Many investors, including us at Urbem, highly appreciate businesses where founders still manage day-to-day operations, lead the board or hold some other position of significant influence. The reason is the so-called founder advantage. A study of the S&P 500 by consulting firm Bain & Co. shows that founder-led companies outperformed others by three-to-one in the S&P 500 over a 25-year period.
So how would founders provide a competitive edge for the business to generate excessive returns? First, we think that founders tend to take a longer-term view and have a greater desire to maximize the sustainability of their company. In contrast, professional corporate managers tend to focus, to a higher degree, on near-term results (e.g., beating earnings expectations). Also, the long-term success of a business comes mostly from the superior capital allocation, in terms of which founders are often more disciplined and prudent than others. Last, the whole company may easily inherit the founder’s entrepreneurial mentality, like being purpose-driven, cost-conscious, customer-oriented, risk-taking and innovative.
Take a look at SEI Investments (SEIC, Financial). The leading global provider of investment platforms and solutions was founded by its current chairman and CEO, Alfred West, who was then just fresh out of college, as Simulated Environments to develop training simulation applications for banks in 1968. The business pivoted a couple of times over the next several decades and transformed from a small two-person operation into an almost 4,000-employee company as of today. In the meantime, West kept his salary low and his equity stake high. He received a modest base salary of $650,000 in 2018 and personally owned over 12% of the company.
In the early 1990s,West decided to scale down SEI's consulting practice and to enter the asset management business. He lost three of his top executives after making the decision. Fast forward to today, the company manages over $300 billion in assets, which contributes to more than one-third of total revenue.
Looking at the chart below, we noticed that SEI Investments consistently delivered high free cash return on assets over the last three decades.
He has said, "CEOs need to be shareholders. They should have just as much at stake as their employees or their investors."
Similar to SEI, shareholders at Paychex (PAYX, Financial) have also seen consistently high returns on capital over the decades (see below). The Rochester, New York-based company is the recognized leader of integrated human capital management (referred to as "HCM") solutions of payroll, human resources, retirement and insurance services for small- and mid-sized businesses.
Paychex was founded in 1971 by current chairman Thomas Golisano with merely $3,000 and the ambition of making payroll outsourcing easy and affordable for small businesses. Before the company was started, the conventional wisdom was that it was a waste of time selling payroll services to small companies. However, Golisano did the math and proved that smaller companies needed payroll services as much as larger ones, while still offering an excellent return on investment.
“I went to executives at Electronic Accounting Systems with my plan," he once said. "They looked at me and said, 'We don't think it's a good idea.' I sat on the idea for about two more months. Then I walked into the president's office one more time and said, ‘What do you think?’ He said no. I said, ‘Well, I'm going to leave and start a company.’ It was November 1970. I was 29. He wished me well, sort of.”
Today, Golisano still owns over 10% of the $30 billion business he founded.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We own shares of SEI Investments and Paychex.
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