Why Founder-Controlled Firms Are Best

Going public can take away an entrepreneur's edge

Written by Joanna Pachner

It’s in the nature of entprepreneurs to want to build lasting enterprises. And it’s increasingly in the nature of stock market investors to want to make a quick buck.

The latest piece of evidence highlighting the divergent investment horizons for founder-controlled firms and public corporations comes from the University of Toronto’s Clarkson Centre for Business Ethics and Board Effectiveness. A new study compares the 20-year performance of 23 publicly listed Canadian companies controlled by their founding families (defined as those owning at least 30% of shares, among other criteria) to the rest of the S&P/TSX index. The researchers found that these “family firms” had compound annual growth of 7.7%, exceeding the 6.1% growth of their widely held peers.

The study adds to a growing body of research that shows founder-controlled companies deliver higher shareholder returns in the long run because founders are more likely to plan strategically for the long term rather than seeking quarterly share-price bumps. For example, in a speech at a May business leadership event in London, Dominic Barton, worldwide managing director of McKinsey & Co., highlighted how the growing “short-termism” of Western corporations is harming both their shareholders and the economies that look to them for investment. “Partly because they focus on short horizons, public companies shy away from longer-term but more lucrative investments, and end up investing at a quarter of the rate of their private counterparts.”

He cited various evidence for this short-term thinking, including:

  • 55% of CFOs will reject an investment with a positive net present value if making it means missing next quarter’s consensus earnings;
  • Private companies that go public invest 2.8 times less after their IPOs;
  • The average public-sector company applies a five- to 10-percentage-point higher discount rate on project assessments than a private peer in its industry.

The U of T study credited three factors for the better performance of family firms:

  1. Commitment to the firm’s operating principles. “It is often as if [the companies] are taking on an identity which embodies the values of the founding family. This helps to create a unified and productive culture.”
  2. Long-term view in investment decisions. Family firms “tend to focus on the sustainability of the firm for future generations and choose long-term strategy over short-term gains.”
  3. Ability and willingness to change strategy — an agility that allows family firms to “take advantage of new opportunities for long-term success, and to mitigate possible risks from changing markets in order to maintain long-term firm viability.”

These, of course, are some of the key principles behind successful entrepreneurial ventures. Your company is like your child: your priority is preparing them for a long and successful life, not ensuring they get an A in math this semester, at any cost.

But the message of this research is more far-reaching. First, going public can expose you to intense pressure from impatient markets to deliver now rather than build for the future. Second, entrepreneurs are the life blood of the economy because their desire to grow their firms drives them to greater investment. And third, you may do better investing your own money in other entrepreneur-run firms than in widely held corporate giants run by hired-gun CEOs whose bonuses are tied to quarterly results.

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Originally appeared on PROFITguide.com