About eight months ago, one of Elon Musk’s many business ventures, SpaceX, tested its Falcon Heavy rocket by launching Musk’s own Tesla Roadster into space.  It’s now the fastest car in the universe, on a heliocentric orbit around the sun, complete with a mannequin in the driver’s seat named Starman.  Given the career challenges he’s faced this year, Musk is probably ready to take the wheel himself.

Entrepreneurship is an Investment Theme

Investing in founder-led companies is a strategy favored by many investment managers, including some of our clients.  The logic of the narrative is compelling: founders have interest, drive, and motivation.  In our hometown of Memphis, the archetype for this is FedEx.  Federal Express was a term paper in business school written by the founder, Fred Smith (who reportedly didn’t get a very good grade on the assignment).  Founder-led businesses benefit from unique levels of dedication; Smith once covered Federal Express’s fuel bill with gambling winnings in Las Vegas.  He devoted his inheritance and his life to the company and has retained a significant stake in the equity.  Smith is now 74 years old and remains involved in the business.  While the topic of succession comes up, key executive dependency is a comparatively minor topic when the company employs over 300 thousand people.

Not all founders are like Fred Smith, though.  While Tesla’s share price has proved remarkably resilient this year, it has had to be in light of the increasingly erratic behavior of founder, chairman, and CEO Elon Musk.  From smoking pot in interviews to tweeting inaccurate insider information, Musk has made a mess of his leadership role in 2018 and highlighted the potential downside in founder-led companies.

Every Company has Founders

Tesla’s story is relevant to the investment management industry not just because many asset managers are invested in Tesla or otherwise invest in founder-led businesses.  The Tesla story matters because most investment management firms are also founder-led businesses.  The independent broker-dealer industry was born in the 1940s when wealthy investment professionals had to leave their commercial banking jobs because of Glass-Steagall.  The majority of that generation of BDs are forgotten now because of consolidation or failed succession plans or both.  The advent of ERISA in the 1970s brought about a new wave of money managers who built the RIA industry.  The RIA industry is still expanding, despite a recent wave of consolidation.

Most RIAs, independent trust companies, and hybrid RIA-BDs today are founder-led.  The ones we work with are typically successful, having benefited greatly from the talents of their founders, whether in the discipline of attracting clients, choosing investments, or both.  The trouble is that, while companies are usually designed to operate into perpetuity, founders ultimately suffer from mortality.  Given the age of the RIA industry, many firms are facing succession issues, and many won’t survive it.

When Vision Becomes a Blind Spot

If you’ve never read up on the theme of “founder’s syndrome,” then you’ve missed out on a key narrative that explains the valuation of many investment management firms.  Founder’s syndrome is an organizational behavior in which a company is built around the personality of a prominent individual in a company, usually in a senior position, and often the founder himself or herself.

Strong personalities can build strong organizations, but sometimes people start companies because they can’t work for anybody else.  Can you imagine having Elon Musk as an employee?  To the extent that the needs of a founder are made more important than the needs of the business, the business will suffer.  If an RIA is a small enterprise that is more of a practice than an organization, this is no problem.  In larger investment management firms, however, boards who once promoted the interests of a key professional may find themselves in the position of having to protect the business from that same person.  While Bill Gross’s departure from PIMCO is a prime example, it is far from the only example.  More often, we see situations where a creeping change in behavior leaves a senior professional with an outsized influence over the strategy of the firm, even when that strategy no longer serves the goals of the firm.

If an investment management firm grows because of, rather than in spite of, its founder, then the next challenge arises, succession.  Replacing a founder is nearly impossible because a leader in succession is necessarily going to have a different approach to running an organization.  Second generation leadership is more likely to be more disciplined, cautious, and risk-averse.  The organization itself will probably have to adjust to the second generation of leadership such that the needs of the company match the offerings of the executive.

Diagnosing Founder’s Syndrome

If you’re wondering whether or not your RIA is suffering from founder’s syndrome, answer these three questions:

1. Does your RIA, BD, or independent trust company principally exist to serve the psychological needs of your founder (i.e. an all-expenses paid ego trip)?
   The willingness of a founder to identify with their business is a key motivator that leads founders to work harder and longer to ensure the success of the enterprise.  With success, the business returns the favor, and it’s at that point that the founder has to consciously decide whether their firm is really a business or simply an extension of themselves.  This often shows up in compensation plans, when the founder(s) fail to draw a market-based line between their pay as employees and their returns as owners.  Since small RIAs are owner-operator businesses, this can be easier said than done.  But if the economics of the business are sufficiently segregated, then the founder is more likely to be working for the business, rather than the other way around.
2. Is your founder unable to delegate?
   If your RIA’s success or failure rides on the skills, knowledge, and actions of your founder, then growth beyond a certain point will be difficult (if not impossible).  Many founders are perfectionists and can’t accept work done differently than they would do it themselves.  I once had a founder lead me through the office because he wanted me to meet the many talented people in his firm, only to instruct each one of them very thoroughly in exactly what he wanted them to tell me.  Needless to say, if a founder cannot delegate, then the scale of their company will be necessarily limited to their own capacity to work.
3. Is your founder willing to accept new leadership?
   Graceful exits are difficult, particularly when your name is on the door.  While founders certainly have a role in “letting-go,” transition plans are an organizational responsibility, so boards and other senior executives share in the role of providing for the sustainability of the organization.  The one theme I’ve consistently noticed is that transition takes much, much longer than people think it will.

I learned long ago that people are a package deal – you take the good with the bad and you don’t get to pick and choose what parts of a person you accept.  Like all founder-led companies, RIAs can benefit from the entrepreneurial zeal of the men and women who started them.  Unfortunately, that same appetite for risk-taking can lead to reckless behavior, and the identification of a founder with a namesake enterprise can complicate succession planning.  In any event, the risk associated with a founder-led RIA can lead to extreme results: taking advantage of a moon-shot opportunity, or a business that’s lost in space.