99% of the public and 95% of venture and investment capital have got it wrong!
You own shares and you think that means you own part of a company, right. No. It is time to expand on and explore company ownership, shares and investment rights.
You probably believe that shareholders own a company?
Shareholders quite simple don’t own a company. Why do we make this assumption about ownership and how do we unpack and explore why it is important to challenge this thinking, acknowledging a deep-rooted human bias that we like to think that we can own something.
Ownership is the state or fact of exclusive rights and control over property, which may be any asset, including an object, land or real estate, or intellectual property. Ownership involves multiple rights, collectively referred to as title, which may be separated and held by different parties.
After reading this post, you may want to take a bash at editing the entry. Indeed the origin and use of the word OWN has a checkered history from German. The use in English law “being an owner” and the rights thereof were set in c1600. However, in the context of ownership of a company, the word and its actual meaning is much less clear than you might expect. You own shares and share have rights, but the company owns the title and assets.
Ownership takes many forms but the simple two are functional and emotional. I explored the same framework of thinking about functional and emotional TRUST here. It has many of the same issues.
Ownership (functional) assumes there is something to own and to have title over, is has all the legal frameworks and protection you need. Exploring the phrase, “possession is 9/10th of the law.” highlights the difference between functional ownership and your rights even if someone else is in the possession of an asset and a belief (emotional ownership) that you own something because you have it, including an attachment or desire. Emotional attachment of ownership extends to national treasures and your sports team. We have witnessed many campaigns from loyal fans who have, no more than an emotional attachment being very vocal that they are the true owners, have rights and a voice. Consider the case of function and emotional ownership when you hand legal title of an asset (cash) you own to an agent for investment. The transfer of title does not mean you break the emotional ownership because they are acting on your behalf. Why does this emotional ownership matter, in the case of an agent looking after your investments such as a pension, because they are unlikely to have the same attachment, incentives or motivation as you! This difference in motivation [can/ will/ might/could] result in them acting in their best interests or their employers best interest to align with a bonus and not in yours? Given that there are at least dual obligations (employment and commercial) and legislative and personal ones, which emotional ownership has precedent and what has a higher priority?
Ownership of shares and companies.
Reading that shareholders are NOT the owners of companies will not feel right, and therefore we need to unpack it. The Limited Liability act of 1855 and 1856 set out a ruse so that shareholders no longer had unlimited liability (longer story). The legislation did this by creating an entity that no-one owned, as it owned itself (genius). When considered alongside the earlier 1844 Joint Stock act, it becomes unclear where and with whom liability lies and this legislative gap remains today. Even the updated Companies Act 2006 which governs company law in the UK does not address this issue. Whilst it is the longest piece of legislation ever enacted in the UK, with over 1,300 sections the act: modernises and simplifies company law, it codifies directors duties, it grants improved rights to shareholders and simplifies the administrative burden carried by UK companies. However, something quite fundamental is assumed, no one owns a company, but the company itself. As a shareholder, you own a portion of the rights which are granted in the articles, but you don’t own the company.
Shareholders quite simply don’t own a company.
Why is this fact, that shareholder don’t own a company, important?
Before we get carried away, it is worth thinking that what we have, whilst a little messy, works. We have companies, investment, shareholders and an operating economy with companies at its heart. The important thing is not the revelation that shareholders don’t own companies but that one confusion creates another confusion which is more problematic - which is accountability, responsibility for governance, oversight and liabilities. How should/ can a company find its north star or establish its moral and ethical behaviour as the company owns itself.
Step up the directors!
The void of leadership, ownership and who guides the business is filled by the Directors. These are the ones who’s names are at companies house in the UK. Yes, there are shadow director complications but just having a business card with director on is not enough to be a Director. The shareholders shifted their unlimited liability via legislation to a limited liability vehicle so limiting their loss to capital. The UNLIMITED liability moved and is now on the Directors. To be precise Directors and not executives.
The Directors on the board are compelled to act in the best interests of the company as a whole, not to represent the interests of just one shareholder or even a group of like-minded investors. That rule applies irrespective of the circumstances in which the Director has been appointed. This rule only change is at insolvency (another long story)
What exactly is the problem?
What exactly is the problem if a Company is owned by itself. The Directors have to act in the best interests of the Company, which is something that owns itself. A company on its own has no ability to determine right from wrong, that is what the Directors who are responsible and accountable, are there for. The Directors have unlimited liability in this duty. The shareholders and especially investors (venture or PE) believe they own the company but have no liability beyond the capital. One obvious point of interest is an investing shareholder who is also a Director who potentially has an immediate conflict of interest. Technically under the companies ACT 2006 they should declare that they are renumerated and how this remuneration is calculated as it may be conflict of interest and is not for them to determine. As Directors they have to always act for the company, but in so many board meeting I see Directors who have used their investment position to take a board seat aiming to protect their position over and above what is good for the companies. Waiting to invest to the last minute, asking for better terms, looking at down rounds for positions. Shareholders have their voice at AGM’s whereas a capital subscriber you get a place to exercise your rights.
Director’s delegate authority to the executive team to enable them to act and delivery on a day to day basis. The Directors remaining fully liable for all the actions of the executive, therefore a point of focus becomes a detailed analysis of what the executive team do and not if the executive is following the north star of morals that the Directors (company) has determined. Governance and oversight are lost both to tick box compliance and to covering risk and liability to satisfy insurance requirements for the Directors. Often the executives are taking both day-to-day responsibilities for delivery and also the oversight and governance of themselves, leaving the Board to be a PR exercise, for which they hold unlimited liability. The executive is the police who polices themselves, not always to anyone else’s benefit but their own. (cough: remuneration)
Back to the Shareholder issue, shareholders have rights and therefore duties and responsibilities as shareholders. They are not owners, with limited liability but should we question that and look to shareholder being owners and act like owners? This question remains to be debated, should shareholders be more accountable for governance and should their limited liability be removed to ensure they are motivated to do this role? For me, the bigger issue remains from this confusion; who owns (title and emotion) for governance and oversight?
Take Away
The purpose of this article was to be clear that shareholders are not owners, when shareholders (capital providers) act as owners this is not their right. Shareholders often have conflicts of interest and many investor directors don’t understand the two roles they have as limited liability holder of rights and unlimited liability responsibilities as a Director. When Directors are in a board room they must and can only represent the company. Indeed they are the moral compass of the company and need to determine what they have delegated to the executives who have no responsibilities or accountability in law, other than those who are shadow directors. Fundamentally there is a need to get better governance and oversight if we desire to improve our businesses practices for sustainability, fairness and stewardship.