The Case for Investing in Founder-Led Companies

The Case for Investing in Founder-Led Companies

When it comes to making sound investment decisions, the quality of the management team running the company is of utmost importance. There are different ways to evaluate the level of commitment and talent of a CEO, but a simple rule of thumb can be particularly powerful: companies led by their founders are usually managed with the right long-term mentality.

According to a 2005 study by Martin L. Marten featured in Harvard Business Review:

Founder-led companies had a market-adjusted return of 12% over the course of three years and a survival rate of 73%, compared with a return of -26% and a survival rate of 60% for firms that hired a new CEO...

This doesn't necessarily mean that every entrepreneur is good CEO material. Companies and their management teams sometimes need to adapt to changing conditions as they grow in size. However, once a founder proves that he or she can be a successful CEO; chances are the company is in remarkably good hands as long as the founder is leading.

Buying shares of Berkshire Hathaway allows investors to have their money managed by Warren Buffett himself, arguably the best capital allocator ever. Buffett´s talent has allowed Berkshire to grow its book value per share at a compound annual rate of 19.7% from 1965 to 2012, more than double the total return of 9.4% annually generated by the S&P 500 Index during the same period.

The Oracle of Omaha has almost all his net worth invested in Berkshire, aligning the interests of shareholders with his own interests in an indisputable way. Furthermore, Berkshire is about much more than money for Buffett, it's his legacy to the world and he will do his best to make sure that the company remains in the best possible hands after he is gone.

It wouldn't be reasonable, or even fair, to expect from his successors the same kind of extraordinary genius Buffett has shown over the decades. But the Oracle of Omaha has a good eye for picking capable and honest business managers, and Berkshire has a long-standing culture of stewardship. This should allow investors in the company to sleep soundly at night when it comes to thinking about Buffett's succession at Berkshire.

Retaking the reins
While Buffett famously takes a hands-off approach to the day-to-day management of his acquired companies, some founding owners find it necessary to return to the helm in order to bring operations back on course. Take Howard Schultz, for example, who can be considered the barista to the world. He founded Starbucks in the 80's and built a coffee empire from a single coffee store in Seattle, practically inventing a whole new product category. Schultz has been the driving force behind Starbucks' differentiated customer experience, which is a key success factor for the company.

If that weren't enough, in 2008 he returned to the role of CEO after an eight-year pause to reinvigorate the company and turn its financial performance around. The company was over expanding back then and the Starbucks experience was becoming watered down. As a result financial performance was decaying too.

Since Schultz reclaimed his throne, the company refocused on what matters most: providing high quality products and a superior customer experience. Both customers and shareholders have enormously benefited by Schultz´s return, and they should feel comforted by the fact that he is managing the company's expansion without losing sight of those differentiating factors that make Starbucks much more than a simple coffee store.

Jeff Bezos of Amazon has always applied a long-term mentality to business management and capital allocation decisions. He has invested heavily to consolidate Amazon's position in online retail and expanded into areas with high-growth potential like cloud computing, even if that means eroding profit margins in the short term.

If Bezos were a traditional externally-hired CEO, he may be more oriented toward quarterly profit figures in order to please Wall Street. But instead of that, he puts all his effort in building a gigantic empire with unparalleled competitive strengths, and the stock market has even rewarded this approach by focusing on the company's long-term prospects as opposed to its falling profit margins.

Similar to Amazon's Bezos, there is no Tesla without Elon Musk. The company's founder and CEO is one of the most successful and visionary leaders around; he has already made some remarkable inroads in industries like electronic payments, solar energy, and space travel. When you are trying to revolutionize the automotive industry, having one of the most extraordinary entrepreneurs in the world on your side is clearly a valuable asset.

Musk is all about products first, profits later. As a result the Model S has received numerous awards and recognitions such as the 2013 World Green Car of the Year, 2013 Motor Trend Car of the Year, Automobile Magazine's 2013 Car of the Year and, more recently, the highest safety rating of any car ever tested by the National Highway Traffic Safety Administration.

Demand for the Model S has exceeded expectations and Tesla has now reached profitability. Even if carbon tax credits are a big factor behind that achievement, the fact is that Tesla is not losing money anymore and that says a lot about its long-term viability and growth. Musk's long-term vision and focus on the products have been enormously profitable for Tesla shareholders as the stock has risen by a whopping 500% over the last year.

Founder CEOs usually have a deep understanding about the company and its success drivers. They also have a strong personal connection with the company, which fosters long-term strategic thinking over sort-term profit maximization. When it comes to selecting companies with the right management team, having the founder on board tends to be a valuable plus.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

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Andrés Cardenal owns shares of Berkshire Hathway and The Motley Fool recommends, Berkshire Hathaway, Starbucks, and Tesla Motors. The Motley Fool owns shares of, Berkshire Hathaway, Starbucks, and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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