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  • ProCervo Thoughts & Musings

Management & fiduciary duties: not a love story

It wasn’t too long ago that I went to an event of one of my portfolio companies. It was one of those companies that had grown over the last 50 years with roughly the same management. It was a sunny day and people were in a cheerful mood so I was quite surprised when I found the face of the CEO not too far from mine. “Stop being nasty! I am very much in control!” (or something to that effect) the elderly man shouted at me before stomping off. An unpleasant surprise it was but this kind of response to questions is not rare. Many founders and long-standing managers consider challenges to their management and leadership practices an insult and can get quite upset. Some months ago, I received an email from a founder who was quite emotional that I was discussing the company with other investors.


The issue arises when a company grows (or is already big) after you have made your investment. Just a few months ago, the company was courting you and your money. Shortly after, it belittles you as a small-time investor who has only put in “a small amount of money”. Management’s gaze is on the horizon to the riches that large VCs (Venture Capital: firms that invest in young companies) and Family Offices offer. You will find that you have dropped to the back of the queue when it comes to management access and information. The shareholder updates become rarer and you start hearing about business developments through the grapevine, i.e. other investors, competitors etc.


While this is not pleasant, it is not unusual. To some extent, you would not want the company to spend excessive amounts of time on investor communication. However, you would want them to be always - always! - available to shareholder questions or concerns. It does not have to be the CEO personally, but someone should be there to answer your questions. Many small companies find that difficult. Some are even surprised that shareholders should care what management does with their money. Some consider any kind of question a criticism or a personal attack.


This brings me back to my earlier point: If you find something unusual with “your” company, e.g. that it pays higher rent or commissions than other businesses in this field, you would presume that “your” management has a reason for it. Still, you would want to know why. Frustratingly often, you will get disappointing answers like “this is market rate” (which it obviously is not) or “we have always done it like that, why do you ask?”. The truth is that not all managers are 100% diligent all the time. Some show criminal energy (see “Management just wants to have fun” vignette) but most take the “don’t fix it if it is not broken” approach. I need to explain that. Many of us will have come across the urban myth of the boiling frog. Legend has it that a frog jumps out of boiling water boiling water but is happily basking in lukewarm water that slowly comes to a boil. The story is not scientifically correct but conveys what I am trying to say. Like the frog in the slowly heating water, management get used to certain practices being ok. Hiring friends, letting their personal properties to the business … that kind of thing. These habits go unchallenged for decades and management sees that as validation. But business practices that were ok in 1990s are not ok in 2022. Ethical standards move, Investment thinking evolves and investor protections have tightened. The same holds for management’s pet projects that take up too many resources. These are just examples and nowhere near a comprehensive list. It is completely legitimate for investors to ask questions. These questions should help improve business processes and at the end of the day produce better results for the business.


In my experience, far too few business leaders are open to these kind of challenges. Most of them believe that investors do not understand the business. That the amount invested is much too small to make them relevant. That they are a distraction for the busy management. As a general rule, the more justified your question is, the stronger the negative response. When a business leader calls you “nasty”, you are almost certainly on the right track!


The underlying attitude of “you can always sell [your investment] if you don’t like it” is as absurd as it is insulting. Management are agents with the Fiduciary Duty to look after their investor’s money properly. Regardless of size. They are not doing you a favour. If they think, your investment is too small, well, they did not have to accept it in the first place.


Shareholder agreements, byelaws, etc. are not just pro-forma exercises that are forgotten after the funding round is closed. They contain your rights (and sometimes obligations) as shareholders and the standards that you can expect. You should read them before investing and insist that the company respects them.


It is much easier to put your point forward when you are part of an investor syndicate (group of like-minded investors). Safety in numbers. You can share the work, spread the [legal] cost and benefit from each others’ expertise. You can find like-minded investor networks in the link section of the website. Ideally, your group will have a board seat but that is more the exception than the rule for individual investors.


I have to admit that more often than once I have invested in companies where I did not have strong protections. I took a pun. Why did I do that? Because the business model appeared uniquely attractive that I just had to be part of it. Because management’s incentives appeared aligned with mine. Or some other reason. You can do that but be aware that you are taking a pun with very little control over your investment.


Alex

September 2022



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