Not all shareholders are created equal – Snap goes public with non-voting stock

Snap’s IPO

Academics tend to say that you can’t have your cake and eat it too, yet this is what Evan Spiegel and Robert Murphy did with Snap a few months ago. Snap Inc., the company behind Snapchat, was introduced on the NYSE on March 2^nd. This event marked the first time that a company has gone public with non-voting stock on a U.S. stock exchange.[1] Co-founders Evan Spiegel and Robert Murphy, respectively the current CEO and CTO, retain complete control of the company. Even though they own only 45% of the stock, they have around 70% of the voting rights in the company.[2] The pre-IPO investors hold shares that give them lesser voting rights. As such, Snap currently has three classes of shares:

• the shares with super voting rights held by the founders,
• the shares with lesser voting rights held by the pre-IPO investors and
• the shares held by the public investors that bought shares on the NYSE, which confer no voting rights.

Snap has been widely criticized for its decision to issue shares without voting rights. In the weeks leading up to the IPO, numerous articles appeared in which Snap was criticized. For example, the Council of Institutional Investors proposed to bar Snap from stock-market indexes such as the S&P 500, because the company’s structure would “undermine the quality and confidence of public shareholders in the market.” Others argued that without voting rights, shareholders would be hostage to the actions of management.

Precedent

Snap might be the first company to issue non-voting stock in an IPO, it is not unique in corporate America to limit the voting rights of shareholders. Back in the day when Microsoft and Apple went public, they did so with a traditional structure of one vote per share. But things have changed. Famous predecessors in going public with limited voting rights for shareholders are Google, Facebook, GoPro, Groupon and Zynga. However, each class of shares still had some voting rights, albeit limited. When Google did its IPO, the founders held 33% of the shares and 38% of the voting power. When Facebook went public, Mark Zuckerberg held 28% of the shares and 58% of the voting power.

The debate about limited voting rights                                      

Limiting the voting power of shareholders can serve a legitimate purpose. The founders argue that the use of this mechanism allows them to plan more long term.[3] A major drawback of being publicly listed is that the company has to publish its quarterly results. This puts a lot of pressure on the company to perform each quarter. It makes the board of directors and the executives think short term, instead of planning long term. After all, who cares about what the results will look like in 5 years? If a company has a few bad quarters in a row, the stock price will plummet and pressure will mount to replace management. With the use of dual class stock, the company is shielded from such short termism. Advocates of dual class stock argue that this is a good way to maximize shareholder value. Put more bluntly: dual or triple class stock is popular among tech companies because it allows them to innovate without risking a shareholder revolt. The founders have a fear of being misunderstood geniuses, so they make sure that they do not have to be understood by their shareholders. After all, nobody wants to risk being pushed out of their own company.

This idea is similar to the argument brought forward by Goshen and Hamdani.[4] They claim that dual class stock is useful because it allows the controlling shareholder to pursue his own vision (the authors call this the “entrepreneur’s idiosyncratic vision”). In the long run, this is good for all shareholders because the benefits of pursuing this vision are distributed equally.

Additionally, certain companies use multiple class shares to preserve values. The New York Times Company has a dual class structure in which the Sulzberger family retains control of the company. The family has often stated that they believe that the dual class stock helps preserve the independence of the newspaper and that they have no plans of changing the corporate structure – even under strong criticism from its shareholders.

Some companies with dual class stock have done very well. The stock prices of both Google and Facebook have soared since their IPO’s. In these cases, it was clearly a good thing that the founders were in control of the company. In the end, money rules and if returns have been good, investors are happy. But dual class stock is not a guarantee for success. Like the executive of a large pension fund noted in the weeks building up to Snap’s IPO: “For every Google and Facebook, there is a Zynga or GoPro.”. Stock prices of Zynga (-73%) and GoPro (-61%) have dropped significantly since their IPO’s.

In some ways, you could argue that the caveat emptor principle applies: you know what you are investing in. When you invest in stock from Snap, you know that you are hostage to the plans of CEO Evan Spiegel. However, investors are presented with “Hobson’s choice”. They only have two options: either they buy the shares without voting rights, or they don’t buy any shares at all. Many are institutional investors and have pressure to perform. They cannot afford to leave money on the table. If the next big thing comes around, they must be in on it, regardless of governance concerns. In the end, everyone suffers from FoMO (Fear of Missing Out). Do you really want to miss out on possibly the best investment of 2017 because you don’t like the governance structure of the company?

Investors argue that the use of dual or triple class stock is worrying because it limits their ability to force the board of directors and the executives to make changes. These changes might not be needed when the company is successful, but they are needed when the company’s results have not been good. With the use of dual class stock, the board of directors and executives are shielded from shareholder pressure and cannot be forced to make changes. The shareholders are prevented to control the company that they technically own.[5]

The founders could argue that they are best placed to make the key decisions for the company, and this might very well be true at the time of the IPO. However, there is a risk that this structure will become inefficient over time. Bebchuk and Kastiel illustrate this with the example of Viacom Inc. This company adopted a dual class share structure which allowed Sumner Redstone to retain complete control of the company. At that time, Mr. Redstone may have had all the right attributes and it may have made sense for him to lead the company. Now, however, he is 93 years old and a judge in a recent civil suit against him said that that it was “not in dispute that Redstone suffers from either mild or moderate dementia.” It is clear other people are more fit to lead the company. While Viacom is an extreme example, it does illustrate the problem. Evan Spiegel and Robert Murphy might be a perfect fit for Snap at the moment, but nobody knows whether they will still be the right men for the job in 10, 20 or 30 years time. As a solution, Bebchuk and Kastiel argue that a dual class share structure should be accompanied by a sunset provision. This way, the structure would revert to one share, one vote after a certain period of time (10 to 15 years), unless an extension of the structure is approved by shareholders unaffiliated with the controlling shareholder.

Change on the horizon?

As noted, investors are unlikely to be deterred by the lack of voting rights if the company has good prospects. That leaves us to conclude that (tech) companies probably will not change their ways. If change is to come, it will have to come from a higher authority. The SEC (the Securities and Exchange Commission, which regulates the securities industry and whose mission is to protect investors) has tried to regulate the stock exchanges’ policy in regards to dual class voting, but it has failed to do so.[6] Congress will have the last word.

Vincent Chantillon
LL.M. Candidate, Class of 2017
Northwestern University Pritzker School of Law

[1] Wall Street Journal, “Tech founders want IPO cash – and control – ‘dual-class’ shares, which give majority to a few, spread in Silicon Valley”, 4 April 2017; Financial Times, “Snap’s unconventional IPO will test staid investors”, 3 February 2017.

[3] An example is the open letter from Larry Page and Sergey Brin, founders of Google. Wall Street Journal, “Letter from the founders”, 29 April 2004.

[4] Z. Goshen and A. Hamdani, “Corporate control and idiosyncratic vision”, The Yale Law Journal 2016, 560.

[5] T. Wen, “You can’t sell your firm and own it too: disallowing dual-class stock companies from listing on the securities exchanges”, University of Pennsylvania Law Review 2014, 1497.

[6] The district court found that this fell outside of the scope of the SEC’s powers. T. Wen, “You can’t sell your firm and own it too: disallowing dual-class stock companies from listing on the securities exchanges”, University of Pennsylvania Law Review 2014, 1515.