Mark Zuckerberg’s majority control over Facebook Inc., a model adopted by founders of Zynga Inc. and Groupon Inc., has become the new normal in Silicon Valley as entrepreneurs’ desire to hold sway trumps shareholder power.
At least 10 of last year’s technology initial public offerings included a special class of shares that give the founders more votes than new shareholders, according to data compiled by Bloomberg. Only five such IPOs were filed in 2010, with four in 2009 and three apiece in 2005 and 2007. In addition to Groupon and Zynga, companies such as Zillow Inc. and LinkedIn Corp. have embraced the approach.
The trend gained steam in 2004, when Google Inc. created a dual-class structure for its IPO, granting its co-founders and chief executive officer two-thirds of voting power. While Google had to overcome banker opposition at the time, Zuckerberg faces less resistance now. Founders of newer startups, such as Dropbox Inc. and Square Inc., may follow suit, said Charley Moore, chairman of legal-services site Rocket Lawyer.
“This is the current flavor,” said Bruce Alan Mann, a senior partner at Morrison Foerster in San Francisco who has been involved in more than 100 IPOs. “Prior to 1987, the New York Stock Exchange wouldn’t even list dual-stock companies. Five years ago, people weren’t asking about them. Now everyone is asking about it right away.”
Technology companies favor the structure because it gives them the ability to set the course for the business even as they raise money to execute those plans, Moore said. The approach can backfire when founders lose their “mojo” and investors have less power to intervene, he said.
Twitter, Pinterest, Dropbox
While it’s impossible to know the stock structure of still-private companies, Twitter Inc., Pinterest Inc., Dropbox, Square and other startups appear to be organizing themselves the same way Google did before its IPO, Moore said.
The dual-class strategy isn’t new. Traditional media companies and other old-line businesses have used the approach for decades, often to preserve a family’s influence. News Corp., Viacom Inc. and New York Times Co., for example, give a disproportionate amount of voting power to founding members. The New York Times and other media companies have said that insulation from the vagaries of the public market can help protect a news outlet’s editorial independence.
In the case of News Corp., CEO Rupert Murdoch controls 40 percent of voting shares while owning less than a percent of nonvoting shares, which are more widely traded. That power has allowed him to overrule the will of other shareholders.
‘Good for Mark’
James Murdoch, the deputy chief operating officer, would have lost his seat on the board last October at the company’s annual meeting without his father’s votes.
Seeing the trend take off in the startup world isn’t a boon to shareholders, said Anne Sheehan, director of corporate governance at the California State Teachers’ Retirement System, which manages about $156 billion in assets. Funds like Calstrs often invest passively in the indexes, and when companies like Facebook or Google are added, investors must accept the structure, she said.
“They’re good for Mark Zuckerberg or the founders of Google, but are they good in the long run?” Sheehan said. “If they want to get public money and play in the big leagues, why is tech any different?”
An estimated 65 U.S. venture-backed companies will sell shares to the public this year, possibly more, up from 53 in 2010, according to Dixon Doll, co-founder of the venture-capital firm DCM Inc. His firm is an investor in social-media company Renren Inc., which went public with a dual structure last year.
‘Extraordinarily Hot Companies’
Not every company can pull off a split-stock structure, he said.
“It’s done only when you have really extraordinarily hot companies, where they know they’re hot and they know they are going to be worth multiple billions in the market someday,” he said. “There are times like this when people can get away with it, and do.”
Only 38 members of the S&P 500 and 271 members of the Russell 3000 Index have dual shares, according to GMI Ratings, a governance consulting firm in New York. Since Google’s debut, about 27 technology and Internet companies went public with dual shares among more than 1,266 IPOs, according to data compiled by Bloomberg.
Yelp Inc., the consumer-generated reviews company, was the first dual-stock tech IPO this year, according to the data.
Many of best-known startups maintain small boards, fitting the profile of companies that pursue dual shares, Moore said.
‘Looking at Facebook’
Companies that have three or fewer outside board members include Pinterest, an online bulletin board; Dropbox, a provider of Web-based storage; question-and-answer site Quora Inc.; Flipboard Inc., the maker of a magazine-like application for the iPad; and Nest Labs, the creator of a technology-powered thermostat.
Zuckerberg adopted a dual-class structure in 2009. He has 10 votes for every other shareholder’s single ballot. Facebook plans to raise as much as $11.8 billion in the IPO, the biggest offering on record for an Internet company. The Menlo Park, California-based company would be valued at as much as $96 billion in the deal.
“People look at Facebook and see what they have done,” said Stephen Venuto, a partner at Orrick, Herrington & Sutcliffe LLP in Menlo Park, who helped Facebook set up its initial corporate-governance structure. “It’s become a much more common thing to implement dual-class capital structures in Silicon Valley companies.”
He declined to comment on the capital structures of any of the technology startups he has worked with.
“The reality of it as well is the investors have realized that a company will usually succeed or fail based on the success of the initial founding team,” Venuto said.
Google founders Larry Page and Sergey Brin doubled down on their effort to maintain control last month, when the Internet-search giant said it would issue a third class of stocks to existing shareholders. The new shares have no voting power.
The original structure was designed to insulate them from shareholder pressure, allowing them to make risky purchases such as the 2006 acquisition of YouTube, Page and Brin said last month. The third class of shares will help them make more stock-based acquisitions and pay employee stock compensation without diluting voting power.
Bankers no longer object to these arrangements, unlike when Google first went public, said Lise Buyer, principal at Class V Group in Portola Valley, California.
“When Google did it, there was tremendous pushback from the banks,” said Buyer, who advised Google on its IPO. “Today the bankers are often the ones suggesting it. It may be everybody tries it, because the market seems to be giving everyone a pass.”
Zynga, one of Facebook’s biggest partners, revamped its stock structure last year to give founder Mark Pincus 70 times more voting power of shareholders who buy stock publicly.
Venture capitalists are willing to put more faith in the vision of startup leaders than in the past, Moore said. Apple’s late CEO Steve Jobs, who lacked that support early on in his career, can take some credit for that change.
“Steve Jobs was forced out of Apple as a young leader, in favor of the more experienced John Scully,” Moore said. “That was part of the basic venture capitalist handbook of the past.”