The news of Elon Musk's tweet about taking Tesla private this week caught huge attention, obviously. A 20 percent premium over then-current prices? The stock closed up about 10 percent that day and many wondered whether the unorthodox approach was even legal.
Musk's explanation was that it was all about the short sellers: people who basically bet that a stock's price will drop. The company has faced a lot of questions about its ability to manage production and logistics or even maintain enough cash flow to stay in business.
But there's another aspect. Musk has deeply entwined his personal finances with the company's fortunes. And you have to ask whether that's a wise thing, since what's good for the company at a given time might not be good for the CEO.
First, a hat tip to Forbes contributor Jim Collins, who noticed a connection in May.
If you search the most recent Tesla proxy statement for the word "collateral," you find a few references. One is the following statement:
"The Board has a policy that limits pledging of Company stock by our directors and executive officers. Pursuant to this policy, directors and executive officers may pledge their Company stock (exclusive of options, warrants, restricted stock units or other rights to purchase stock) as collateral for loans and investments, provided that the maximum aggregate loan or investment amount collateralized by such pledged stock does not exceed twenty-five percent (25%) of the total value of the pledged stock. Tesla management monitors compliance with this policy by reviewing and, if necessary, reporting to the Board or its committees the extent to which any officer or director has pledged shares of Company stock. Our Board believes this share pledging policy to be in the best interests of the Company and our stockholders by providing directors and executive officers flexibility in financial planning without having to rely on large cash compensation or the sale of Company shares, thus keeping their interests well aligned with those of our stockholders, while also mitigating risk exposure to the Company."
Keeping officers and directors from selling off blocks of stock is a way to keep the markets from assuming something is wrong and that insiders are looking for a way out.
Other mentions in the statement show which officers or directors are using stock in this way. One had 136,566 shares pledged at the end of 2017. Another had 83,205. A third, 148,333.
And then there's Elon Musk. According to the proxy, by the end of 2017, he owned outright 33,632,421 shares of stock, with the right within the first two months of 2018 to exercise options for another 4,220,620 shares, for a total of 37,853,041.
And he has "13,774,897 shares pledged as collateral to secure certain personal indebtedness." Assuming he exercised the options, that's 36.4 percent of his holdings. Given the current share price at the time of writing, that's more than $4.8 billion in stock.
According to the company's 25 percent rule, the loan or investment amount being covered by the stock can't be worth more than $3.3 billion, so the amount in question is likely lower than the current value.
At the end of 2016, Musk had 11,420,723 shares pledged as collateral. At the end of 2015, it was "4,000,000 shares of which are pledged as collateral to secure certain personal indebtedness owed to Morgan Stanley." (At the time, his shares totaled 21,854,840.) In December 2014, his total shares were 35,528,859 and the number pledged as collateral was 7,424,899.
All of this is legal, but it also puts Musk in a tricky situation if the stock price takes a dip. Here's how Collins put it:
"How is Musk using the money he has borrowed against his Tesla shares? The only hints as to the parameters of that leverage came from disclosures in Tesla's prospectus for its March 17, 2017 offering of equity and convertible notes. That document divulged that Musk had loans secured by his personal Tesla holdings from Morgan Stanley (one of the underwriters of the offering) totaling $344.4 million and from institutions not involved in the offering of another $279.9 million. It's impossible to know exactly how much Musk has borrowed against that collateral, but his penchant for startups--SpaceX, The Boring Company, Hyperloop One, etc.--is most likely consuming that cash."
CEOs often dislike short sellers, but Musk seems particularly focused on the group. Whatever the actual explanation of the collateral use, it puts him into a difficult circumstances should the stock price suddenly drop. It would force him to either cover the margin call on the loss of stock value or face a lender who's able to make up the difference by selling shares.
This isn't to say that going private isn't in the best interest of Tesla. It may well be. Managing a company in the public eye is difficult and can be maddening, especially when profit is a significant distance off. But it is impossible for Musk to make a move that won't be inherently tied to the company. A guaranteed valuation of $420 could help ease his position at a time when at least one major short seller I've interviewed doesn't expect the company to last long given its indebtedness and cash burn.
The big lesson for entrepreneurs is that keeping space between your finances and those of your company is wise. Not only does it help prevent confusion in accounting and taxes, but it helps strengthen confidence on the part of investors who won't wonder if there might not be some alternative reasons for strategic decisions.