In an IPO landscape marked by low output and absent tech companies, the initial public offering of Snap Inc. (formerly Snapchat) has been hotly anticipated since Snap’s confidential filing with the SEC in November 2016. As excitement built for the high-profile offering, rumors surfaced that Snap would preserve the control of its founders, Evan Spiegel and Robert Murphy, post-IPO, possibly through common stock with no voting rights. Snap’s Form S-1, filed on February 2, confirmed that Snap plans to implement a tri-class share structure with only non-voting shares of common stock available to the public. Snap’s offering is the first of its kind and the logical conclusion of a recent trend in which founders retain voting control post-IPO through multiple-class share structures.
Trend toward multiple-class shares
Multiple-class share structures are hardly a new development; they were a prominent takeover defense in the ’80s, briefly banned by the SEC in response, and are now enjoying a renaissance. A 2016 study of IPOs from Proskauer found that nearly a quarter of issuers debuted with multiple classes of common stock—up from 14% in 2014. Proskauer postulated that multiple-class share structures could be going mainstream. Certainly, recent years have seen a rash of high-profile multiple-class IPOs with founders maintaining disproportionate control relative to their economic interest, many within the tech industry. Examples include Google, LinkedIn, and Fitbit, which each debuted on the market with a 10:1 ratio of votes per share held by insiders to those held by public investors. Groupon publically offered Class A common stock with one vote per share, but gave its Class B common stock 150 votes per share. Snap’s tri-class share structure most closely mirrors that of Zynga Inc., which assigned 70 votes to each Class C share held by founder Mark Pincus and seven votes to each Class B share held by other insiders, but just one to each publicly offered Class A share.
Snap’s control structure
Snap’s post-IPO capital stock will consist of designated preferred stock and three classes of common stock: Class A, Class B and Class C. Although each class of common stock carries identical economic rights, the voting rights, as well as transfer rights and conversion, vastly differ.
Shares of Class A common stock, the only class offered to the public, do not carry any voting rights. As a result, new investors will not be able nominate directors, submit stockholder proposals under Rule 14a-8, or participate in any shareholder vote, except under very limited circumstances in which their equal economic rights are threatened.
Class B common stock will go to current holders of preferred stock (i.e., executives, pre-IPO investors and other insiders). Each share of Class B common stock is entitled to one vote.
Class C common stock will be set aside exclusively for Mr. Spiegel and Mr. Murphy as founders and the current holders of Snap’s Series FP preferred stock. Each Class C share is entitled to ten votes. The Wall Street Journal reported that Spiegel and Murphy “are expected to hold more than 70% of the voting power despite owning roughly 45% of the stock.” Once Mr. Spiegel receives the final installment of a CEO award, Snap predicts that Mr. Spiegel could exercise voting control alone.
Both Class B and Class C common stock possess mechanisms that further concentrate voting power in Mr. Spiegel and Mr. Murphy. Shares of Class B common stock automatically convert to Class A common stock, and thus lose their voting rights, upon death of the holder or transfer to a new holder. Similarly, Class C common stock automatically converts to Class B common stock nine months after the death of the holder or upon a transfer to a -non-founder holder. Moreover, pursuant to a founder proxy agreement, in the event of disability or death of Mr. Spiegel or Mr. Murphy, each has the power to exercise all voting and consent rights of the other’s shares for the duration of disability or for nine months following death.
Weak corporate governance
Concerns abound over the effect of dual-class share structures and Snap’s unprecedented non-voting offering on corporate governance and investor rights. The Council of Institutional Investors sent a letter to Snap signed by 18 members urging adoption of a one share, one vote capital structure, and in late January 2017, the Investor Stewardship Group began a campaign to abolish dual-class shares. Much of the commentary regarding Snap’s tri-class structure is critical.
The chief worries are that Snap’s share structure breeds a lack of accountability and that it entrenches management. First, Snap can function with little to no oversight from public shareholders who have no voice. Additionally, though the board of directors has a fiduciary duty to all shareholders, its monitoring function is impaired when the same parties the board must oversee are those that can appoint or fire directors at will. Adding to the lack of accountability is that Snap’s Class C common stock allows the founders to control the company without incurring a proportionate amount of economic risk.
Second, under Snap’s share structure, management will be essentially immune to shareholder efforts to oust them. Investors will be unable to utilize their typical toolbox of corrective mechanisms; activist dialogue with management and board pressure loses its bite without voting power, and proxy fights and hostile takeovers are impossible. Only the most egregious mismanagement or most nefarious misdeeds will be worth the immense cost of litigation not guaranteed to lead to a change in management.
Proponents, however, argue the structure is simply best for long-term growth. The typical defense of multiple-share classes centers around a visionary founder whose leadership, companies say, would be unduly burdened by shareholders’ myopic focus on short-term gains. However, despite the prevalence of the multiple-class share structure and such companies’ insistence that it produces the best results, multiple-class companies have mixed records. Anecdotally, although the shares of Facebook and Google have soared, Zynga priced its shares at $10.00, but the price dropped to $5.00 within a year and is now hovering around $2.50. Groupon shares priced at $20.00, but are now worth about $3.60. A 2012 study by Institutional Shareholder Services Inc., a proxy advisory firm and leader in corporate governance, found that companies with a single class share structure outperformed multiple-class share structured companies in all periods but the first year. The average 10-year return for companies with multiple classes of common stock was 7.52%, compared to 14.26% for companies with a single class.
Theoretically, the absence of voting rights should adversely affect Snap’s share price, as investors are unwilling to pay top dollar for weak rights and an inherently riskier investment. However, Snap is a hot and much hyped tech company in an IPO market with few competitors; it appears unlikely that the shares will suffer a significant price discount due to weak investor rights. The results of the aforementioned ISS study indicate that there indeed may be a negative price effect over time as enthusiasm wears off and the reality of investors’ inferior position sinks in.