Why Schroders believes founder-led businesses can help investors double their money

Ally Selby: Hello and welcome to The Pitch, brought to you by Livewire Markets. I'm Ally Selby, and today we're very lucky to be joined by Schroders' Head of Private Assets, Claire Smith, for a secret to success in both public and private markets. Thanks so much for joining us today. 

We often hear in public markets, at least, that founder-led businesses are the cream of the crop. Is that the case in private markets?

Are founder-led businesses the cream of the crop? 

Claire Smith: Yeah, we think so. So, 60-70% of our deal flow in the buyout part of the market is previously family-owned or founder-led businesses. And there's quite an interesting dynamic that creates a lot of alignment of interest. Typically, when we enter one of these companies, we want the founder or the family to retain a 40% stake and we'll buy a 60% stake. Whenever we buy a company, we always underwrite to at least double our money. So if you think about that, and that's usually over a four to six-year time horizon, the family or the founder can actually make more money in that four to six-year period than they did in the entire history of the business. 

So, you get a lot of alignment of interest. You get access to companies that usually have a very good reputation in their particular market but perhaps haven't had the capital or the knowledge to expand. And you get this really, as I said, really strong alignment of interest where everyone's highly focused on executing a business plan and then exiting the company over that sort of four to six-year horizon.

• It could be internationalisation - going into surrounding geographies, they might not have had the capital or the knowledge of how to do that previously,
• Adding other products to their product suite or expanding vertically along the supply chain of the business,
• Or it can be as simple as adding a new C-suite. So, effectively, transitioning the founder out and replacing them with experienced C-suite executives in that part of the market, putting in place a new board of directors - just really professionalising these companies and making them ready for that next phase of ownership.

Do you ever face conflict when investing in founder-led businesses? 

Claire Smith: That's definitely a key consideration - if the founder or the family aren't ready to step away and relinquish the reins to a new investor, that can create a lot of conflict and can really impede those plans. That's a huge part of our due diligence. And we've got a 25-year track record of investing in private equity. A big part of the due diligence is whether the founder or family is ready to let go of the business, making sure they're aligned, that they're going to help us execute that value creation plan, be involved in the company for enough time, but then be ready to transition out at the end. 

We find the entry and exit dynamics can help with that because when we're acquiring the company, as they retain a stake, it's not often around the most efficient price - it's about who's the best partner to grow their business. Then at the exit, we do want it to be a competitive auction process when we sell the company. So, I think getting them excited about that, getting them excited about the returns they could make and seeing their family legacy effectively move to that next phase.

Claire Smith: We have an interesting company in our portfolio at the moment, which is a UK pharmaceutical company, and they specialise in effectively taking drugs that have rolled off their patent period and then producing those drugs. So it's quite a revenue heavy business, but quite technologically difficult. So, that was a founder-led business. 

The main change there was starting to transition out the founder and put in a really experienced C-suite and a new board of directors. Additionally, we helped them expand into pan-Europe distribution. So previously, it was just UK-focused, and we've helped them navigate all those regulatory, legal and language barriers into accessing the European market. Additionally, we've helped them add products. So, they've added a rare disease drug to their suite, which is really expanding in that pharmaceutical part of the market. 

That's a really interesting company that we are hoping to exit later this year. We've taken it from what was a very well regarded, but really just UK-focused, more narrow product business and internationalised it, added drugs to their menu and added that really experienced C-suite. So ready for that next phase of ownership. It's been in the portfolio for about four to five years now. That's the typical hold period for these companies we usually underwrite, assuming it's going to take about five years to execute all those plans.

Claire Smith: For our part of the market that we're involved in, often we're not buying through an M&A process. It's more bilateral - approaching these families or founder-led businesses and effectively trying to encourage them to become privately owned. So we're not as reliant on the M&A market for investments. 

We're not really reliant on the IPO market for exits. So, because our companies, whilst we buy in small and we can often help double the size, they're often still too small for IPO at that stage. So, through a normal cycle, we'd only really exit about 10% of our portfolio via IPO. So the IPO market being shut hasn't affected us so much because we typically sell upmarket to a bigger private equity fund or to a corporation in that same space. And there is still a lot of dry powder at the larger end of the market.