While founder-led businesses have a strong track record of outperforming, there’s more to this investment approach than simply picking a group of such companies and hoping for the best, according to Michael Bell, chief investment officer at Solaris Investment Management .

In particular, investors should distinguish between key attributes and key risks when it comes to identifying well-run, founder-led businesses, he suggested.

Speaking at the 2024 Pinnacle Investment Summit recently, Bell highlighted Solaris’ analysis of the performance of Australia’s top 12 founder-led companies against the ASX 200 between 2019 and 2024.

It revealed that founder-led companies increased more than 400 percent over that five-year period, compared to 65 percent for the broader market over the same time period.

"There's something about founder-led companies that makes them excel," Bell said, identifying six key attributes contributing to this trend.

Namely, these are determination, capital allocation, alignment, deep industry knowledge, culture, vision and passion in founder-led businesses.

"These founder-led companies tend to have low bureaucracy in them, they're able to make decisions quickly and there aren't many obstacles," he said, pointing to the example of the Goodman Group and its successful foray into data centers.

Similarly, given the longer tenure of founders at the helm of a business compared to the average CEO, businesses benefit from good long-term capital decisions, he said.

"I'm told the average CEO has about a five-year tenure in Australia, [it’s] it's not a lot of time to make long-term capital decisions, but founders tend to be around 10-20 years, so they make good, long-term capital decisions that are generally successful,” Bell said.

He also noted that founders typically have a large portion of their wealth tied to these companies, resulting in better alignment with the business, helping them develop a strong vision, team and performance culture.

Previous analyzes by Milford Asset Management also found a "consistent theme" of outperformance among founder-led, family-owned or employee-owned businesses.

In a June market note, Michael Higgins, portfolio manager of the Milford Small Companies Fund, pointed to a significant 31.7% annualized outperformance by founder-led, family-owned or employee-owned businesses held in the fund.

"As early as August 2021. for the first time we analyzed the performance of these businesses against the broader market index. The results were stunning,” he said.

"The founder-led portfolio returned 41 per cent per annum over three years versus the S&P/ASX Small Ordinaries index's return of 9.2 per cent per annum."

Reviewing the results in 2024, with around a third of the portfolio already invested in these businesses, Higgins said the data "reinforces why we love founder-led companies".

“The three-year performance of the founder-led portfolio to April 2024. (23 companies) was 24.9 per cent per annum versus the S&P/ASX Small Ordinaries index return of 2.7 per cent per annum, outperforming the 22.2 per cent per annum return,” he said.

Like Bell, he identifies a number of key differentiators that favor founder-led businesses over their competitors, namely a long-term mindset, skin in the game, and emotional investment.

Unpacking red flags

However, while investor interest is growing around the founder-led business, Bell noted that there could be a number of risks.

In particular, he reiterated the importance of scratching the surface to uncover any "red flags."

“There are red flags to identify when looking at founder-led companies [and] the only way to identify those red flags is if you're actively investing, that's critical,” he said.

The first red flag, Bell said, is when the founder chooses to sell, thereby reducing the alignment of the business and shareholders.

"Sometimes there's a reason they're selling — it could be a divorce — but generally when you sell, you reduce compliance, and we don't like to see that," Bell said.

He also noted that management issues may also require a second look.

“With any of these founder-led companies, you want to make sure that [they’ve] I have a strong management team and a strong board that holds the founder accountable,” he said.

Finally, Bell pointed out how the retreat of management among these firms can prove worrisome.

"What we don't like to see is management retreats or large management retreats in these companies. A living example is Fortescue, they have had three CEOs in the last two years. This is too big a withdrawal for us,” he said.