Solving the second-class stock conundrum
By Rob Cox
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Over dinner in San Francisco recently, an activist investor and an internet entrepreneur got into a heated discussion. The two men, with a gap of about two decades between them, were debating the practice of many young, growth businesses in the technology world – though it happens elsewhere too – to issue multiple classes of stock, generally one for hoi polloi investors in public offerings and another for founders and other insiders with super-charged voting powers.
This, the investor felt, violates a tenet of democratic capitalism: “one share, one vote.” It treats public shareholders of Silicon Valley’s hottest properties as second-class citizens. Not so, argued the information industrialist, now working in his second mega-startup. Visionaries need to build their businesses without the distraction of having to please uppity investors every quarter. Giving them control of their boards of directors and key corporate decisions is vital.
The protagonists sort of agreed to disagree. Investors don’t have to buy shares if they don’t like the voting arrangements – though some might say that companies often don’t have to seek money from public investors, either.
But surely there is a way to square this circle. What if a mechanism could be created that would allow founders like Facebook’s Mark Zuckerberg or GoPro’s Nicholas Woodman to execute their plans for global domination, leavened with promises to make the world more awesome, without pesky shareholder interference – but also preserving in the long term the one share, one vote concept?
Say hello to “Class V” stock. There are already lots of companies with Class A and B shares, and a few – like Google – with C shares. Going all the way to the 22nd letter of the alphabet sounds unduly complicated. But it’s just another symbol, standing for “voting,” or maybe “vision.”
Class V shares would grant their owners extraordinary voting powers, akin to the 10 votes per share that Google, GoPro or Facebook Class B shares carry. But unlike B shares, this would only last for a defined period, say 10 years. In that sense, they would resemble voting options that need to be exercised before they expire. After a decade, Class V stock would simply convert into regular Class A common equity.
This would give founders time after going public to develop a company’s business with minimal scope for interference from shareholders. Including the years before listing, they should have long enough to navigate the headiest phase of growth unencumbered. And winding down voting rights at a defined date should reduce the risk that company bosses and boards become entrenched.
The structure gives visionary founders the initial autonomy they want and investors are usually willing to give them, while eventually allowing all shareholders to have a say if company leaders don’t deliver the goods – or aren’t as good at managing businesses as starting them. That’s a better alignment of interests than the current Class A and B norm.
The idea has drawbacks, of course. There’s a risk that as the conversion date approaches, Class V holders get antsy. They might try to use their soon-to-expire voting power to redraft company by-laws, extending their voting rights, or eliminating the conversion to Class A entirely. Or they might try to cram through deals that many investors would dislike while they can.
Some risks could be mitigated by giving Class A shareholders their own vote on certain things, like changing Class V rights. And overall, the dangers don’t seem any greater than those under existing dual-share arrangements.
Google’s co-founders Larry Page and Sergey Brin, along with Chairman Eric Schmidt, own approximately 92 percent of the company’s Class B common stock, giving them 61 percent of the voting power for the whole company with a combined economic interest that’s only a fraction of that.
“This concentrated control limits or severely restricts our stockholders’ ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial,” Google warns in disclosures filed with the Securities and Exchange Commission. As well as its super-voting Class B shares and regular Class A paper, Google not long ago introduced Class C stock with no voting rights at all.
To be fair, investors have so far been well served by this arrangement. Since Google went public 10 years ago this August, the stock price has risen nearly 10-fold. But the three key men are arguably less important to Google’s fortunes at this stage. While the departure of all three at once would freak out investors and employees, the Googleplex would probably function perfectly well with, say, only one of them left in the building. And there’s also a case that shareholders, even if they suddenly had more voting power, would want the trio to remain and would largely leave them alone.
That’s how it should be when things work out. But Class V equity would also address the hazards of founders overstaying their welcome. That’s arguably what has happened, say, at once high-flying game maker Zynga, where the super-voting founder, Mark Pincus, remains as hands-on chairman despite having brought in a chief executive last year. The company’s shares are trading at under a third of the December 2011 IPO price.
Contrast that with Microsoft. Steve Ballmer and Bill Gates probably stayed too long: in its first decade as a public firm, the stock surged some 6,000 percent, but in the past 10 years the value of the software giant has gained less than 50 percent, underperforming the broader market. In the absence of special voting rights, it was possible for shareholders, led by ValueAct Capital, to push for Ballmer’s resignation, which also led to Gates exiting as chairman.
The revamp of Microsoft’s boardroom would have been impossible – or at least far more difficult and delayed – had the founders held 10 times other shareholders’ voting power. For today’s tech wunderkind who thinks he (or, very rarely, she) is more of a Brin than a Ballmer, Class V stock would be a way to show investors that self-belief.