Why We Prefer Founder-led Companies
Relentless work ethic, natural drive, and skin in the game often lead to better outcomes that are hard to replicate in non-founder-led companies
Too Long, Didn’t Read? Quick Highlights:
Founders by default have created something that didn’t exist before through persistent study, problem identification, and relentless work ethic. Such natural drive is usually impossible to replicate
Publicly traded company founders have already achieved financial freedom and instead derive meaning from the challenge, identity, creativity, and ethos in building their company. Furthermore, successful founders are rather passionate about what they do, providing an enormous edge over other types of managers
High ownership concentration of stock between the founder CEO and key executives reduces agency costs. “Skin in the game”, as Taleb puts it, aligns interests primarily through creation which has transformed to direct ownership. This leads to capital allocation and investment decisions that are primarily of long-term benefit to shareholders
Founder CEO’s begin as specialists, as opposed to “professional managers”. This generally results in deeper knowledge of product, customers, industry, and competitive landscape. Over time successful founders develop complex managerial skills, yet still possess the founding vision; this managerial aptitude provides such companies with enormous advantages
Case Study – We analyzed data from the BVP Cloud Index and found that founder-led publicly traded SaaS companies outperform non-founder-led
Average CAGR Since IPO (Founder-Led: 61%, Non-Founder-Led: 39%)
Median CAGR Since IPO (Founder-Led: 47%, Non-Founder-Led: 42%)
Early in our investing career, we posed a question to a senior venture partner that has helped shaped how we think about investing. While this framework matters more for early stage companies, we believe its application extends to the public markets.
The conversation went as follows:
Us: “Given you are extremely experienced and successful in venture investing, what would you say are the most important analyses you perform to determine the likelihood of success for an early stage company?”
Senior Venture Partner: “I always look closely at 4 key aspects of a business, as these 4 things determine 90% of my successful outcomes.
Team
Team
Product
The last and most important of them all, Team”
Through the years, we have found that this application rings true, even in the public markets. The management team that is running the day-to-day operations is of utmost importance, as they will be making decisions around product, marketing, sales, strategy, culture, etc. that will either make or break investment returns.
We have also discovered, via natural curiosity and company diligence, that our best investments tend to be in founder-led businesses. Most of our investments to date have been in such companies, and well over 80% of investments we strongly consider are “founder-led” companies.
We’ve identified four core reasons why we are attracted to founder-led businesses and have supplemented our rationale with a quantitative case study that demonstrates founder-led outperformance.
Purpose and Unstoppable Tenacity Propagate Creation
Founders generally operate using a special recipe, that is, they identify a problem and work relentlessly to solve it. Part of this calculus requires founders to deeply understand a set of users and create something that such users want or need, often before users know they desire the provided service. This leads great companies, at times, to be developed on accident as the founder was driven to provide a compelling solution as opposed to “starting a company”. Hence, getting an idea off the ground requires a founder to have the singular vision of developing something that truly delights customers and solves a real problem.
Successful founders often possess super-human focus and tenacity, examples include Bill Gates, Jeff Bezos, Reed Hastings, Jeff Lawson, Elon Musk, and the Collison brothers. It is hard to replicate the grit and hustle possessed by a successful founding team. They were the only people in the world to evaluate an opportunity, relentlessly pursue it, and ultimately execute and deliver a delightful customer experience. Over time, these use cases transform into larger opportunities as the company scales.
It becomes increasingly easy for investors to gloss over the original vision and focus a founder possessed since a public market narrative naturally takes over. We have found the best founders keep the fire burning bright and progress with the same pertinacity that existed years ago. Whether you like him or not, Mark Zuckerberg understands his company (and arguably all social networks) better than anyone else; after all, he built it from the ground up. Other seasoned executives have complimented Mark as Facebook has grown, but his original vision and passion cannot be replicated. This is due to Mark’s genuine interest that sparked the desire to start Facebook.
Paul Graham recently wrote an essay revolving around how such interest is tethered to “earnestness”. Paul uses the following passage to shed light on what he considers to be the most enduring quality a founder can possess:
“The highest compliment we can pay to founders is to describe them as "earnest." This is not by itself a guarantee of success. You could be earnest but incapable. But when founders are both formidable (another of our words) and earnest, they're as close to unstoppable as you get.
When you call someone earnest, you're making a statement about their motives. It means both that they're doing something for the right reasons, and that they're trying as hard as they can. If we imagine motives as vectors, it means both the direction and the magnitude are right. Though these are of course related: when people are doing something for the right reasons, they try harder.”
It’s Not About the Money
While it is impossible for investors to understand the psychological innards of executives, it can be observed that founder CEO’s of stellar publicly traded companies are typically economically advantaged. This is especially true with technology businesses where innovative companies quickly scale to hit escape velocity, resulting in rapid wealth accumulation for founders.
Many of these founder CEOs have the opportunity to walk away, retire, and live a purposeful life away from business; after all we are talking about millions and often times billions of dollars in net worth. Interestingly enough we have observed through studying many companies that exceptional founder CEO’s aren’t motivated purely by money but rather the challenge associated with the continual development and progression of the business they created.
Building a company is very different from receiving one. There are indeed exceptions but generally we believe that founders have a special attachment to whatever they built; they become increasingly interested with progression and preservation (especially after financial security). A great example of founder care is Berkshire Hathaway where Buffett has been monomaniacally determined for more than 60 years to keep the compounding machine running; such determination is not common amongst “professional CEOs”.
In the 2019 Berkshire Hathaway Annual Meeting Buffett and Munger were asked “what they valued the most in life now?”. At 88 and 95 years old, Warren and Charlie provided the following answers:
Buffett: “We get to do what we love to do every day. I mean, I literally could do anything that money could buy pretty much, and I’m having more fun doing what I do than doing anything else…”
Charlie: “Anybody’s lucky if he gets so that what he spends his time at he really likes doing, that’s a blessing.”
Make of these answers what you will, but we choose to infer that these managers are not running Berkshire in their old age for monetary gain but rather because their identities and livelihoods are invaluably connected to the business. They have been immensely successful, enjoy what they do, and will keep working until they no longer are able to…… what more could be demanded of management?
Note: We are referring to Berkshire Hathaway as the conglomerate it is today, architected by Warren Buffett. We realize Buffett was not the founder of the original textile business
The Invaluable Nature of ‘Skin in the Game’
High ownership concentration of stock via the founder CEO greatly reduces agency costs and leads to long term decisions that have a high probability of positively impacting the business. Founder CEO’s have greater ‘skin in the game’, meaning that more of their wealth is tied directly toward the performance of the business. With more of their wealth in the company there is a strong incentive for founder CEO’s to ensure long term prospects for the business. This long term outlook generates proper alignment between founder and shareholder interests.
Research has supported this for sometime now, with a 2009 study observing that “mean stock ownership of founder CEOs is 11.1%, while non founder CEOs have have a mean ownership of just 2%. Of all founder CEOs, 13.6% hold more than 25% of the outstanding shares of the firm.” We believe there is no substitute for ‘skin in the game’, and as investors we must be extremely prudent when evaluating a manager’s ultimate dedication to the business via direct ownership percentage. Nassim Taleb has discussed this point at length many times over, but several years ago provided the following insight:
“Have you wondered why, on high-speed highways there are surprisingly few rogue drivers who could, with a simple maneuver, kill scores of people? Well, they would also kill themselves and most dangerous drivers are already dead (or with suspended license). Driving is done under the skin in the game constraint, which acts as a filter.
It’s a risk management tool by society, ingrained in the ecology of risk sharing in both human and biological systems. The captain who goes down with the ship will no longer have a ship. Bad pilots end up in the bottom of the Atlantic Ocean; risk-blind traders become taxi drivers or surfing instructors (if they traded their own money).”
Skin in the game forces founders to adapt rigor and discipline in terms of capital allocation. Businesses are complex adaptive systems that more so than ever, via acceleration of the internet and cloud, have the power to disrupt and be disrupted at alarming rates. Such systems are often cultivating powerful positive and negative feedback loops and managers are required to take advantage of, and respond to, such mechanisms via capital allocation. We are of the belief that successful founders have a chance of understanding such procedures more adroitly than their “professional” managerial brethren.
Corporate strategy is about making choices and trade-offs, and possessing skin in the game requires managers to execute investment decisions that have a high probability of success. Although Stripe is still a private company, it is assuredly on track to become yet another fantastic founder-led public business. Patrick Collison shared the following remarks on “The Knowledge Project” podcast in 2018:
Shane Parrish: “How do you maintain that ability to place massive bets?”
Patrick Collison: “It’s really a question of how do we make sure that we can place bets that don’t have excessive downside, or sort of fatal downside, or maybe fatal downside across a whole portfolio of bets.”
Outstanding founders that possess robust capital allocation skills seem to make decisions that have a high probability of generating long-term compounding success, or as Collison indicated, they are good at making asymmetric investment decisions. Jeff Bezos clearly possesses such thinking and relays a bit of his thought process in the 2005 Amazon Shareholder Letter:
“We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations….. We will make bold rather than timid investment decisions where we see sufficient probability of gaining market leadership advantages.”
Acceleration by Way of Specialization and Preservation by Way of Managerial Adaptation
Founders begin by identifying and solving a problem that no one has before. To successfully accomplish this herculean task founders typically have to be obsessed with the problem and properly diagnose the associated business opportunity. This obsession drives them to simply put in more time than others and become a specialized practitioner of their craft. Such specialization doesn’t come from academia or studious observation, but rather from the various successes and failures begat by laser focus, active problem solving, and consistent ideation (we would argue that there is a SERIOUS difference).
When companies are in the incipient stages of development specialization is of ultimate importance, as it allows the business to win the bloody street fight that is startup competition. But as the company grows in size, and increasingly complex managerial needs emerge, founders must effectively become executives or replacement talent will be needed in short order. Think of the most iconic companies today, a good majority of them have been led by founder CEO’s that were able to appropriately answer the executive call and develop robust managerial acumen.
While Steve Jobs, Bill Gates, Reed Hastings, Mark Zuckerberg, Jeff Bezos, and Elon Musk come to mind the next generation of fantastic companies are also being led by founder CEOs like Shay Bannon at Elastic, Pieter Van Der at Adyen, Jeff Lawson at Twilio, Forest Li at Sea, and Scott Farquhar and Mike Cannon-Brookes of Atlassian to name a few. While they have surely received assistance, the above referenced names have constructively made executive transitions and generated stellar public market business performance.
Specialization allows founders to create a compelling product / service and solve the puzzle of engaging and retaining customers in scalable form. As the company expands, founder CEOs must delight other key parties such as employees, advertisers, partners, and investors. Dealing with these various constituents is wildly different from operating purely in the bowels of product machinery; such transition takes an immense level of personal progression and adaptation. Effectively building, and flexing, executive muscle takes special character as leading leaders is different from steering a product oriented team. The transition is so critical that it often takes humility, identification and acceptance of weakness, and outside executive assistance.
Rich Barton says the following in relation to the founder to CEO transition:
“I’m not saying everyone won’t scale….. some will – but many will not……. Leaders will need to be up-leveled and supplemented with outside talent. Founder/CEOs who are not able to do this will ultimately be up-leveled themselves.”
Additionally, Patrick Collison wonderfully expounded on company scale and the analogous managerial development process on “The Knowledge Project” podcast:
“There is a personal version where you certainly don’t start out being well adapted to, or at least in my case, particularly skilled in organizational management and leadership. Depending on the rate of growth of the company you need to acquire those skills on a timeline that is largely out of your control. And depending on the rate of growth of the organization that might be a pretty difficult thing.
I’ve just had to accept my sort of managerial inadequacy relative to what either is required in the moment, or sort of will in the near term and pending future be required, and just figure out strategies to try to acquire those skills and abilities as rapidly as possible.”
Founder CEOs that become prominent public company executives have developed mental models that allow them to create, adapt, collaborate, but also preserve. We feel that such flexibility and managerial ability may serve as a substantial competitive advantage in the long run.
Case Study – Founder-Led Publicly Traded SaaS Companies Outperform Non-founder-Led
To quantitatively assess our preference for investing in founder-led companies, we evaluated the historic return data for all the constituents of the BVP Cloud Index (n=54) and segmented each company by either founder-led or non-founder-led.
To not skew the data based on time horizon differential, we chose to segment the companies by IPO year to adjust for the natural decline in growth as a company scales and matures (i.e. we wouldn’t want to compare Adobe’s CAGR since IPO in 1986 to a company that IPO’d in 2019)
To classify a company as founder-led, we required that at least one of the original founders be actively involved in running the company today in either a CEO or other senior leadership role. We included other executive roles since a small subset of founders prefer to focus on leading the technology stack due to their specialization and skill in that area which will be most beneficial to the company – i.e. Artur Bergman at Fastly was founder and CEO for 11 years before transitioning to Chief Architect to focus solely on the technology stack.
Of the 54 companies, 67% fit the criteria as founder-led and 33% we classified as non-founder-led. This breakdown can be observed by year below:
After segmenting the companies by founder-led vs. non-founder-led, we compared them across their IPO cohorts and found that 4/6 of the founder-led cohorts outperformed their non-founder-led peers (Note, there are 7 cohorts but 2017 had zero non-founder-led IPOs).
If you look at the average CAGR across these cohorts, founder-led companies outperform with an average CAGR of 61% vs. non-founder-led CAGR of 39%. Even if you adjust for the outlier performance of the 2019 peer group and implement a median metric, founder-led companies still outperform with a median CAGR of 47% vs. non-founder-led CAGR of 42%.
This data doesn’t mean investors should solely consider evaluating founder-led companies, as there are plenty of great non-founder-led businesses. But we do suggest this data quantifies why we generally prefer founder-led companies as we believe interests are better aligned for long-term success.