When you are investing in a mature company, you are investing in a brand. You are investing in a business. For the most part, unless the guy running it is a criminal, it just doesn’t really matter that much who is in charge. Even if the CEO quits, there is a strong pool of talent to choose from and it is unlikely that a change in management will do much to change the overall valuation of the business.
When you invest in smaller companies, management is everything. You are really investing in the hopes and dreams of an individual. At best, you’re hoping that a team of people can take a product to the next level. It is all about believing in the jockey, not so much the horse.
In the decade that I’ve done this, I’ve realized that there are a few key things to think about when researching that individual. The most important thing to keep in mind is what sort of ownership position the CEO has. I want to see a CEO with a LOT of skin in the game. I cannot emphasize this enough. Secondly, I want a CEO who believes in himself. I want a CEO who is there because he thinks the stock is going up—not because of a healthy pay package. I want to see a CEO who takes a minimal salary—just enough to pay the bills. I want to see a CEO who’s working for the good of the business.
You see a lot of CEOs with lavish perks and bonuses. I do not want to see that. I really want a guy who sees the big picture and thinks that rather than looting the company, he can make a lot more by focusing on growing the business and share price. Boards often give out restricted stock and options. I want to see a CEO who’s put his own money on the line because he believes in himself. I want to see a CEO who bought his shares with his own money. I want to see a CEO who regularly buys stock in the open market.
People leave paper trails. Google the guy, has he done anything illegal? Has he done anything particularly stupid in life? Read his bio. Where else has he worked? Call around, find out what sort of guy he is. People will usually remember a guy who was able to climb a corporate ladder someplace. Has he ever been in management at a public company? If so, you can usually see how good his track record was. Did he run a public company? Was it a successful venture? If he was running a division of some other company, how did that division do? This all takes some time and effort, but it is invaluable. I want a guy who works 20 hours a day, 7 days a week. I don’t want to invest with a guy who leaves at noon for the golf course. I want to invest with a guy who others admire and think is a winner.
I have to say that there is no exact mold that a CEO should fit into, but it should be pretty close to what I’ve described above. In particular, I’ve found that the most successful investments I’ve made have had a few things in common at the CEO level. For starters, the guy was usually a pretty successful individual at a much larger company, or at his past business. He’s somewhere between 40 and 65 and he’s been in business long enough to have seen a few economic cycles and learned from past mistakes. He knows what a large company should act like and builds his small company with the same internal systems that a large company should have. He’s taken a job at a smaller company because he believes in the business and wants the upside from sizable ownership. Usually the guy took a very significant pay cut to go and be his own boss. There’s just something special about a guy supporting a family who is willing to leave a lucrative job in upper management somewhere and risk it all because he believes in himself. Usually those sorts of people are quite successful types.
Once you’ve found the right CEO, call him up. Talk to him. Take him out for dinner. You cannot do this with a large company—you end up talking to some investor relations guy at best. You’d be amazed at how open and excited small CEOs are to talk to potential shareholders—even if you do not have the money to buy lots of shares. Think about it a second. The guy lives and breathes his job. It is his life. His family is sick of hearing about work—his employees don’t want to hang out with the boss and relive work during their free time. If your CEO really likes his job, he probably wants to talk about it at night—over dinner—over beers—any chance he can. Go and get dinner with the guy. If he talks about the weather, or golf, you have the wrong CEO. If he talks and talks about what’s going on—what he’s trying to do—what he sees as problems, then he at least lives work at a very high level. This is what you want in a CEO. You want a guy who thinks it’s a hobby, not just a paycheck.
You’ll also be amazed at how forthcoming some CEOs will be about the business. Make sure you do your homework before you waste someone’s time. CEO’s appreciate when you know a lot about the business, when you know a lot about their competitive position. They really appreciate you when you tell them something that they don’t know about their business—or their competitor’s business. This is your chance to ask some hard questions. Press releases like to talk about what’s going right. Find out what’s going wrong. What are the problems with the business? What should you keep an eye on? What keeps the CEO up at night? How does he think about capital allocation? If the stock is cheap, what are they going to do about it? If they want to buy back stock—figure out why the CEO thinks that’s smart. Maybe the CEO will tell you that frankly the stock isn’t cheap. If he gives you a story about hiring marketing guys to help promote the stock—run!
These trips can be fun. Go with a friend so you can share notes afterwards. Watch the CEO’s body language. Do you think he’s telling the truth? Ask your friend. Have breakfast with the CFO the next morning. Do the stories match? Have you learned anything new? Small companies don’t have lawyers and investor relations experts to coach them. Sometimes they let something slip. Sometimes they don’t even realize they’re telling you something that they shouldn’t. Get a few drinks with the mid-level guys. They have no idea what the party line is. Ask them what’s going on. Get a feel for how things are.
You’re not trying to figure out how the quarter is going. You don’t want to know about non-public information. You are trying to figure out what the three and five year plans are. You are trying to figure out if you are comfortable with this management team.
This all takes time. It takes effort. It takes a bit of money. I’d rather spend a few hundred dollars and fly out to meet a CEO, rather than lose millions because I was lazy. Trust your gut. If something doesn’t feel right, don’t invest. There’s tens of thousands of companies in the world. Wait until you find the right one. Losing money is far worse than missing out on a winner. Wait until all the stars align—then play it BIG!