“If a restaurant has an absentee owner, over time the service quality will slip and the waiters will have their hand in the till.” (Robert Vinall)
Our goal with exceptional quality-growth businesses is to become long-term owners. This essentially means that we are entrusting the custody of our capital to the right people, preferably at the right price. As Fundsmith’s Terry Smith notes, “When you choose to invest with us on behalf of your clients, you’re subcontracting their capital to us to look after. The reality of this process is that we subcontract it to the management of companies.” In the long run, our investment performance will depend heavily on whether these management teams are exceptional stewards of shareholders’ capital or squander opportunities for the sake of short-termism and pleasing Wall Street.
We believe that founding families having a substantial ownership stake tilts the odds in our favor by aligning incentives, and the numbers prove us right. Extensive research conducted by Bain & Company compared founder-led firms with the rest of the S&P 500 and discovered that the former group outperformed the latter nearly threefold between 1990 and 2014. Similarly, using its proprietary database of 1,000+ publicly listed family or founder-owned businesses, Credit Suisse found that between 2006 and 2020, this universe outperformed non-family-owned companies by an annual average of 370 basis points. As a side note, although the latter study found that those with the largest family ownership stakes (over 70%) achieved the highest returns, researchers do not believe that a linear relationship between the two variables can be identified. This suggests that the simple notion of family involvement appears to be the decisive factor in the outperformance of these businesses.
We can find a clear underlying distinction in how these companies allocate capital, which is essential for long-term shareholder value creation. Multiple studies have shown that if the founder or the founding family is involved, substantially more money is spent on both intangible assets and traditional capital expenditures. Note that the difference seems most staggering in the R&D category, which we think can partly be explained by the accounting treatment of these expenditures. As a reminder, research costs (along with marketing dollars) get directly expensed instead of capitalized and amortized over time (like investments in physical infrastructure), a problem the EVA framework rightfully remedies. Outside management teams are less inclined to report lower profits (even temporarily) despite the risk of underinvesting and eroding the moat. Additionally, it is no wonder that founder-involved businesses tend to have ~30% more patents than their peers, which is evidence of their propensity for taking calculated risks to foster innovation.
We believe that an owner’s mindset is not only evident in the capital allocation policy of these companies, but it also infuses them with a profound sense of purpose and drive, prioritizing sensible risk-taking and a culture of personal responsibility. As opposed to a typical public company focusing on meeting quarterly earnings guidance, a founding family’s personal net worth is tied to the business, leading to a virtuous cycle of long-term value creation. A hired CEO expecting to spend just a few years at the helm is unlikely to act in the same way as an owner-manager with an oftentimes multi-generational timescale.
The quantitative evidence certainly indicates that using founder involvement as a screening criterion has its merits as a strategy. Rob Vinall, a fund manager who openly prioritizes this aspect, states: “I invest almost exclusively in companies with active and engaged owners. Very occasionally, you find managers who think and act like owners even if no owner is present, but this is the exception rather than the rule. If a restaurant has an absentee owner, over time the service quality will slip and the waiters will have their hand in the till. With large companies, it is no different.” That being said, our primary focus in EVA Monster screening remains shareholder value creation. However, we had the impression that in our investable universe, family involvement might be higher than average. After compiling the relevant data, we discovered that every second EVA Monster in our coverage meets the criteria of family ownership with a 10%+ stake and/or is led by an actively engaged founder. This ration is at least two times higher than among members of the S&P 500 index. While it is difficult to ascertain whether there is merely a correlation or even causality between shareholder value creation and family involvement, this revelation nevertheless astonished us.
Investing in founder-led firms doesn’t guarantee success. However, the overarching idea is that, all else being equal, founders tend to exhibit higher levels of determination, discipline, resourcefulness, and self-accountability, translating to durable and oftentimes more dynamic EVA growth over the long run. Our view is unchanged in the sense that we look for the combination of a strong secular growth theme and great business strengths first and only then judge management quality or founder involvement, not the other way around. As long as there is a CEO who is a good capital allocator and business operator at the same time, their ownership background is rather irrelevant. This is a rare breed indeed, even though excellent managers such as Microsoft’s Satya Nadella are here to remind us that they do exist.
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