‘After this I have control,” Mark Zuckerberg once wrote in an instant message to a friend. It was the dawn of Facebook Inc and Zuckerberg was plotting to force his former partner, Eduardo Saverin, out of the business via an arcane legal manoeuvre. Today, that control is something he has still not given up. Through a special class of shares that give him 10 times more votes than most other shareholders, he retains his iron grip on the company he founded.
Last month we found out just how much Facebook is willing to pay for that control. Legal documents revealed that it had agreed to give $69m (£54m) to a group of shareholders for legal fees they incurred while fighting a plan to tighten Zuckerberg’s control of the company even further. That was on top of the scandal over Facebook’s hiring of outside PR firms to discredit its critics, which led to renewed calls from some investors for Zuckerberg to resign as chairman of the board and make all shares equal.
Such share schemes may be unusual outside Silicon Valley, but inside it they are now increasingly common. Once the preserve of family firms and media companies who needed to access capital while preserving their independence, they now exist at Google, Spotify, Dropbox and Fitbit.
Snapchat raised eyebrows last year when it went public with no voting rights at all; its most recent annual shareholder meeting consisted of an online conference, lasting two minutes 46 seconds, in which its chief lawyer politely reminded listeners that its two co-founders retain 96pc of the voting rights. Many tech firms, including Facebook, Amazon and IBM, also let their chief executives serve simultaneously as chairmen of their boards – normal in the United States, but rare in the rest of the world.
These arrangements have been “highly controversial”, says Prof David Larcker, an expert in corporate governance at Stanford University, because they appear to undermine a basic assumption of the Western corporate system.
“The control that shareholders have is they can look at a manager and say, ‘you turned out not to be a good person, we’re going to vote you out,’” he says. “That’s the implicit contract.” So why are tech founders so obsessed with them? And, more to the point, will markets punish them?
According to Howard Scott Warshaw, a Silicon Valley therapist who specialises in untangling the troubles of “hi-tech leaders and the super-intelligent”, there are deep psychological needs at play.
“Technical entrepreneurs are really people who are giving birth,” he says. “On some level, the idea of selling a company can be equated to the idea of losing control of your child.”
Unlike many traditional entrepreneurs, who can’t wait to license their ideas to someone else and reap the rewards, tech founders see their products as a means of changing the world – and they don’t trust anyone else with their baby.
Founders remember the agonies of Steve Jobs, ousted from his company after a long power struggle, and of Nolan Bushnell, pushed out of Atari (where Warshaw once worked) by a chief executive who had come from a textile company and wanted to make video games the same way.
Sure, there are “major egos” involved, says Warshaw, but it’s also fear: “That someone is going to destroy my creation – that I need to be here to guard the vision, because the people who are going to take it over just have dollar signs in their eyes.”
The problem, according to critics, is that such structures lead to poor decisions because they concentrate too much power in the hands of too few people. “They’re basically dictatorships,” says James McRitchie, a sociologist and corporate governance activist. “You don’t tell the emperor the bad news, you tell them what they want to hear because you want to move up in the organisation. And the emperor always thinks they’re right.”
Accordingly, the last year has seen growing efforts to limit or curtail dual-class shares. The California state teachers’ retirement fund, which owns shares in Facebook, has called on the company to scrap the system, saying: “If you want to use other people’s money, they need to have a say in how the business is run.”
The Council of Institutional Investors, which includes asset managers such as BlackRock and T Rowe Price, has asked the New York Stock Exchange to require dual-class shares to come with sunset clauses. And Robert Jackson Jr, head of the US Securities and Exchange Commission (SEC), has said that “asking investors to put eternal trust in corporate royalty” is “antithetical” to American values. This summer he put the brakes on a proposed “Long-Term Stock Exchange” for fear it would entrench founder control in a similar way.
These critics have a point. Consider the American media giant Viacom, which has been consumed by a series of legal battles over the mental state of Sumner Redstone, its 95-year-old controlling shareholder, leading to a precipitous drop in its share price. Or look at Zynga, the former mobile gaming titan that infuriated millions of Facebook users with its flagship game Farmville, and that abandoned its dual-class structure after several years following a fall from grace in 2012.
At Tesla, Elon Musk’s autocracy has been called into question by a series of unforced errors involving marijuana and expensive tweets. As part of a settlement with the SEC he has been forced to quit as chairman, though his 22pc stake can still defeat most shareholder proposals under the company’s supermajority voting rules.
The acumen of Snapchat’s chief executive, Evan Spiegel, is also in doubt. Its shares have plunged by 80pc since going public.
It is Uber that has best illustrated the dangers of multi-class stock. In 2017 its shareholders ousted Travis Kalanick, its founder and chief executive, who had adopted hardball tactics against critics and regulators. But it took them another four months to break his power by passing a series of reforms including a return to “one share, one vote”. In a lawsuit, one of Uber’s largest investors, Benchmark, accused Kalanick of using his control “to pack Uber’s board with loyal allies in an effort to insulate his prior conduct from scrutiny and clear the path for his eventual return as CEO”. That lawsuit was dropped on condition that dual-class shares end.
But the economic evidence for democratic control is mixed. Some studies suggest that firms with strong shareholder rights tend to perform better. An SEC investigation found that companies with expiring dual-class share structures trade “significantly” above those with perpetual ones, and those that drop such structures see their valuations rise. But a literature review by Laurie Hodrick and David J Berger found studies that showed the opposite, too. MSCI, which calculates market indexes, says that from 2007 to 2017 companies with unequal voting outperformed their peers, and that excluding them from indexes would have reduced those indexes by 30 basis points per year.
Investor democracy also has its downsides. “There are just a lot of pernicious forces in the marketplace,” says Michelle Greene, chief policy officer at the Long Term Stock Exchange (LTSE). Its long-term voting, she says, is not the same as dual-class stock, but is aimed at solving similar problems: “excessive short-term pressure”, a focus on quarterly profits over “long-term growth”, and stymied innovation – “because innovation requires you to be able to fail in the short-term”. Both Facebook and Google justify their share structures in similar terms, saying that being free to take risks and be true to their founders’ vision delivers more long-term value for their backers.
As for the markets, they don’t seem to value democracy very highly. They continue to snap up tech stocks at impressive prices. Indeed, according to Rett Wallace, founder of the tech-focused market intelligence firm Triton, many investors may consider dictatorship a selling point. “Companies with higher founder power tend to outperform companies with lower founder power,” he says, referring to a custom metric his company created to measure founders’ control of their companies. “The idea is that having skin in the game focuses the mind. If founders have the most to lose, but also have the most control, that can be a very effective protection for investors.” Investors, he says, may have consciously calculated voting rights are worth less to them than a good chief executive with no shackles.
In any case, it is hard for markets to meaningfully punish companies with unequal voting structures. Even the most activist of investors may have fiduciary duties that require them to buy the best-performing stocks. If those stocks are Facebook’s or Google’s, can they really afford to say no? Moreover, says Wallace, the liquidity of public markets makes it easier to just sell stock that you don’t want than get entangled in some endless battle for control. “It’s the ultimate vote, to sell,” he says. “Is anyone launching proxy wars at Snap? No, they just sold it down – like ‘here, why don’t you keep all the votes and take this crappy stock back too’.”
Come the next downturn, and with too many start-ups fighting for too little cash, founders may no longer get away with such concentrated control. For now, however, there is little reason for a young entrepreneur who has any choice in the matter to ever let shareholders look after their baby.
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