These 3 Companies All Face The Same Key Risk

It’s common to hear that companies with smaller market capitalisations are riskier than the large blue chips. But, there is little talk about why small companies are riskier as an investment than their large counterparts.

Personally, I am quite comfortable with investing in smaller companies as their businesses tend to be easier to understand. But over the years, I’ve come to realize that there is indeed a key risk associated with such companies that many investors might have overlooked.

This risk is common to even companies in radically different industries such as Neo Group Ltd  (SGX: 5UJ), Q & M Dental Group (Singapore) Limited (SGX: QC7), and Kingsmen Creative Ltd (SGX: 5MZ). The trio, with relatively small market caps of between S$136 million and S$413 million, are involved with food catering, dental and healthcare services, and corporate marketing, respectively.

That one important risk

The key risk here is succession. All the three companies mentioned above have one commonality: They are all still being managed by their founders.

Succession risk is certainly not exclusive to only smaller companies – after all, it’s also a big issue with the giant US$360 billion Berkshire Hathaway, a conglomerate that is still managed by Warren Buffett even after he took over the company 50 years ago – but the influence that a founder has is much stronger in a smaller company.

A founder would have shaped the culture of his company since the beginning. In a smaller company, he (I use male pronouns purely to avoid awkward phrasing) would likely have immense power as most employees and other stakeholders (such as customers and suppliers) see him as someone who deserves to wield such authority for having created and growing the company to where it is.

Moreover, it’s most likely the case where a founder would still be the main decision maker in a small listed-firm. Without its founder (or founders), smaller listed companies may no longer function as effectively.

Large corporations face lesser issues

It is true that some large companies are still managed by their founders with some notable local examples being Raffles Medical Group Ltd  (SGX: R01)Olam International Ltd (SGX: O32), and Wilmar International Limited (SGX: F34).

But in the case of larger companies (for some perspective, the market caps of the trio above range from S$2.2 billion to S$20.7 billion), it’s likely that much of the decision-making process have already been institutionalized. In other words, larger companies are likely able to continue functioning effectively even after their founders leave.

Thus, investors interested in smaller companies need to be aware of this key risk that is present in most founder-led businesses. Before you invest, it is important to understand the company’s succession planning process.

A critical stage of a company’s life is the transition from being a founder or family-managed business to an institutionalised business that is run and managed by professionals. If the succession is not done smoothly, it can affect the future growth of the firm.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns Berkshire Hathaway and Wilmar International Ltd