. He discarded the commodity hardware and the horizontal strategy to pursue a radical vertical integration. Alongside the fundamental hardware and operating system, he introduced applications. One day, he got a big stage and changed the world when he suggested we could all have 1,000 songs in our pockets. He even added retail stores.
He didn’t win people over immediately; in the years after his return, the share price was either dropping or not moving at all. This meant the value of Apple was barely above their IPO price from 17 years before.
That didn’t matter, because founders think long term, and that’s what Jobs did. Slowly and consistently, Jobs executed.
The share price, adjusted for splits was $0.20 on September 16, 1997, the day of his return. It’s $174 today. $10,000 invested at the time would mean $8.7M today.
A story from close to home
40 years ago today, a Doctor called his ‘tech’ friend to suggest the pair go into business together. The ‘tech’ guy told his friend to take a few Valiums and call back later.
The idea seemed crazy, why would a Doctor want to leave a high-paid general practice to start a business in technology when personal computers hadn't yet been released? Perhaps because this Doctor recognised the potential to harness emerging technologies in the field of medicine, and wanted to be at the forefront of this trend which would change the world of medicine.
Founders can be persistent. And eventually, persistence pays off.
So from a modest two-story residential building at 450 Swan Street in Richmond, Victoria, 2 gents got to work. Of course, you know the rest of this story.
Under Sam Hupert's leadership, Pro Medicus completely changed the world of medical imaging, eventually going public on the Australian Stock Exchange in 2000. In 2005, they embarked on a partnership with the global imaging group Agfa to introduce a range of software products to the global market.
Then, In 2007, Hupert stepped down as CEO, believing that others were better suited to grow the international-facing business. Unfortunately, the Agfa partnership was going sideways. This prompted Hupert's return to the helm in 2010.
This is where we see the founder’s hedge.
Unfased by the initial setback on the international stage, Hupert forged ahead. He made his best decision when he received a phone call from the former CEO of a small company who was open to selling their software. Sam had met this CEO at the annual Radiological Society of North America conference. This software was called Visage, and it had been going through a transaction to be purchased already, but the initial buyer had now pulled out.
Visage had this simple and powerful value proposition to let radiologists view reports and large image files, generated by X-rays and other scans, from their mobile devices in seconds, enabling them to make diagnostic decisions remotely.
So Sam decided to buy them for $US3.5m. Today, Pro Medicus still runs its radiology information system software, now called Visage RIS. This imaging software constitutes the majority of revenue and is driving the growth of the business.
Over the past two decades, the founders transformed Pro Medicus into a global, multi-billion-dollar company. It wasn’t easy, and that’s where you want to back founders. Truly having a long-term lens allows you to power through the years of hard work, and periods were you’re nearly certain you will die (this happened to Pro Medicus 2011).
In 2010, the share price hovered around the $0.50 mark. It’s $72 today. $10,000 invested at the time would mean $1.44M today.
Other good examples
Certainly, the stories mentioned above represent extraordinary cases. Admittedly, they are significant outliers. It's essential to acknowledge that investing in founders doesn't guarantee success, and there have been instances where investments in founder-led ventures have resulted in losses. However, the overarching idea is that, when all other factors are equal, founders tend to exhibit higher levels of determination, discipline, resourcefulness, and self-accountability.
Here are a few additional examples (credit to a16z for the list).
Amazon – Jeff Bezos
AMD—Jerry Sanders III
Apple – Steve Jobs
IBM—Thomas Watson, Sr. (*)
Intel—Andy Grove (*)
Meta - Mark Zuckerberg
Microsoft —Bill Gates
I have a job, and being the CEO of Nvidia is a great privilege. It is once in a life time opportunity.
– Jensen Huang
Photo: a young Jen-Hsun Huang in his early years as an engineer
Research #1 - University of Ohio
German economist Rüdiger Fahlenbrach, currently a professor at the Swiss Finance Institute at EPFL and serving as the Institute's Senior Research Chair, has dedicated a significant portion of his career to investigating corporate governance issues stemming from the separation of ownership and control within modern public corporations.
In 2009, his pursuit of this research avenue led him to delve into a comparative study between "founder-CEOs" and "successor-CEOs." The results of this study were encapsulated in a paper titled "Founder-CEOs, Investment Decisions, and Stock Market Performance," published by the University of Ohio.
Fahlenbrach's findings unveiled several distinct characteristics of Founder-CEO companies, including their propensity to:
Invest more significantly in research and development,
Allocate higher levels of capital expenditures,
Engage in more targeted mergers and acquisitions.
As a consequence of this, an equal-weighted investment strategy, focusing on founder-CEO firms from 1993 to 2002, would have yielded an impressive benchmark-adjusted annual return of 8.3%.
If this doesn’t sound impressive, let’s put it into perspective. The tumultuous dot-com crash occurred in the early 2000s. Against this backdrop, founder-CEOs delivered a substantial excess return of 4.4% per year (after accounting for various firm characteristics, CEO attributes, and industry affiliations).
Source: Fahlenbrach, Rüdiger. "Founder-CEOs, investment decisions, and stock market performance." Journal of financial and Quantitative Analysis 44.2 (2009): 439-466.
Photo: a young Estée Lauder - one of my favourite founders
Research #2 - Bain and Co
Bain & Company is renowned for its thorough research in this domain. Partners Chris Zook and James Allen have extensively examined this topic and outlined their findings in their book, "The Founder's Mentality: How to Overcome the Predictable Crises of Growth."
Their research reveals that founder-led companies within the S&P 500 consistently exhibit superior performance. They tend to have 31% more patents, valuable innovations, and a propensity for taking calculated risks to drive innovation.
The essence of the founder's mentality comprises three pivotal elements:
A Clear Sense of Business Insurgency or Purpose: Founders infuse their companies with a profound sense of purpose and drive.
A Front-Line Obsession with Attention to Detail and Empowering Front-Line Staff: These companies prioritise meticulous attention to detail and empower their frontline employees, recognising the crucial role they play.
An Owner's Mindset Emphasising Speed, Risk-Taking, and Personal Responsibility: Founder-led firms foster an owner's mindset, prioritising agility, risk-taking, and a culture of personal responsibility.
Their extensive research underscores that companies upholding the founder's mentality are 4 to 5 times more likely to emerge as top performers. This is evident in the performance of S&P 500 companies with deep founder involvement, outpacing others by a remarkable 3.1 times over the past 15 years.
We found that the companies most successful at maintaining profitable growth over the long term were disproportionately companies where the founder was still running the business (such as Oracle, Haier, or LBrands), was still involved on the Board of Directors (like Four Seasons Hotels and Resorts), or, most importantly, where the focus and principles of how to operate that the founder had originally put in place still endured (as at IKEA or at Enterprise Rent-A-Car)
What Taleb Would Say
An excellent book which a number of investors recommend is Nassim Nicholas Taleb’s Skin in the Game: Hidden Asymmetries in Daily Life.
To me, that book represents well the value in power of alignment between founders and their businesses. Taleb’s points, if they were applied to founders mean:
Long-term Mindset: Founders focus on multi-generational growth, while CEOs' average tenure is short-term, leading to different priorities.
Skin in the Game: Founders' personal investment aligns their interests with the company's success, fostering commitment and performance.
Soul in the Game (Emotional Investment): Founders' passion and love for their businesses create a long-term intent and drive for success, often underestimated in its impact. A founder’s commitment goes far beyond financial incentives, which in turn can contribute to remarkable performance.
“Entrepreneurs are heroes in our society. They fail for the rest of us.”
― Nassim Nicholas Taleb, Skin in the Game
Chris Mayer’s 5 Key Themes
In his excellent book, '100 Baggers,' Chris Mayer identifies five predominant themes that frequently manifested in companies achieving a 100-fold return on investment:
They start small
You’ve got to hold these for a very long time
Low multiples are preferred
High returns on capital are very important
Owner Operators are preferred
On his last point, he shares three compelling studies on the world of owner-operators.
The findings of these studies are as follows:
Rich founders (or founders that get rich) tend to keep winning. A study in 2012 concluded that companies built by members of the Forbes World's Billionaires list had handily beaten the stock market over 15 years. "The rich do indeed get richer. Now we provide an index of billionaires that may allow the rest of us to get richer, too,’’. Billionaires’ have access to a wide network of people, and tend to execute. (Ref. Shulman and Noyes, 2012)
Family-owned businesses think more long-term and win. This one was done in 2005, and the authors show that family-run companies have produced considerably higher stock returns than their non-family counterparts. They showcase 2 reasons:
1. Family-owned and controlled companies sidestep the classic agency problem, a challenge often faced by publicly traded companies, where professional managers may prioritise personal interests over shareholder welfare.
2. They avoided offering quarterly guidance, and focused on long-term value creation instead. (Ref. McVey and Draho, 2005)
CEOs with Skin in the Game can be just as good. There is a category of CEOs who, while not the original founders, operate with a founder's mindset and hold a substantial stake in the company. I love this category as well. A 2009 study found that companies where the CEO voluntarily holds a significant portion of the company's stock consistently outperform the market (Reference: Lilienfield-Toal and Ruenzi, 2009).
In the next few parts of this series, I will look at Founder Led businesses on the ASX.
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I’d like to offer a special thanks to my friend Chadd Knights for sharing some valuable resources with me that were critical in the writing of this article. Thanks brother!
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