Source: Recode – All
Lyft and Pinterest are the latest in a trend of IPOs that mean owning stock isn’t as powerful as it used to be.
These companies all have multi-class stock structures, meaning that some of their stock — usually that which belongs to the founders — has much more powerful voting rights than others and therefore much more impact when it comes to company decisions. Owning stock in a typical company where one share equals one vote means you have a say in that company commensurate with how much of it you own.
In the case of Lyft and the soon-to-be-public Pinterest, both have a class of special stock with 20 votes for every one vote a regular shareholder has. That means that while Lyft’s cofounders own just 7 percent of the stock, they control close to a majority of votes. Typical multi-class — usually dual-class — ratios are around 10 to one.
They’re part of a larger trend, especially among tech companies, in which founders are more frequently retaining power over their companies even as they go public and their stock is dispersed among new shareholders. Superior-class stock ownership is restricted to insiders, like founders, early investors, and executives. This type of stock has existed for almost a century, but only in the past few years have instances of it really ticked up.
Of the four tech stocks that went public so far this year, two, or 50 percent, had multi-class stock structures, according to data from Jay Ritter*, an IPO expert and finance professor at the University of Florida. Some 15 percent of non-tech companies that went public in 2019 so far have employed similar stock classes. Of course, this is a very small sample size since it’s early in the year and the government shutdown stalled some IPOs. Still, the trend toward special stock classes has generally been increasing since Ritter began recording the data in 1980.
Why is this happening?
In short: Because it can.
Multi-class voting structures are part of the founder-knows-best ethos, which is particularly prominent in Silicon Valley, where the founder is the company, or at least is perceived that way.
The argument for this practice is that founders need superior voting rights in order to ensure investments in long-term progress over short-term stock price. Founders, the rationale goes, know the company better than anyone else and have its best interests at heart. Special stock also prevents hostile takeovers by activist investors, who also are often looking for short-term returns.
Many companies have chosen to stay private longer to avoid public shareholder scrutiny — which is part of the reason for the subdued amount of tech stock in the first place. The reality is that if investors want to get their hands on the limited amount of newly public tech companies, they are increasingly willing to stomach whatever founders want.
“The model is either, ‘Trust me or don’t trust me,’” Anup Srivastava, the Canada research chair at the University of Calgary and co-author of a recent Harvard Business Review report on dual-class stocks, told Recode. “‘You have a choice not to buy shares. If you want to buy shares, then follow my rules.’”
Additionally, there’s the sense that tech companies are more opaque than non-tech companies, so voting rights might be lost on consumer investors.
“Public shareholders like you and me don’t understand much about these companies,” Srivastava said. “We understand that Walmart buys and sells inventory. We don’t know exactly how Facebook and Amazon operate.”
He points out that Alphabet/Google’s A and C stock classes — both can be purchased by consumers but the former has one vote per share, while the latter has no votes — trade at approximately the same price. Google’s founders also have their own special voting stock, class B, that has 10-to-one votes and can’t be traded on the public market. This indicates trust in founders Larry Page and Sergey Brin, as well as class A investors, to best execute decisions for the company.
Even in companies with equal voting stock, only large institutions and mutual funds, in addition to founders and early investors, are likely to own enough stock to have a meaningful effect on corporate decisions.
Proponents for one share, one vote, however, make the case that some wildly successful tech companies — Apple, Microsoft, and, most notably, Amazon — have managed to invest in their futures while giving every stockholder a fair share of voting rights. Amazon, in particular, has been known to forgo much of its profit in exchange for investing in its core business as well as new initiatives. This has resulted in diversified and highly profitable revenue streams like Amazon Web Services. It should be noted, however, that CEO and founder Jeff Bezos still owns the largest share of Amazon stock, even after his split with his wife MacKenzie Bezos.
Institutional investors and large mutual funds see more shareholder power as a good thing.
“It makes boards more accountable to all shareholders and they’re more likely to respond when management stumbles,” Amy Borrus, the deputy director of the Council of Institutional Investors, an association of asset owners and managers representing about $40 trillion in assets, told Recode.
“Even the most promising leaders are not infallible,” she said. “The boards might have provided closer oversight if the founders weren’t so exalted.”
Investors are still purchasing stock with inferior voting rights, so there is clearly a demand. But some of that might be short-lived.
“Investors are buying these stocks because there’s money to be made in the short term,” Borrus said. “In the longer term, it’s not a good deal.”
It’s so far unclear what the rise of multi-class stock means for shareholder returns. Studies have shown both positive and negative results, but it will take more time to know for sure what this means for the newer tech companies following this route.
Where are we headed?
Organizations like the institutional investor and global asset-manager consortium Investor Stewardship Group want companies to eliminate or at least reduce the use of multi-class stock structures on the principle that shareholders “should be entitled to voting rights in proportion to their economic interest.”
The Council of Institutional Investors is calling on stock exchanges** not to list companies that don’t have “sunset clauses” that would dissolve multi-class stock structures within seven years of a company going public. Stock exchanges set their own listing requirements, and both major New York exchanges, NYSE and Nasdaq, accept companies with dual-class stock.
“The idea is once a company becomes mature and large enough, it should subject itself to the discipline of capital markets,” Srivastava told Recode. “The problem is how to determine if the company has become mature.”
And it might be too late to stop these stock types from launching in the first place.
“If the NYSE and Nasdaq open their doors wide to dual-class companies, Hong Kong doesn’t want to be at a disadvantage,” Borrus said.
Uber, which is looking for a valuation between $90 billion and $100 billion and is one of the most anticipated IPOs of this year, is expected to begin public trading in early May. Back in 2017, the private ride-hailing company got rid of its dual-class voting structure that had enabled its previous CEO, Travis Kalanick, to make a lot of bad decisions.
It’s unclear what sort of voting structure Uber will ultimately decide on when it joins the public market, but its choice will certainly inform how tech companies list in the future.
* Ritter’s data excludes a number of atypical company types, like real estate investment trusts and special purpose acquisition companies, as well as IPOs with offer prices under $5 a share. His full methodology can be found here.
** CII’s numbers are a bit different from Ritter’s due to methodology choices.