Tech,  Wealth

Why Founder-Led Companies Are Key to Long-Term Investment Success

Approximately nine percent of the enterprises within Scotland’s mortgage portfolio are helmed by their founders. Entrepreneurs, by virtue of their foundational roles, often possess superior acumen for instigating transformative shifts within swiftly evolving markets.

Founder stewardship, while not a panacea nor obligatory, frequently denotes alignment with our enduring objectives.

Tom Slater, the principal portfolio overseer at Baillie Gifford (BG), articulated in a March investment memorandum entitled “Why Scottish Mortgage Trust Favors Founder-led Enterprises.”

As per the latest data, BG commands global assets under management totaling a staggering US$287.6 billion, with Chinese assets comprising approximately US$25 billion.

Presently at the helm of Edinburgh’s premier investment institution’s flagship entity, Scottish Mortgage Investment Trust (SMT), Slater formerly collaborated with BG’s esteemed fund manager, James Anderson, until the latter’s retirement in April 2022.

Slater epitomizes the embodiment of BG’s overarching ethos, discerning greatness in burgeoning enterprises.

BG staunchly subscribes to the philosophy that genuine investment necessitates long-term commitment to a select few exceptional enterprises, as returns on investment exhibit asymmetry, predominantly stemming from a minute fraction of companies.

This ingrained philosophy has garnered BG the reputation of a “super long-term investor,” whose temporal purview spans a decade, not mere quarterly cycles.

Regarding the widely debated matter of ByteDance’s TikTok facing potential expulsion from the U.S. market, Slater opined that irrespective of its U.S. presence, investments in ByteDance remain poised for profitability owing to its extraordinary business model.

Public disclosures reveal BG’s investments in ByteDance totaling at least US$490 million across its four investment trust funds, with Scottish Mortgage commanding the lion’s share.

Slater contends that TikTok’s substantial investments in local data infrastructure and data security fortifications provide avenues for shareholder returns even in scenarios necessitating divestiture or U.S. market exit, albeit suboptimal for the company.

He further underscores TikTok’s global revenue diversification, with minimal dependence on U.S. revenues.

In an earlier interview with “Barron’s,” Slater underscored that a significant majority of ByteDance’s operations center around China, leveraging the founder’s leadership to exploit the domestic market’s vast potential.

It warrants mention that BG’s investment footprint extends significantly into unlisted enterprises, with Scottish Mortgage Trust allocating nearly 30% of its investments therein.

Given this context, a substantial proportion of BG’s portfolio entities remain nascent or in the rapid growth phase, elucidating the pronounced correlation between founders and their entrepreneurial endeavors.

During a recent dialogue with the Smart Investor team, a discerning investment manager from a multibillion-dollar private equity institution expounded upon various perspectives and illustrative instances illuminating the appraisal of exceptional entrepreneurs.

For instance, in assessing a long-tracked consumer electronics manufacturer, key considerations encompass the founder’s prescient business strategy, robust execution capabilities, adaptability to evolving market dynamics, and a high success rate in executing planned ventures.

Such perspectives and experiences align closely with Slater’s observations on founder-led enterprises.

Most of us agree that Amazon’s Prime subscription service is an excellent customer retention tool that brings your best customers back time and time again. But this isn’t always obvious. When Prime launched in 2005, Amazon was barely profitable. And the service, which offered two-day delivery of unlimited items, suddenly turned the company’s most profitable customer into its biggest source of losses.

Since our first investment that year, Amazon has taught us many lessons about the importance of founder leadership. Able to focus on whatever will create the most long-term value, Jeff Bezos is able to use his authority as a founder to make counter-intuitive decisions.

For nearly three decades, this allowed him to push for change despite the opposition of many around him.

His successor, Andy Jassy, ​​has led Amazon Web Services’ cloud computing division since its inception, so he’s equally qualified.

01 Looking for people with a long-term vision

The key for us is to find leaders who are long-term business leaders who can break away from the market’s focus on earnings over the next quarter or two. Doing so allows them to make decisions that are in the best long-term interests of investors.

We didn’t mean to do it or even track it initially, but the founder/leader factor is definitely growing in importance in a portfolio.

Today, nearly 90% of the companies we invest in are led by founders: from Peter Carlsson of battery maker Northvolt to Marcos Galperin of e-commerce and payments giant MercadoLibre ) to the Collison brothers of payment processor Stripe.

Is there a typical founder? Hard to say. There are different nuances around the world.

But whether in the United States, Europe or China, we see the same sense of personal ownership and responsibility for the growth of the business, a sense of urgency to get things done, and an unwillingness to let bureaucracy get in the way of the company’s mission.

It is difficult for professional managers to have this sense of priority and make transformational decisions that drive change throughout the organization. Especially since their incentives are often performance bonuses tied to earnings. To improve short-term performance, they can do a variety of things to the business, including cutting spending on research and development and marketing. But this can cause serious damage to long-term outcomes.

We like management teams that invest in brand equity and optimize performance over a 10-year period.

02 Complete the change

A strong founding leader can make radical decisions to ensure change happens. This is important in a market environment where technology and consumer tastes are constantly changing. Against this backdrop, stagnation could cause huge losses. Ambition and adaptability become crucial.

Take Shopify, for example: The e-commerce software provider has thrived during the Covid pandemic by helping small businesses compete with big box retailers.

The company then expanded into delivery and logistics, a lower-margin business that founder and leader Tobi Lütke describes as a “sideline” to the main business.

Shopify has been loss-making for much of its history, but rising interest rates mean increased costs for building and connecting logistics infrastructure. To adapt to this changing business environment, Lütke made an abrupt change of direction in May 2023, selling Shopify Logistics and reducing the size of the business by 20%.

Companies are turning to generating more cash amid rising borrowing costs. This is an example of founders making tough decisions to allow the company to nimbly compete in a very different environment.

03 Continuity is important

Over the past 20 years, it has become increasingly common for founders to lead companies for longer periods of time. This is partly because financial backers are less likely to push them away and let “adults” join, but also because the company grows faster during the founder’s tenure.

We like them to have a desire for wealth so that they see long-term value appreciation as an important measure of success, and we align our goals with each other.

Founders have an impact at every stage of a company’s development, and a business’s existence often depends on whether its creators are willing and able enough to turn their ideas into reality.

Typically, as a business approaches maturity, the founder factor becomes less important because you’re less likely to see such drastic changes in the product mix or pace of change.

Apple is the best example. It’s safe to say we haven’t seen a product as impactful as the iPhone since Steve Jobs passed away and Tim Cook took over.

But in terms of value created, the value created by Cook is much greater than the value created by Jobs. So it’s not that businesses can’t continue to succeed after their founders leave, it just sometimes becomes less aggressive.

Alphabet also falls into this category. Compared with co-founder Larry Page, Sundar Pichai has not done anything particularly revolutionary, but the company continues to grow and is the world’s largest and most innovative company. One of the most profitable businesses.

04 There is no magic bullet

I want to emphasize that having a founder leader does not guarantee success. There are many examples of unsuccessful attempts. The interaction between a business and its founders often creates problems. Some founders will be pushed out, and some won’t even be able to keep up with the growth of the business.

This is especially true in enterprise software—cloud-based applications that help businesses become more efficient. The founder may have built a useful tool or product, but the challenge in scaling such a business is selling it to large enterprises.

This involves managing a sales force, managing relationships, and all sorts of more boring things that businesses are interested in, and those skills are completely different. So bringing in a different CEO makes a lot of sense.

Scottish Mortgage is looking for companies that are transforming their industry, delivering goods and services in new ways and meeting unmet needs. These are no ordinary companies. When you have a mission like this, it’s crucial to have talented people at the helm.

Of course, we are not superstitious about “founder worship.” After all, the trust’s biggest holding is Dutch company ASML, which makes machines for making semiconductor chips. This is not founder-led.

Nor do we believe that the continued presence of entrepreneurial leadership is a panacea for many of the problems facing growing companies. We just see that founder-led businesses play a huge role in creating the great companies of the future.

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