Keeping control of your owner-managed Company: Tesla Case Study

If you own and operate an international SME, that is a family business or it is a new business you have started and are growing, you know how you feel about the need for you to be able to control your company.? If you are growing a business that grows by generating more free cash flow and you are deploying your skills as an operator, then you know how important control is.

One overwhelming feature of the heads of family businesses is the control they require over their business and investment affairs. Owners do not trust easily and rightfully so. If there is going to be watered down control, then Owners will usually set aside the planning idea no matter how tax efficient it is.

One notable example of this is Gary Vaynerchuk of VaynerX; he does not have a board. His company is private, he owns a majority of the shares of his company, and he is CEO.? He explains in some of his videos that he feared his company being taken away by directors who do not understand him. Another example is Richard Branson of Virgin Atlantic; his company remained private for a long time.? Dangote Industries of Nigeria has remained private and notably has self-financed an US11 Billion-dollar oil refinery. Dangote did not carry out a public listing in London or NYC, despite the strategic value of the oil refinery as an investment project in Africa.? Look at what happened when Steve Jobs was famously removed from his company, Apple; they had to come back to him for strategic guidance and creativity.

SMEs that are tech companies are a little bit different.? The valuations of these companies usually so high without cash flow, that founders allow VCs to take significant equity and board control and power. In this case, it is commonplace for founders to be removed.?This is not so with operational companies that require operational cash flow to drive valuations and financial performance.?

Family businesses, driven by owner operators, especially international SME owner operators do not cede control. ? Even succession tends to be a problem as many owner-managers prefer to continue working and keep the next generation in the waiting room.

So, an owner operator of an international SME will likely be of the view that installing an independent director, who does not operationally know the business, and is not working in the business, or is not family, or has no experience in the jurisdiction where the business comes from, is not the best idea.? Giving control over strategic operational decisions is not something an owner operator will agree with.?

Simply put, in practice Owner-Managers do not give up control.

Case Study: Tesla started out as a large “SME”.

Elon Musk is known as a driven, high-profile entrepreneur, and as we know from the press or mainstream media, guided Tesla to a specific strategy.? Tesla at one point achieved a valuation of USD $575 billion.? Ford Motor company has been in business for over one hundred years and only has an average valuation in the tens of billions.

When Tesla started out, Musk was essentially an owner-operator of a medium sized company. In the beginning, no cars were actually produced.? Then gradually, after designs and production and major investment in the company, they began delivering cars and going international.? The board of directors in the beginning therefore needed to be a board that gave Musk control to make strategically risky decisions. Granted, the company at some point took money from retail investors.?This is a prime example of how courts, however, should be hesitant to deliver judgements that pave the way to enable investors to remove control from owner operators.

In the past, it was a well-known phenomenon amongst businessmen that when you appoint independent directors, you run the risk of being booted out of your own company. This happened to Steve Jobs.? In Canada and London, there are hundreds of small publicly listed companies that are dormant because the owner operators could not move the ventures forward (often due to an inability to communicate with their board).

In the US Venture Capital industry, it is well documented that VCs take board seats and equity, quite often leading to owners being replaced as CEO from their own company after VCs exercise their judgment.? We saw this in Iron Man when Tony Stark as majority shareholder and CEO decided to take the company in another direction, the board of directors got an injunction against him, because he was infringing their rights.?

?The power dynamics of companies involving independent directors can be very uncertain for owner managers.        

Communication is very difficult to achieve without a relationship.

Effective communication cannot be “defined” per se.? It depends on both the individuals or persons involved. Therefore, owner operators must proceed with the risk that they may simply not be able to convince an independent board member of the soundness of a commercial decision. Not due to a lack of soundness, but due to an inability to communicate with independent directors.?

I always advise owner-operators to avoid going public until they are sure they are ready to release the reins of their business. Even RegD Private Placement fundraising involves some level of independent directors on the General Partner company or via an advisory council.

Any owner operator, building an SME, executing their vision, would be concerned about independent directors with whom they have no relationship.? As outlined above there are independent boards who have come along, disagreed with the founding entrepreneur and taken their company out from under them.? Is this right?

Can you blame Elon Musk for putting people he has a relationship with on the board of his company?? If you have a pre-existing relationship, with a board member, someone who you know you can communicate with, doesn’t it make the most sense to have that person on the board? When you don't have a relationship there is a real possibility you cannot communicate effectively with that person.?

There is so much information in today's world, people are so informed, that convincing people is much harder than it used to be.? It used to be that experts were the only ones who had all the technical information and insights.? Today, people can become quite well informed on any topic and while they may not be operators, they are likely to be more difficult to convince.

The problem with independent board members.

Musk may have needed to appoint directors he had a relationship with because he had to undertake and execute a high-risk strategy to create the value which now exists in Tesla.???

If Musk appointed board members who were completely independent, who he had no relationship with, an inability to communicate with them, and thus was not able to secure support of the board to every time he wanted to implement?a risky strategy, that could have been fatal to Tesla.?

If Musk was to select directors who understood his strategy?but with whom he had no relationship, he would have run the risk that these independent directors could have other relationships or incentives that conflicted with his.

The consequences of taking capital from retail investors.

If you are taking capital from retail investors, you have to accept the public listing requirements and the requirements for independent directors.? As we have outlined above, there are many abandoned publicly listed shell companies where the owner-operators simply could not get the strategic support of independent directors.? These publicly listed shell companies are always SMEs. Quite often international SMEs.?It is often the case that the independent directors are big-city executives who are not in the trenches with the owner operator.?

What happens when directors don’t understand the risk of owner-managed SMEs and what is ‘happening in the trenches? Most times, the company becomes dormant, or the owner operator is removed.        

The notable thing about the case involving Elon Musk's compensation in Delaware is the factual focus and analysis of the directors being close or linked to him.?This was described as a bad thing.? However, there was no real analysis of what it takes to be able to communicate a risky strategy to a board of directors with which you have no relationship.

The shareholders can always sell their shares if they don't like the board or the CEO. It is surprising that the judge in this case did a complete take down of all the relationships of the directors with Musk.? I think it sets a bad precedent.? In a case like this are the majority of shareholders best served by disincentivizing the man that turned Tesla into what it is today?? A majority of shareholders did not bring the action.? Many other firms will now be concerned that the factual circumstances of their board will be used to unravel arrangements.

How can owner-managers retain control of their company when raising capital?

For the reasons described above, Owner-operators are advised to use a Private investment Fund instead of publicly listing their company when they are still at an early stage. The Private Investment Fund is also preferable to VC funding.

PIFs can be Limited Partnerships (LP) with a General Partner (GP). Investors are often Limited Partners and therefore are restricted from being involved in the management of the fund. This is extremely important because owner operators of non-US international SMEs are taking risk and have to constantly innovate and adapt and navigate their way through new situations.? Communicating this constant stream of strategic decisions would place a lot of restrictions on the owner-operator.

LPs do have advisory councils or sometimes board members of the GP might need to be independent.? This problem can be mitigated by the owner operator establishing a Captive Insurance company owned by the PIF which issuing shares to strategic investors.?This can reduce the risk perceived by the strategic investors.

Another alternative is to make the investment fund a trust.? The owner operator would be in control of the trustee company, but the trustee company is obligated to act in the best interests of the trust/beneficiaries. Again, this increases investor protection.

Fund Manager Company

Owner-operators should also consider establishing and licensing their own regulated investment fund management company. If you have your own fund manager company, you can make strategic decisions. You are more able to navigate the risky decisions that owner-operators often need to make without the delay and inertia caused by independent directors who are not operational.? Sometimes owner-operators choose to hire a fund manager as a service provider under a separate investment management agreement.? The problem with this is that the fund manager that has been hired also has directors and principals that the owner manager has to constantly communicate to. Hiring a fund manager would seem to be faster and save time but the cost in time to communicate and the opportunity cost of the owner-manager’s time quickly becomes apparent.

Owner-operators should consider establishing their own fund manager so that they can move the business forward by taking risks and adapting in order to grow the company.

?The new Private Fund Adviser rules in 2025.

The new Private Fund Adviser rules coming into effect in 2025 will greatly increase costs for those raising capital in the USA because there will be much more transparency and reporting.?

Directors of fund managers and investors will have access to a lot more information requiring a lot more explanation and communication.? In the USA when there are misunderstandings the potential for litigation is very great.

Owner-operators are going to have to hire a communications person to carry out continuous communications with investors and any independent directors.

When you know... You can Trust.

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