Updated: Feb 26, 2021
Why you should stick with owner operators?
I've been giving a lot of thought to the ingredients that make up a successful investment. I'm convinced that backing successful owner operators is one of those ingredients.
With so many businesses to choose from in the equity markets to drive total returns, I've often wondered how you identify those businesses that are most likely to be successful. Obviously strong moats, good competitive advantages and tailwinds are all elements that help to drive good growth and sustained profitability over a long time. Additionally the ability to earn strong returns on invested capital is also a necessary ingredient to a successful long-term investment in my book.
However one of the other factors that I think is overlooked by many people is the existence of an owner operator/ founder. Now, owner operator founders tend to be very rare at the helm of the business, certainly as a business gains size and scale. That's largely because as a business scales, the challenges in running and managing a business tend to be more operational in nature which requires a different set of management skills to manage through.
While in the early days vision and strategic drive tend to be the key imperatives to be able to grow a business, as a business matures the ability to successfully hire additional managers to put in place appropriate governance structures and launch international operations tend to be more important attributes. This almost always leads to a temptation of wanting to find successful career managers to manage through the growth pains of the businesses trying to scale.
Having said that owner operators can be a very important part of a business that is in a sector going through tremendous change. I think many of the businesses in the technology sector are ones that benefit from an owner operator founder as the person in charge. Owner operators know what really make their business successful. They also have a vision for how the industry is evolving and are able to make the right bets and typically see things that career managers just can't see and anticipate.
The other thing I like about seeing founders as owner operators of the business is that they typically have large equity stakes tied into the businesses success. This isn't the token level of options and restricted stock units that career oriented CEOs typically receive.
It's a far more meaningful amount which means their incentives are often more directionally aligned with those of shareholders. This is really important because it helps solve the agency problem. Career CEOs generally tend to not be as good with strategic vision and direction setting for one thing. However as agents for the company they tend to be more often interested in their own career advancement and lining their own pockets.
This often leads to wasteful, egregious acquisitions or other actions that are taken to ensure that they hit their performance numbers and near-term bonus metrics rather than being focused on growing long-term. Career CEOs tend to know that once they've exhausted their five-year terms that they are out and have no further involvement with the business. Founder operators tend to have a lot more personal equity tied up such that even if their time as CEO ends they still remain very significantly invested in the business.
So where are examples of successful owner operator founders and what are the track records like? Well, one doesn't have to look much further than the technology sector to see many examples of this phenomenon.
Google, Facebook, Amazon, Apple and Netflix all help illustrate this phenomenon really well. Outside well know large cap tech stocks, I look at examples of companies such as Market Axess, and The Trade Desk as examples that show the tremendous value creation that can be derived by having an owner operator running the show for an extended period of time.
I am more inclined to give owner operator CEOs the benefit of the doubt with respect to new missteps or less than favorable performance updates because of the fact that they do have a vision they tend to be singularly obsessed with the long term success of their business. The timeframe for their actions tends to be measured in decades as opposed to quarters.
For a long-term investor, that tends to be a really good mindset for successful long-term value creation. You really don't want a CEO who is more fixated on meeting the streets numbers and objectives for the next quarter or the next year if there's an opportunity to dominate an industry, which means essentially sacrificing some near-term profits.
That should be a recipe for long-term value creation. Owner operator founders also tend to be quite good at capital allocation because they have a more innate sense of market opportunities and where strategic value is likely to be created.
I look for instance at the vision of Jeff Bezos and Amazon. This truly is one of the great companies that I've admired for a long time in terms of vision and execution. Sure Amazon has many detractors who claim that the company can't turn over profit. But why should Bezos be focused on near-term profitability if he has the opportunity to dominate retail market share for the next 15 years.
I also love the strategic move of the creation of the AWS business from having excess computer capacity which is surplus to Amazon's own e-commerce needs. Bezos has created a new multi billion dollar business literally from nothing. I'm happy to give him the benefit of the doubt with respect to investment of surplus capital, rather then looking for him to take actions that are designed for near-term profitability given that the window for success is such a long time one.
In the case of the Trade Desk, Jeff Green founded the business with a very specific vision for how digital advertising should work, with full transparency to advertisers about where their dollars were spent and what return they earned. He put his weight of his convictions behind the concept, and has grown the business into a $40B giant of the digital advertising industry.
This single minded conviction has allowed him to take decisions to the long term benefit of investors, even though the concept was one that was revolutionary to the advertising industry when first introduced.
Owner operator founders who have significant wealth that continues to be invested in the businesses that they founded make for very good investment choices for the long-term investor. Riding the strategic vision and direction of these visionaries can be a pathway to long-term success. Investors who are looking for growth in particular are well advised to find these types of businesses and stay on for the long haul.