When I asked University of Arizona legal scholar William Sjostrom about the way Elon Musk announced his plan to take Tesla private, he was scathing.
“A securities attorney would say ‘what the hell are you doing?'” Sjostrom told me on Wendesday.
When making a big, market-moving announcement, companies normally halt trading and provide the entire proposal in one well-vetted document—they don’t dribble it out in a series of tweets.
Almost two days after Musk’s initial tweet, major questions remain unanswered, including who will provide the tens of billions of dollars that are needed to finance a plan like this. Musk’s unorthodox approach to announcing the proposal has reportedly attracted attention from the Securities and Exchange Commission.
The larger issue looming over the transaction, however, is almost philosophical. This isn’t like a typical going-private transaction where the company is purchased by a handful of wealthy, sophisticated investors. Rather, Musk says he wants to allow current investors to continue owning shares while simultaneously stripping away from investors the transparency and liquidity provided by public markets.
It’s not clear if SEC regulations allow this kind of transaction to occur at all. But even if they do, the larger question is why shareholders—either Tesla’s current ones or the new ones Tesla would get as part of the deal—would want to go along with this kind of change. Obviously, it would make Musk’s job easier if he became less accountable to shareholders. But the benefits for shareholders are less clear.
Some tech companies have shunned public markets
When Wall Street insiders talk about a public company, they don’t mean a company owned by the government. Rather, they mean a privately-owned firm whose shares are publicly . Tesla, for example, has shares that can be bought and sold on the NASDAQ stock exchange. In contrast, privately-held firms typically have only a handful of investors, and their shares aren’t available to the general public.
Publicly-traded companies are subject to extensive disclosure requirements that are designed to ensure that ordinary retail investors have access to the same information about a company’s finances as the company’s best-connected investors. These rules are the reason that virtually all public companies publish quarterly earnings reports.
In contrast, privately-held companies are free to keep financial information secret, and they have broad latitude to decide when and how to inform shareholders about how the company is doing. The law assumes shareholders in private companies are wealthy and sophisticated enough to fend for themselves when it comes to corporate governance.
Being a public company comes with extra reporting burdens. But traditionally, the big lure of the public markets was that they made raising money easier. During the 1990s technology boom, going public was seen as a key milestone in a startup’s maturation. Netscape was an extreme example, going public in August 1995, just 16 months after it was founded.
But attitudes have shifted dramatically over the last 20 years, especially in the tech sector. Successful tech companies have waited longer and longer to go public. Google went public in 2004, six years after it was founded. Facebook was eight years old when it went public in 2012. Airbnb (founded in 2008) and Uber (founded in 2009) still haven’t gone public yet.
An oft-cited reason to avoid going public is the onerous disclosure requirements imposed on public companies—requirements that were beefed up by the 2002 Sarbanes-Oxley Act.
Elon Musk is right when he says that having your stock publicly traded can be a distraction. A public company’s stock price changes in realtime in response to supply and demand. If a company’s stock price falls, that can create a sense of crisis inside the company whether or not it reflects real problems facing management.
“If you’re a public company, you become the shuttlecock between warring longs and shorts,” venture capitalist Marc Andreessen told me in 2014. (“Longs” are people betting the stock will go up in value, “shorts” do the opposite.) “They bat your stock around like it’s a chew toy.”
But the most fundamental reason technology companies are staying private longer is because they can. Growing wealth inequality and the increasing prestige of Silicon Valley has meant more and more money gushing into the region’s venture capital firms. That has allowed tech companies to raise hundreds of millions—in a few cases even billions—of dollars from private sources.
How a Tesla buyout might work
This wasn’t really an option for Tesla though. Founded in 2004, the company came dangerously close to bankruptcy in 2008. Tesla needed to raise billions of dollars to finance its car and battery factories. Going public, which Tesla did in 2010, looked like the only way to raise the necessary funds.
But Elon Musk has had a serious case of seller’s remorse ever since. His other company, SpaceX, never had an IPO and is still privately held. That has allowed the company to keep its finances private and avoid the media circus Tesla faces around every quarterly earnings report.
And while it’s rare, companies do sometimes shift from public to private. Normally, this involves a small number of wealthy investors agreeing to buy out the rest of the company’s shareholders at a premium to the company’s current share price. A high-profile recent example is Dell, which became a privately-held company in 2013 in a deal that valued Dell at $24.9 billion.
Taking a company the size of Dell or Tesla private requires raising many billions of dollars. The money can be raised by selling shares in the new company or by taking out loans. Dell in 2013 had healthy cash flow, making it possible to finance much of the transaction with loans. The deal saddled the new company with $15 billion in debt it would need to pay off over time.
With a share price of $420, the proposed Tesla buyout would value Tesla at around $70 billion, making it a far more ambitious effort than Dell’s buyout five years ago. And Tesla is already deeply in debt and doesn’t have great cashflow, which means that significant debt financing won’t be an option. So Musk will need to convince people to put up tens of billions of dollars in cash to buy out existing Tesla shareholders. Not many people (or even institutions) have that kind of money.
Musk’s Tuesday tweet that “investor support is confirmed” seemed to signal that he’s already found willing to put up the necessary cash. Musk has also said the transaction won’t result in any one company controlling a majority of Tesla’s shares, so that suggests that a consortium of investors is behind the deal.
But reporters have struggled to figure out who these mystery investors might be.
“Those not involved in Tesla financing include Apple, SoftBank, Uber, TPG, Silver Lake, Mubadala, KKR, and basically every large Wall St. bank,” Dan Primack of Axios tweeted on Wednesday.
One entity that definitely does have billions of dollars is Saudi Arabia’s sovereign wealth fund. The Saudis recently invested $2 billion in Tesla, and it’s possible they would contribute more cash to a buyout plan, though this hasn’t been confirmed.
Musk’s plan might run into legal obstacles
In a classic go-private transaction, a small group of investors would buy Tesla’s shares and become Tesla’s sole owners. But in his Tuesday letter to employees, Musk signaled that he has a different vision for Tesla.
“I would like to structure this so that all shareholders have a choice,” Musk wrote. “Either they can stay investors in a private Tesla or they can be bought out at $420 per share.”
That left experts in securities law scratching their heads.
“I know of no legal way to offer public shareholders of a listed company an equity security while also going private,” Harvard legal scholar John Coates told MarketWatch.
“I don’t think it works,” said securities law expert William Sjostrom to me.
According to Sjostrom, companies are required to comply with public-company disclosure rules if they have more than 2,000 shareholders. There are some nuances in how this number is calculated—most employees can be excluded, for example—but Tesla likely has more than 2,000 shareholders under any reasonable definition.
Historically, this requirement has been a significant factor in the largest tech companies going public. Google and Facebook were both forced to go public by an earlier version of the rule, which set the threshold at 500 employees (the cap was raised after Facebook’s IPO).
Tesla might also explore other loopholes that would allow it to sell shares without running afoul of SEC rules. For example, Bloomberg’s Matt Levine points out that Uber sold shares to investment funds run by Bank of America and Merrill Lynch, which in turn allowed clients of these banks to indirectly own a slice of Uber stock. But those funds are only available to wealthy clients, not ordinary investors.
Musk has pointed to SpaceX, which has sold shares to the investment company Fidelity. As a result, SpaceX shares are a component of some Fidelity mutual funds, allowing investors to buy SpaceX shares as part of a much larger portfolio of stocks. But Fidelity doesn’t provide clients with any way to invest in SpaceX on its own.
Musk seems to be proposing something far more ambitious: finding a loophole to allow thousands of ordinary Tesla investors to hold shares in a nominally private Tesla despite SEC regulations designed to prevent widespread investment in private companies. At a minimum, Tesla would be wading into uncharted legal territory with a scheme like this. And there’s a good chance the SEC would nix such a scheme altogether—especially if Tesla explicitly sold it as a way to allow the company’s existing public shareholders to continue owning shares.
Tesla’s other option would be to register Tesla as a public company—satisfying SEC rules—but not list its shares on a stock exchange. This should be completely legal and would provide shareholders with the same transparency they enjoy now. But if Tesla’s goal is to end the distracting impact of quarterly financial reports, this wouldn’t accomplish that goal.
It’s also not clear why shareholders would go along with a plan to essentially halt open trading of Tesla’s stock. A liquid asset is inherently more valuable than a similar asset that’s illiquid, so on its face, limiting trading of Tesla shares seems bad for shareholders. Musk would need to convince shareholders that giving up their ability to trade shares would lead to strong performance in the long run—a difficult case to make.