Listed companies run by entrepreneurial founders remain very much an American phenomenon, not a European one. And there are some obvious reasons why. But whether these US business visionaries are worth backing is still a matter for debate, say wealth managers. A singular ambition may deliver the returns of a Facebook or a Tesla, but a singular disregard for other shareholders’ interests.
In a 2017 study of $500m-plus founder-led companies, fund manager Schroders found that 70 per cent were listed in the US, with only 6 per cent in Europe. Their tendency to be technology businesses, and America’s history of innovation, seem the most obvious reason for this distribution.
As Bain & Company partner Chris Zook, who studies entrepreneurial businesses, noted in the Harvard Business Review: “Most of the great tech firms — just think of Oracle, Intel, Microsoft, Apple, Dell, Google, Amazon, Facebook and so many others — had founder CEOs.”
His work suggests entrepreneurial equities are largely an American West-Coast phenomenon. However, other research shows innovative founders spread across S&P 500 companies: in 2016, three professors at Purdue’s Krannert School of Management calculated that companies in the index with a founder CEO generated 31 per cent more patents than manager-led businesses.
An American business culture of “insurgency” is another reason for founders still leading public companies, believes Zook. He found it drove founders into “waging war on industry norms on behalf of underserved customers, as Netflix did for video rentals, or to create a new market entirely, as Google has done”.
A third reason appears to be the established US tradition of venture capital investment and long-term risk-taking. An analysis of the Bain research on the Seeking Alpha website concluded: “Why not invest with the best, like Jeff Bezos and Mark Zuckerberg? Amazon and Facebook have outperformed for years and they seem to be able to take risks and make investments most companies wouldn’t be able to”.
Unsurprisingly, then, founder-led companies tend to follow US tech sector growth trends. Schroders finds that founder-CEO companies in the internet, software, biotechnology and pharmaceuticals sectors grow revenues “at a faster pace” than non-founder-led peers.
Their cultural differences — what Zook calls insurgency — seem to manifest themselves in Schroders’ finding that they “invest more aggressively than their peers in research and development capital expenditure and mergers and acquisitions”.
Their American-style risk appetite brings them backing. As Zook notes, “venture capitalists, like Andreessen Horowitz, have been quite vocal about their strong preference for investing in businesses where the founder is the CEO”. As Schroders adds, “with venture capital war chests still strong, public market capital is little impediment to scaling a good idea quickly . . . it is increasingly likely that the founder will still be in charge by the time IPO scale is reached.”
But whatever the reasons, should your wealth manager be investing in their US public offerings, or thereafter?
Simple share price analysis suggests yes. Bain calculates the share price outperformance for US founder-led companies: a 3.1 times higher return than non-founder led companies from 1990 to 2014 inclusive.
However, wealth managers suggest there can sometimes be too high a price to pay for those rises. “For those of us who lack the genius, guts and good fortune of Jeff Bezos, Reed Hastings or Mark Zuckerberg, the equity markets allow us to ride their coat tails as the companies they found go from strength to strength and make us, and our clients, richer in the process,” admits Thomas Becket, chief investment officer at Psigma Investment Management.
He warns that their interests may not be aligned with his clients’, though. For those seeking wealth preservation, a founder-led company that has “bet the ranch” on a product, deal or market — in US entrepreneurial fashion — is not a good holding. How much of the company the founder holds can affect the share price, too. Becket points out: “Proper functioning markets require there to be liquidity and it can impact the price of shares if there is not sufficient supply.”
Even if a founder’s stake does not confer control, separate share classes and voting rights can, says Edward Park, deputy chief investment officer at Brooks Macdonald.
“Common issues between shareholders and entrepreneur founders often revolve around differences between the voting rights of shares held by the founder and those offered in an IPO, which can translate to shareholders having quite limited impact on the activities of the board. This means the external market finds it difficult to influence executive pay, succession planning and the strategic path of the business,” he says.
Facebook has long faced criticism for a dual-class share structure that ensures founder Zuckerberg retains control. Ride-hailing company Lyft has attracted more criticism for proposing its founders have “super-voting” shares in its forthcoming IPO.
Nor may a founder’s leadership style suit enlarged companies in maturing markets.
Katie Nixon, chief investment officer at Northern Trust Wealth Management, says: “The skills necessary to lead a larger, more mature firm are completely different.” Sometimes, this can lead to corporate governance issues, she observes, especially when founders “are not quite ready for prime time” in terms of formal investor communication. Tesla founder Elon Musk recently illustrated the risk: he and his company were each fined $20m by US regulators for misleading investors via Twitter. Becket calls it “the cult of the celebrity CEO”: it can mean “the company’s fortunes start to be influenced by their founder’s media/social media platform”.
Founder-led company succession planning also seems a particularly US challenge. George Lagarias, chief economist at Mazars, highlights the good examples: “Tim Cook has managed to fill Steve Jobs’ larger-than-life shoes [at Apple] . . . Satya Nadella has been a very successful heir to Bill Gates [at Microsoft]” but it is often “family enterprises that suffer”.
There is, of course, one further possible reason why founder chief executive issues are mainly an American, not a European, problem. It was supposedly identified by former US president George W Bush: “The French have no word for entrepreneur.”
When seeking growth stocks with good governance, however, your wealth manager may be glad of that.
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