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The Intangible Quality of a Great Business

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Stockholm (HedgeNordic) – Academic research shows mounting evidence of superior value creation at businesses where the founder plays a significant role either as CEO, chairman, board member, owner, or adviser. Furthermore, transitions that pair a founder in a continuing role with a successor within the organization have often proved to be successful management transitions. Fund manager Andreas Aaen has been capitalizing on this “founder” phenomenon since launching his long/short equity fund Symmetry Invest in early 2013.

“The main characteristic of companies in our portfolio is that they are founder-led,” says Aaen, referring to companies with a founder who acts as president, chief executive, member of the board of directors, or holds some other position of significant influence. One reason behind this focus “is that research shows evidence that that founder-led companies have performed a lot better than non-founder-led companies,” explains the founder of Aalborg-based Symmetry Invest. “The other reason is that we simply gradually gravitated towards this group of companies,” he continues. “The focus was in many different places at inception, but over time we managed to find the sweet spot in these founder-led companies.”

“We simply gradually gravitated towards this group of companies. The focus was in many different places at inception, but over time we managed to find the sweet spot in these founder-led companies.”

Businesses led by founders often benefit from their entrepreneurial spirit and passion, lower bureaucracy, clarity of vision, coherent and cohesive culture, among others. “Companies, employess and shareholders benefit from the founders’ passion for their business, both for the customers and the products or services they provide,” argues Aaen. “Founders are mission-driven, have a purpose and desire to solve a real problem by devoting their time and energy,” he elaborates. “They are not really in it for the money. For them, it is not about the compensation, prestige or fame.”

“When you talk to founders who are passionate and mission-driven, you can see that in their eyes.”

Andreas Aaen also finds founder-led companies more interesting to research and analyze. “When you talk to founders who are passionate and mission-driven, you can see that in their eyes,” says Aaen. “This makes the research process and actual interactions with management teams a lot more fun,” he adds. “Interacting with the founders that have a real passion for their companies and their industries is just what I love to do.”

Founder Protégées

Andreas Aaen and co-portfolio manager Henrik Abrahamson ideally look to populate their 15-18-name long portfolio with founder-led businesses from the European small- and mid-cap space. However, the duo does not have a hardline stance on investing only in businesses with founders at the helm. Symmetry Invest also invests in companies that have transitioned from founder to non-founder successors from within the organization. “We really try to have founder-led companies in the portfolio, but we also look at companies run by successors to the founders,” says Aaen.

“We really try to have founder-led companies in the portfolio, but we also look at companies run by successors to the founders.”

“Three or four of our largest investments are not run by their founders, but by successors who have worked alongside those founders for years,” elaborates the fund manager. These successors know the ins and outs of their businesses and understand the founder-originating culture better than any other hired CEO. “We normally try to avoid companies where the founder steps down and the board takes a new guy from the street regardless of his or her experience.”

“A business does not necessarily have to be led by the founder, but I learned that founders normally tend to care about their businesses really well and they do well for themselves and other shareholders.”

Aaen also does not steer away from companies with a really big shareholder sitting on the board. “It is very important for smaller and mid-cap companies to have the founding entrepreneur or a big investor who can take control and lead these companies,” says Aaen. With a fragmented ownership structure, argues Aaen, the management team can take the business in the wrong direction without shareholders being able to reverse the course at short notice. “A business does not necessarily have to be led by the founder, but I learned that founders normally tend to care about their businesses really well and they do well for themselves and other shareholders.”

Capital Allocation

The focus on founder-led companies enables Symmetry Invest to invest alongside CEOs who often have a long-term vision and a sense of legacy, have significant “skin in the game,” and have incentives aligned with the ones of shareholders. These combined tend to lead to better capital allocation, which is essential for the long-term value creation enjoyed by so-called compounding machines. “Capital allocation is one of the most important aspects of our analysis,” says Andreas Aaen.

“The founders may not necessarily be better at capturing the upside of capital allocation, but they are a lot better at mitigating the downside of bad capital allocation,” argues Aaen. “Founders know their businesses better than anyone. A founder’s business is another child for them,” he elaborates. “They tend not to bet their house on a bad acquisition, for instance. There are many good capital allocators that could achieve good results on the upside, but I definitely think founders are protective and better at avoiding bad capital allocation decisions.”

“The founders may not necessarily be better at capturing the upside of capital allocation, but they are a lot better at mitigating the downside of bad capital allocation.”

Aaen also emphasizes the importance of “internal” capital allocation decisions focused on how and where capital is reinvested into the business. “The conversation on capital allocation usually concerns whether the company should work with merger and acquisitions, share buy-backs, dividends, and internal investments,” says Aaen. “These decisions are no doubt very important for long-term value creation,” he points out. “What we found, however, is that almost all the companies we invest in always have the best opportunity for capital allocation internally.”

“The businesses we look for are high-growth compounder stocks,” says Aaen. These compounders need to reinvest most of their earnings to maintain the “compounder” status. “Because these companies need to reinvest a lot of capital back in the business, the questions we ask are whether the company should lower costs, raise prices, launch a new product line, invest in an existing product, or expand into a new country,” emphasizes Aaen. “We want companies to optimize the internal rate of return of those investments.”

“The reason we focus on understanding these internal capital allocation decisions is that it is much harder to make adjustments to these decisions.”

“The reason we focus on understanding these internal capital allocation decisions is that it is much harder to make adjustments to these decisions,” explains Aaen. According to the Aalborg-based manager, it is hard to reverse the decision to start a new research and development program, or the decision to raise prices, or the decision to lower costs by firing an entire department. “The process of understanding these allocation decisions involves a lot more qualitative research.”

Symmetry Invest aims to achieve an annual return of 20 percent before fees, implying that “if companies do not find opportunities to reinvest, we need a dividend yield of 20 percent to achieve our target return,” explains Aaen. “We want companies to grow, and if businesses keep compounding, we do not care very much if the price-to-earnings goes from 12 to 15.” He prefers never to sell if investments go well, arguing that investing in a company is “like going into a marriage.” No good marriage ever ended in divorce.

 

This article features in HedgeNordic’s In-Depth series on “Quality Investing.”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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