When it comes to investing in successful companies over the long term, it is important to consider many factors such as return on capital, its competitive advantage, industry growth rates and, of course, the price you’re being asked to pay.
But there is also mounting evidence that investing in companies where its founder is still involved in some capacity, can also help generate superior returns.
A study by Bain & Co in 2016 found that founder-led companies delivered returns 3x greater than the rest of the Fortune 500 over a 15-year period. Citigroup conducted a similar study on the UK market over the past three years and found that founder-led companies under their coverage have significantly outperformed those led by non-founder CEOs.
This begs the question, why? I believe it comes down to a combination of culture, understanding and incentivisation.
I recently read the excellent book Shoe Dog, a memoir by Phil Knight, who founded Nike. It gives a great insight that Nike’s success has had little to do with the ‘Swoosh’ logo but instead the passion of Phil and the team he built up around him, often fellow ex-athletes, who had a common goal of producing the perfect running trainer.
His co-founder, Bill Bowerman, even went as far as to ruining his wife’s waffle iron melting rubber in an attempt to create a new sole that would grip but be lightweight. Phil is now in his 80s but remains the chairman of Nike and recognises that protecting the culture and passion within the business is crucial to Nike’s continued success.
We see a similar recognition for the importance of creating a strong company culture in one of our fund holdings, Alpha FX. On a recent tour around their new office with CEO and Founder, Morgan Tillbrook, I noticed on the wall their ‘Mission’, which is to ‘attract, develop and retain the right people, to fuel our continuous momentum and competitive maturity’. As a result, the company has a very selective recruitment process, choosing only to hire from outside the industry to ensure they haven’t picked up bad habits from their competitors.
Alpha FX also offers wide participation in the company share scheme, so that everyone benefits from the company’s success, and it has state of the art office facilities that its employees can enjoy.
Founders are more likely to understand the front line of their business than outsider CEOs. For instance, another of our holdings is Dart Group (better known as tour operator Jet2). Its founder and executive chairman, Phillip Meeson, is much more likely to be found at Stanstead Airport in the early hours interacting with his customers and gauging their experience, than in a City boardroom trying to convince investors to buy his company’s shares.
Performance of Premier UK Growth vs sector and index over 5yrs
Source: FE Analytics
Jet2 only launched its holiday business in 2007 and had 34,000 holidaymakers in its first year. This year it will carry 3.8m passengers. Jet2’s remarkable growth has been achieved by customers enjoying their experience with a high percentage repeat booking for the following year. Some 5 per cent of Dart Group’s profits are shared amongst its staff so that even those on the check-in desk benefit from the company’s success.
It’s no exaggeration to say that Thomas Cook may still be operating today if it wasn’t for Jet2’s rapid growth driven by its focus on customer experience, which begins with its founder.
Founders tend to see their company as their life’s work and therefore likely to have a longer-term focus. Non-founder CEOs, on the other hand, are incentivised by relatively short-term goals.
Long-term incentive plans (LTIPs) often vest over three years, which in my opinion is hardly long term. Investment in innovation can take years to generate returns, sometimes leaving CEOs on relatively short-term performance metrics facing the prospect of reducing their own remuneration should they decide to proceed with the investment.
With technological disruption now rife, it is arguably more important than ever for companies to invest and innovate. Today’s biggest companies, such as Amazon, Apple, Google and Facebook, can all attribute a large proportion of their success down to their respective founders’ willingness to continue investing for the long term.
Companies that put in place disincentives for long-term stewardship are destined for poor outcomes. A prime example is Carillion. The seeds of its downfall were sown long before its eventual collapse. The performance metrics of the annual bonus and LTIP schemes in place for the executive directors were predominantly based on earnings per share. This isn’t uncommon, but in Carillion’s case it created a disincentive for management to repair the stretched balance sheet through a discounted equity raise, which would have led to earnings per share falling.
In stark contrast to Carillion is another of Premier UK Growth fund’s holdings, Frontier Developments. Its CEO, David Braben, founded the company 25 years ago. He pays himself a relatively modest salary and annual bonus but still owns over 30 per cent of the company’s shares, so he is well aligned with Frontier’s other shareholders.
Furthermore, his passion for video games reassures investors that the quality of the game isn’t going to be jeopardised in order to meet short-term financial targets. Frontier’s reputation is now such that Universal Studios approached them to make a Jurassic Park game. Since listing in 2013, Frontier’s shares have returned 700 per cent and its latest game, Planet Zoo, went straight to the top of the chart on its release in November.
When it comes to ESG for founder-led companies we have had to remain vigilant. Proxy voting service providers are very helpful but they adopt a mechanical ‘tick box approach’ that follows the UK Corporate Governance Code.
However, founder-led companies often have structures that don’t comply with the code, yet this isn’t necessarily a bad thing.
Take Dart Group for instance, at its last AGM our proxy voting service provider was recommending that we don’t vote in favour of re-electing Phillip Meeson’s as a director. This is because he holds the dual CEO and chairman role and has been a director of the company for 31 years. He might be marking his own homework but considering he owns over 30 per cent of the shares in issue, in our opinion there is no one more aligned with shareholders or better experienced to do so, so we elected to ignore the recommendation and vote alongside management.
The Premier UK Growth fund currently holds multiple founder-led companies yet we don’t set out to buy them. Instead we focus on buying high quality growth companies at the right valuation but perhaps it’s the founders, thanks to their understanding of the company, the culture they create and their long-term focus, that drives the high quality growth that we seek.
Jon Hudson is co- manager of the Premier UK Growth fund. The views expressed above are his own and should not be taken as investment advice.