What do some of the world’s most successful businesses, such as Amazon, Facebook, Netflix, and Tesla, have in common? They are businesses led by their founders.
The people who operate the business are an often overlooked component in stock analysis. Outstanding firms are led by great management teams, who must act aggressively to steer the rocketship.
In this article, we’ll look at some research and data to see why founder-led businesses outperform the competition!
By the Numbers: Founder-Led Businesses
After reading this essay in the Harvard Business Review by Chris Zook, a partner at Bain & Company, I became interested in founder-led organizations. According to an in-depth analysis conducted by Bain & Company, an index of S&P 500 companies in which the founder remained actively involved “performed 3.1 times better” from 1999 to 2014.
Other major findings from studies that support the “founder-led” hypothesis include:
More creativity
In a 2016 study, Purdue University professors Joon Mahn Lee and Joonhyung Bae and Hong Kong Baptist University professor Jongsoo Kim discovered that companies managed by founding CEOs have a 31% increase in patent count before controlling for R&D investment. Even after correcting for R&D paystubs, the analysis discovered a 23% rise in the number of patents.
Abnormal Returns
Rüdiger Fahlenbrach, an Ohio State University professor, presented a study in 2007 that indicated founder CEO companies invested more in R&D, capital expenditures, and mergers and acquisitions. According to the analysis, an equal-weighted investment strategy that invested in founder CEO led enterprises from 1993 to 2002 would have produced an annual benchmark-adjusted return of 8.3%. Even after accounting for a wide range of company and industry factors, abnormal performance remained at 4.4%.
High Profit Growth
In April 2006, FORTUNE senior writer Jon Birger reported that 26 FORTUNE 500 companies had founder-CEOs. Mr. Birger noted that these 26 companies returned an average annual return of 18.5% from 1995 to 2005, which is 7% more than the FORTUNE 500’s average return during the same period. Profit growth at the 26 founder-led companies was also higher, expanding at an average rate of 19.6% per year from 1995 to 2005, compared to 11.7% for the FORTUNE 500.
Risk / Return Metrics: Dominant Joel M. Shulman’s research, published in the Journal of Risk and Financial Management in 2010, examined monthly stock returns of publicly traded companies in the United States from 1998 to 2010. Professor Shulman stated that there was compelling evidence to support the idea that companies driven by American entrepreneurs outperform many stock market indices. According to the study, founder-led firms outperformed on key risk and return indicators such as the rate of return, Sharpe ratio, Sortino ratio, alpha, active premium, information ratio, and Up Capture ratio.
Why Do Founder-Led Businesses Outperform?
There’s a lot of evidence that founder-led businesses outperform the rest, so the obvious question is why.
Chris Zook and his co-author conducted hundreds of interviews with founder-led organizations as part of the aforementioned Bain & Company study to discover factors explaining this outperformance. They labeled the commonalities between these organizations as “founder’s attitude” as a consequence of the survey. They recognized the following themes:
- Insurgency in business: Founders waged war on industry norms to assist underserved clients.
- Front line obsession: Founders have a penchant for details and foster a culture that values those on the front lines of the organization.
- Owner’s perspective: The founders moved fast to establish a culture of personal accountability for risk and cost.
Professional CEOs find it challenging to share the same vision as the firm founder. Founders of world-changing organizations are frequently visionary visionaries with a clear vision of the future.
The second factor is more personal and pertains to the founder’s relationship with his company. As Fidelity points out in this article, founders frequently regard their firm as a life-long effort and are more driven to combat any difficulties that arise. Founder CEOs frequently refer to their companies as “kids,” and they are more likely to make decisions that optimize long-term success.
With a global pandemic impending in 2020, corporations have been confronted with huge unexpected obstacles. Nonetheless, the Global X Founder-Run Companies ETF (BOSS), which invests in founder-run businesses, has outperformed the S&P 500 by roughly 15% since the start of the year.
Where Can I Find Founder-Led Businesses?
If you wish to invest in a pre-built portfolio of founder-led companies, the Global X Founder-Run Companies ETF is an option.
It is an exchange-traded fund founded and managed by Global X Management Company LLC that invests in US founder-led firms with varying market capitalizations and operating in various industries. It uses a full replication technique to track the performance of the Solactive U.S. Founder-Run Companies Index.
Tesla Motors Inc. (TSLA)
Tesla, Inc. develops, manufactures, rents, and distributes electric automobiles as well as energy generation and storage technologies. Elon Musk, Tesla’s CEO and co-founder, leads the company. Mr. Musk is also a member of the company’s board of directors.
Zoom Video Communications Corp. (ZM)
Zoom Video Communications, Inc. offers a platform for video-first communications. Eric S. Yuan created Zoom in 2011 and it is headquartered in San Jose, California.
The company Wayfair Inc. (W)
Wayfair Inc. sells furniture, décor, decorative accessories, housewares, seasonal décor, and other home items both domestically and internationally. Wayfair Inc., headquartered in Boston, Massachusetts, was founded in 2002 by Steven K. Conine and Niraj S. Shah. The Board is co-chaired by Mr. Shah and Mr. Conine. Mr. Shah is also the CEO and President of the company.
Sea Limitations (SE)
Sea Limited is a Singapore-based global consumer internet corporation. Digital entertainment (Garena), e-commerce (Shopee), and digital financial services are among the services provided by the company (SeaMoney). Forrest Li, Gang Ye, and David Jingye Chen created Sea Limited in 2009, and it is headquartered in Singapore.
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