When it comes to public investors, tech companies increasingly seem to be coming to the belief that their money is welcome – but not their input.
A growing number of tech startups are choosing, when they go through their initial public offerings, to put in place dual- or multiclass stock structures that limit or even bar common shareholders from having a say in how the firms are run. That should be a red flag for investors, because such arrangements can be abused by insiders at the expense of common stockholders.
The latest example of such an arrangement: Dropbox, which made public on Friday the paperwork it filed to go public . After the cloud storage provider completes its offering, insiders including CEO Drew Houston will hold shares that give them 10 times the voting power as those held by regular investors. By himself, Houston would control nearly a quarter of all the voting power at Dropbox.
That structure would give Houston and other Dropbox insiders “the ability to significantly influence the outcome of matters requiring stockholder approval, even if they own significantly less than a majority of the shares,” the company warned prospective investors in its regulatory filing Friday.
Dividing shareholders into classes
Multiclass stock structures effectively insulate insiders from pressure from activist or other shareholders. Such arrangements can thwart even those shareholders who own large stakes in particular companies – or those that band together with other investors to form a large ownership bloc – from influencing how they are run or what they pay their executives.
Outside of a few closely held, family-run companies, it used to be fairly unusual for public corporations to have multi-class stock structures. While Google and Facebook each debuted on the market with such structures, they were seen as unusual cases. Both were big successes before hitting the markets, and, in both cases, investors were practically falling over themselves to invest in the companies.
But increasingly, much smaller tech startups that would seemingly have less pull with investors have been demanding similar terms. Snap’s multiclass stock structure awards no votes at all to common shareholders, while conferring nearly 96% of all voting power to cofounders Evan Spiegel and Robert Murphy. Meanwhile, at Roku, a relatively small consumer electronics giant, CEO Anthony Wood has 32% of the voting power thanks to the company’s dual-class stock arrangement.
The managers, founders, and executives who benefit from such arrangements often tout muliticlass structures as a way to help them focus on their companies’ long-term growth, rather than on the often short-term concerns of the stock market. And some companies have undoubtedly benefited from giving more freedom to far-sighted managers.
But the arrangements also practically invite abuse. Because they put so much control is put in the hands of a few insiders, those insiders can rig the game – or the company – to their benefit. They can give themselves gigantic pay packages, say, or lavish benefits at the expense of the company and, ultimately, regular investors.
That’s not just theoretical. Facebook, which already had a dual-class stock structure, announced two years ago plans to create a third class of stock that would have no voting power. The move was an effort to allow CEO Mark Zuckerberg, who already held majority control of the company with his super-voting power shares, to maintain his dominance over other shareholders even as he sold some 99% of his shares.
Facebook ended up dropping the plan – but shareholders had to sue the company first.
Meanwhile, Snap, which is dominated by its two cofounders, handed out to Spiegel restricted shares worth a whopping $637 million at the time of its IPO last year – even though Spiegel already controlled billions of dollars worth of Snap stock. That stock grant is the largest of its kind on record since at least 2011, according to Equilar, a research firm.
At least in theory, investors can make companies think twice before trying to insulate insiders with enhanced voting powers. Investors could refuse to buy shares at public offerings or could factor their lack of control over such companies into the prices they’re willing to pay. Startups that see their peers struggle to fetch a decent price at their IPOs might decide to avoid setting up two or more classes of shares.
But in reality, that doesn’t seem to be happening. If anything, investors seem more willing than ever to swallow reduced voting rights as the price for getting in on a hot new tech IPO.
Facebook investors eventually realized what Zuckerberg’s enhanced voting powers could allow him to do. My guess is other investors will eventually learn similar lessons – but likely only after they’ve paid for them.