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Succession and the rise of ‘skin in the game’ managed funds

The Inside Network's Jimmy Dunn takes a good, long, drama-filled look at the latest wave of equity funds that base their investment philosophy on companies that are exclusively founder-led.
Analysis

Having just used a couple of international flights to binge on Succession, it got me thinking about the reality of founder-led companies on the share market – in which I suspect that the reality is just a little bit different to the goings-on at Waystar RoyCo.

There are plenty of major listed companies around the world in which the founders – or at least, the founder’s family – retain big portions of the equity, even the majority; and still run the companies.

And while outside shareholders are mostly portrayed on Succession as a necessary irritant, there is a breed of fund manager that likes nothing better than co-investing alongside the founder.

  • “Quite simply, you know you’re getting maximum alignment, because it’s the ultimate-skin-in-the-game scenario,” says Lawrence Lam, founder and managing director of Melbourne-based Lumenary Investment Management, which runs a global equities strategy focused exclusively on founder-led companies. 

    “Because it’s their own wealth, they’re willing to invest more for the long term, to sacrifice short-term gain. Founders usually think longer-term than professional CEOs and management teams, who are usually only sticking around for a few years, and potentially, have their aim on maximising their remuneration, and set the goal posts that way. Consequently, they’re often happy to kick the capital expenditure can down the road.”

    Lam’s fund, the Global Founders Fund, typically only holds up to 20 positions, but says there are plenty of founder-led companies from which to choose; there are up to 2,000 stocks in Lumenary’s potential universe.

    “In the US, there’s a lot of companies where the founding families own 10 to 20 per cent and are in management; there’s also a lot in Europe and Asia, but in those markets, the founders typically own 30 to 60 per cent. The US companies tend to raise capital more often; they want to grow quite quickly, to win market share, and they’re more prepared to issue equity and dilute themselves.

    “In Europe and Asia, they tend to play a longer game; they will raise capital, but not at the same pace, they are more cautious about dilution,” Lam says.

    With partner Jonathan Wilson, Adrian Ezquerro runs Elvest, which is short for Emerging Leaders Investment Company, a small-cap investment firm focusing on Australian companies. Founder-led is not the sole criterion for Ezquerro and Wilson, but – under their term, ‘management alignment,’ Ezquerro says it’s a “massive factor”.

    “The presence of a founder or founding family, and/or an owner/manager, is a big driver of conviction for us in a stock. In essence, you have as a co-investor a founder/business leader that has their family’s wealth on the line – but is backing that with deep knowledge, specialisation, great passion, and drive to succeed. They live and breathe the business, and it’s really obvious when you meet them. You have a partner with a laser-like focus, very high attention to detail, a very strong streak of entrepreneurship, and the ability to execute, which, over the long term, is the most important factor.

    “For us, the fact that there’s a significant correlation between founder-led, owner-manager type businesses and outperformance is probably the most important thing,” he says.

    Ezquerro points to a study done in 2016 by global management consulting firm Bain & Co., that found an index of S&P 500 companies in which the founder remained deeply involved “performed 3.1 times better” over the 15 years from 1999 to 2014. “In our experience, that result has been replicated in the Australian market, going back ten to 15 years,” he says. “It comes back to these founders having that embedded passion and drive to succeed, and grow the business.”

    In particular, says Ezquerro, the capital allocation skills are usually better. “Founders are usually very loath to dilute themselves, so you tend to see self-funded growth. For them it’s all about growing revenue, controlling costs, pay a dividend, reinvest and grow the business. They do that relentlessly, for years. It’s very simple but incredibly effective – it’s self-funding growth, and growing per-share value, rather than raising capital every year and is growing profit, but not necessarily earnings per share.”

    The contrast between that and professional CEOs, who may be focused on net profit, can be stark. “Having this demonstrable alignment is far better than investing in a professional CEO and management team. Some of them are very good custodians of companies, but you typically find that they are paid to meet KPIs, they may be pressured to maximise the dividend; they have their tenure, and they want the big salary, the big bonuses. It is human nature.”

    Boards and remuneration committees often try to “proxy” ownership through using options and share issues and hurdles, he says. “As a manager, I pay much more attention to the notices where you have a CEO and board stepping-in to the market and putting their own money on the line to buy shares, and grow their ownership of the company that way, as opposed to being given free shares or cheap options upon hitting some spurious hurdles.

    “But when you’ve got everything on the line it acts to sharpen your focus on true, sustainable growth,” says Ezquerro.

    Examples of ASX founder-led stocks:

    Nick Scali Furniture – Anthony Scali took over from his father Nick. The company listed in May 2004, raising $40 million, and has not issued any shares to raise capital since: all growth has been funded by internally generated cash flows. The company is now valued on the ASX at $990 million. The Scali family owns 13.6 per cent.

    Jumbo Interactive – Mike Veverka, founder and CEO; founded the digital lotteries company in 1995 as Squirrel Software Technologies. From a 1999 float (as Jumbomall) that raised $11.8 million, Jumbo Interactive is now valued at $930 million. The Veverka family owns 14.1 per cent.

    Hansen Technologies – Kenneth Hansen started the business 50 years ago: son Andrew Hansen has been with the business since 1990 and only stepped down as CEO in June this year (he is still managing director, focusing on  strategic growth activities.) The company is a leading global provider of software and services to the energy, water and communications industries. Listed June 2000. The Hansen family owns 17.5 per cent of the company, which is valued at $1.1 billion.

    Mineral Resources – Chris Ellison was the founder of iron ore and lithium miner, and mining services provider, Mineral Resources in 2006 (he was the founding shareholder of each of the three original subsidiary companies of Mineral Resources). The company is valued at $12.3 billion, and managing director Chris Ellison’s family owns 12.6 per cent.

    Objective Corporation – Tony Walls founded software company Objective Corporation: his first office was his bedroom in his parents’ house in Port Kembla. OCL listed in 2000, raising $6 million: the company is now valued at $1.3 billion, and the Walls family owns 65.4 per cent.

    Corporate Travel Management – Jamie Pherous founded Corporate Travel Management in 1994 at the age of 25. It has grown from a team of two in Brisbane to become one of the top five corporate travel managers in the world. The company floated on the ASX in 2010, raising $22 million: it is now valued at $2.8 billion. The Pherous family owns 12 per cent. 

    Fiducian Group – the financial services company was founded by its executive chairman Indy Singh in 1996, and listed in 2000: Singh still owns 34.8 per cent of the company, which is valued at $194 million. 

    Seven Group – the Stokes family owns the majority stake in industrial services company Seven Group, which has appreciated more than three times over the last ten to 15 years. Seven Group is valued at $16.9 billion.

    WiseTech Global – Richard White founded software company WiseTech Global in 1994 and listed it in 2016. The company has revolutionised the logistics and supply chain management industry. The White family owns 40.9 per cent of WiseTech Global, which is valued at $27.8 billion.

    James Dunn

    James is an experienced senior journalist and host of The Inside Network's industry events.




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