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At The Money: Should You Invest in Companies Led by Founders? · Masters in Business

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  Speaker 1: Bloomberg Audio Studios.
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  Speaker 2: Podcasts. Radio. News.
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  Speaker 1: Should you invest in companies led by founders? Peter Thiel's
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  Speaker 1: VC Founders Fund has over $ 20 billion and produced excellent returns.
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  Speaker 1: How can ordinary investors get access to funds of companies
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  Speaker 1: headed by founders? To help us unpack all of this
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  Speaker 1: and what it might mean for your portfolio, let's bring
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  Speaker 1: in Michael Monahan. He is a partner and portfolio manager
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  Speaker 1: of the Founders 100 ETF, stock symbol FFF. He's also
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  Speaker 1: been a Wall Street analyst, a private market investor, a
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  Speaker 1: tech startup CEO, and a public equity portfolio manager in
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  Speaker 1: his career. So, Michael, let's just start with the basics first.
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  Speaker 1: What's the central thesis behind the Founders 100 ETF? Why
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  Speaker 1: should founder-led companies outperform even after they've become large public companies?
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  Speaker 2: Barry, thanks for having me. The data shows that founders
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  Speaker 2: outperform by about 3x. We looked at 11,000 stocks over
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  Speaker 2: 30 years. And on average, founder-led companies grow 4% greater
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  Speaker 2: than the S & P. Wow.
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  Speaker 1: So let's stay focused with that 3x. I believe that
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  Speaker 1: was Bain Research that founder-led companies tend to outperform other companies.
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  Speaker 1: What is it that drives that three times outperformance? Is
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  Speaker 1: it that founder-led companies tend to be heavily represented in
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  Speaker 1: the technology sector? Is it a function of age or size,
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  Speaker 1: or is this just survivorship bias?
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  Speaker 2: We've got companies led by founders all across the economy.
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  Speaker 2: So it's not just a concentration in technology, although there
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  Speaker 2: is a lot of a technology company that are led
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  Speaker 2: by founders. We don't think it's survivorship bias. We think
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  Speaker 2: that founders bring something really unique. They have the vision
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  Speaker 2: to see where to go. They have the execution to
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  Speaker 2: execute that plan they've envisioned. They have the charisma to
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  Speaker 2: build a big team around them. And they've got the
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  Speaker 2: grit to get through the hard times combined with the
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  Speaker 2: fact that they think in decades where a board hired
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  Speaker 2: CEO is just trying to make the next quarter and
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  Speaker 2: the next PowerPoint presentation for the board.
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  Speaker 1: How much of this is due to the fact that, hey,
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  Speaker 1: if you're going to start a new company from scratch,
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  Speaker 1: by definition, you're a risk taker. How much of the
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  Speaker 1: outperformance of founder-led companies is simply just embracing that higher
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  Speaker 1: tolerance for risk?
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  Speaker 2: I don't know if that's the factor that's showing it.
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  Speaker 2: I think if you dig in, a lot of these
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  Speaker 2: guys are successful because they de-risk all along the path, right?
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  Speaker 2: So if you listen to, say, Mark Andreessen, he talks
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  Speaker 2: about at the zero stage and the one stage and
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  Speaker 2: the two stage, it's all about de-risking the problem as
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  Speaker 2: you move along. So I would gently say that I
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  Speaker 2: think founders de-risk their business even more than non-founders.
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  Speaker 1: Really, really interesting. And you yourself is a founder. Your
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  Speaker 1: startup was Beartooth Radio. It didn't necessarily find an exit,
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  Speaker 1: but I'm curious, how did that experience of standing up
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  Speaker 1: a company from scratch affect your view of founder-led firms?
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  Speaker 2: I think it completely reframed how I think about building
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  Speaker 2: a company. I had spent my first 15 years of
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  Speaker 2: my life working for great companies. I worked at Goldman Sachs.
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  Speaker 2: I worked at Sanford Bernstein. But there's a big difference
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  Speaker 2: between working at a world-class organization where you fit into
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  Speaker 2: their system and building your own system from zero to one.
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  Speaker 2: I was fortunate enough to get exposure to some of
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  Speaker 2: these really good technology founders and just saw how differently
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  Speaker 2: they thought, how passionate they were, how they brought vision
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  Speaker 2: that you know, sort of corporate managers didn't have.
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  Speaker 1: So let's zoom in on that. How do you define
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  Speaker 1: a founder? Must the individual have actually started the original enterprise?
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  Speaker 1: So do you include anyone who perhaps acquired or reinvented
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  Speaker 1: or merged with or effectively refounded an already existing company?
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  Speaker 2: So we define founder-led as the original founder. That's the
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  Speaker 2: person who started the company. still running it, most often
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  Speaker 2: as the chief executive officer. Occasionally, it'll be the chief
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  Speaker 2: technology officer, or in the case where a medical or
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  Speaker 2: scientific company, it could be the chief medical or chief
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  Speaker 2: scientific officer. So it's the chief officer running the company
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  Speaker 2: day to day. We looked at the data. Board member
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  Speaker 2: doesn't have the efficacy we want. Chairman doesn't have the efficacy.
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  Speaker 2: It's only if the founder's sitting in the seat every
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  Speaker 2: day running the company.
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  Speaker 1: And some classifications, really straightforward. Obviously, Michael Dell founded Dell Computers,
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  Speaker 1: Zuckerberg at Facebook. What do you do with the more
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  Speaker 1: ambiguous cases? And I think probably the biggest one is
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  Speaker 1: Elon Musk, who was an investor, not an original founder
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  Speaker 1: of Tesla. There are debates about the merger with PayPal.
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  Speaker 1: We could talk about SpaceX. How do you draw the
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  Speaker 1: lines there? You're really less interested in the technical founding
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  Speaker 1: issue than the driving animus of the company. Is that
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  Speaker 1: a good way to distinguish it?
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  Speaker 2: I think that's fair that. We have a rigorous process
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  Speaker 2: to decide, and you and I can hit a couple
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  Speaker 2: edge cases at the end. But we look to see
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  Speaker 2: who the original founder is. Most of the time, it's
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  Speaker 2: clear cut. Sometimes it's not. And then so we have
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  Speaker 2: to dig in. We have to say, who does the
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  Speaker 2: company define as the founder? Or Elon's a great one
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  Speaker 2: to examine because there is. For some reason, there's controversy
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  Speaker 2: as to whether he's the actual founder. We dug in
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  Speaker 2: and did the hard work. The company defines him as
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  Speaker 2: the founder. And in fact, it was either 2012 or 2014,
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  Speaker 2: there was a court case where this was actually settled.
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  Speaker 2: And Elon Musk is one of the five original founders
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  Speaker 2: of the Tesla Motor Company.
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  Speaker 1: I would modify that to say Elon wasn't the original founder.
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  Speaker 1: But once he took over, he so totally revamped the company.
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  Speaker 1: that it looks nothing like the prior enterprise. So is
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  Speaker 1: there any reason to split hairs with that? Same sort
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  Speaker 1: of thing with PayPal or SpaceX. How do you think
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  Speaker 1: about those two?
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  Speaker 2: So I think SpaceX, he clearly was the founder. I
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  Speaker 2: don't think anyone else lays claim to it, right? PayPal
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  Speaker 2: was the merger of a couple entities. It was the
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  Speaker 2: entity that sort of the original X entity that Elon
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  Speaker 2: was building merged into Peter Thiel's company. But there are
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  Speaker 2: edge cases. Berkshire Hathaway is a great example. I don't
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  Speaker 2: think anyone would doubt that Mr. Buffett was the founder
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  Speaker 2: of Berkshire. But he bought a failing textile company as
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  Speaker 2: part of a massive acquisition. And that company that acquired
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  Speaker 2: that and many other things, he's the founder of. And
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  Speaker 2: Monster Beverage is kind of the same way. They acquired
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  Speaker 2: a juice company, but it was really the energy drink
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  Speaker 2: company and the other acquisitions they made that is the
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  Speaker 2: founding of the Monster Beverage company.
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  Speaker 1: Yeah, that makes a whole lot of sense. So amongst
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  Speaker 1: your current holdings, you have founders like Alex Karp of Palantir,
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  Speaker 1: Larry Fink at BlackRock, Mark Ruin at Apollo. Each of
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  Speaker 1: those companies had multiple co-founders. How relevant must the individual
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  Speaker 1: who remains be to the company, to its strategic vision,
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  Speaker 1: to really as its dominant force?
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  Speaker 2: It's kind of our test is, were they original co-founder?
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  Speaker 2: And we often look to the company to define it.
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  Speaker 2: Most of the companies in their origin story or their
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  Speaker 2: history will list who the original co-founders are. As long
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  Speaker 2: as at least one remains as an executive, that meets
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  Speaker 2: our test.
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  Speaker 1: So now that we take the list of however many
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  Speaker 1: founder-led companies there are, I think it was 11,000. You're
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  Speaker 1: going to break that down to a list of 100.
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  Speaker 1: What are the underlying criteria that determines which of those
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  Speaker 1: thousands and thousands of founder-led companies end up in the
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  Speaker 1: 100 that are in FFF?
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  Speaker 2: Really great question. So we looked at 11,000 stocks over
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  Speaker 2: 30 years. And during that 30-year time period, there's about
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  Speaker 2: 800 founder-led stocks at any one time. So in the
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  Speaker 2: current market, there's about 800 founder-led stocks. From there, we
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  Speaker 2: look at the 200 largest by market capitalization. And then
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  Speaker 2: my co-founder and I come from a fundamental background, especially her.
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  Speaker 2: She's a classically trained Columbia Business School value investor. We
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  Speaker 2: build a valuation model using some factors to pick what
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  Speaker 2: we then believe are the 100 best out of the
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  Speaker 2: 200 largest.
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  Speaker 1: Interesting. And I'm looking at, Your largest holdings, Meta, NVIDIA, Oracle, Palantir, Dell, Arista,
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  Speaker 1: and CrowdStrike, a lot of this is a heavy overlap
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  Speaker 1: with technology, AI, high growth, big cap companies. Why go
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  Speaker 1: with a founder's fund instead of just a simple NASDAQ 100?
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  Speaker 2: We have very different exposures than the NASDAQ 100. We've
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  Speaker 2: got about 80% active share versus NASDAQ 100. We've got
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  Speaker 2: much higher exposure to founders, 100% founders versus about 20%
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  Speaker 2: of the NASDAQ 100. And it's a different portfolio construction.
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  Speaker 2: NASDAQ 100 is limited to only NASDAQ stocks. And there's
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  Speaker 2: obviously incredible high growth in-tech and out-of-tech stocks on the NYSE.
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  Speaker 2: And it also, we feel like we've got a little
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  Speaker 2: better spread across the economy. Right now, the NASDAQ 100
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  Speaker 2: is 30% exposed to semiconductors, S & P at 20,
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  Speaker 2: and we're only at 10. So we do have exposure
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  Speaker 2: to technology, but we really are bent across the entire curve.
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  Speaker 2: We're not substantially overweight versus, say, the S & P.
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  Speaker 2: We are slightly overweight, but I don't think we're massively
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  Speaker 2: overweight versus the S & P.
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  Speaker 1: Yeah, I was looking through your holdings and I saw
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  Speaker 1: a lot of industrials and energy and financials, which you
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  Speaker 1: don't necessarily see in the NASDAQ 100. But I'm glad
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  Speaker 1: you mentioned the 80% active share. So many ETFs I
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  Speaker 1: look at end up being closet indexers. This is really
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  Speaker 1: a very concentrated portfolio with the top 10 holdings really
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  Speaker 1: accounting for a big chunk of your Exposure, how much
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  Speaker 1: of what drives the performance of this is really just
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  Speaker 1: a conviction strategy, a concentrated portfolio with a long tail
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  Speaker 1: of sub 1% holdings? Tell us about the concentration and
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  Speaker 1: also tell us why do you have the rest of
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  Speaker 1: these small holdings? They're almost like placekeepers to keep an
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  Speaker 1: eye on.
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  Speaker 2: So we run a modified market cap weighting. That is,
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  Speaker 2: we take the market cap and we allow that to
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  Speaker 2: define how much position size we're going to take for
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  Speaker 2: each position. The reason we modify it is we put
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  Speaker 2: a hard cap of 7.5%. So we rebalance quarterly. So
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  Speaker 2: every quarter we reset the portfolio. We don't take any
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  Speaker 2: single position more than 7.5% because we want to have
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  Speaker 2: some diversification in the portfolio and that's where we come
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  Speaker 2: up with the weightings. And the reason we end up
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  Speaker 2: with some of these smaller weights at the bottom, it's
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  Speaker 2: just defined by where they are on a free float
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  Speaker 2: market cap. What I would tell you, Barry, it's really interesting.
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  Speaker 2: There'll be days I wake up, I look at our portfolio,
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  Speaker 2: our top holdings are down, and the portfolio is actually
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  Speaker 2: up because those other 75 to 80 stocks that make
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  Speaker 2: up the balance 50%, they drive sometimes when the big
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  Speaker 2: guys aren't working. So It's sort of just we allow
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  Speaker 2: the market capitalization to set our position sizes.
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  Speaker 1: All right. So now we know the criteria for selection,
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  Speaker 1: the criteria for waiting. Let's talk about the most challenging
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  Speaker 1: aspect of managing a portfolio, the sell discipline. What leads
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  Speaker 1: you to taking a company out of the portfolio? Is
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  Speaker 1: it just something as simple as the founder leaving? Or
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  Speaker 1: do you also run through... operating parameters and other fundamentals.
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  Speaker 1: And when suddenly you're starting to think, hey, this company
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  Speaker 1: doesn't have the growth prospects we were hoping for, is
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  Speaker 1: that a basis for ejecting them or is it a
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  Speaker 1: variety of things?
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  Speaker 2: The main reason we would sell a stock is if
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  Speaker 2: the founder leaves. So in the prospectus, we state that
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  Speaker 2: if a founder announces their resignation or we will sell
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  Speaker 2: within 90 days of that announcement. So we don't wait
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  Speaker 2: for them to actually leave. We would sell on the announcement.
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  Speaker 2: The second way a stock would get stalled is if
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  Speaker 2: the fundamental overlay flags a condition that says to sell
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  Speaker 2: the stock. So one of the ways we like to
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  Speaker 2: describe the fundamental overlay, it was built by my partner.
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  Speaker 2: It's really looking for what she calls burnt pizza crust.
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  Speaker 2: We think all of our founders can make great pizza.
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  Speaker 2: We don't want to tell them whether to make pepperoni
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  Speaker 2: or margarita. The factor looks and it says, are one
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  Speaker 2: of these crusts getting burnt? And if so, we'll slide
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  Speaker 2: it out and bring in the next best company.
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  Speaker 1: Really, really interesting. So to wrap up, If you're interested
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  Speaker 1: in a venture fund like Peter Thiel's Founders Fund, but
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  Speaker 1: you don't have a quarter billion dollars to gain access
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  Speaker 1: to it, consider the Founders 100 ETF stock symbol FFF.
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  Speaker 1: Be aware of the fact that this is a concentrated
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  Speaker 1: portfolio with a high active share, and it may not
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  Speaker 1: perform as well. Similarly to the S & P 500
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  Speaker 1: or the NASDAQ, but it is concentrated and it focuses
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  Speaker 1: on companies being led by the original founders. I'm Barry Ritholtz.
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  Speaker 1: You're listening to Bloomberg's At The Money.