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Snap and WeWork illustrate the shortcomings of dual-class shares



Silicon Valley has pioneered lots of dubious innovations in recent years, but the problems of one in particular seem to become more readily apparent by the day.

That innovation has less to do with technology than corporate structure. Somewhere along the way, the investors in tech startups thought it would be a good idea to regularly give their founders outsized, often unchecked control over them in perpetuity.

The dangers of these schemes should have been obvious to everyone who enabled them. And yet we seem to be learning again the old adage that “power corrupts” and “absolute power corrupts absolutely.”

The latest lessons along those lines come this week from Snap and WeWork.

At Snap, CEO Evan Spiegel’s power to run things as he sees fit appears to be driving away numerous experienced executives and managers— further solidifying the leadership bubble he seems to exist in.

Meanwhile, at WeWork, Adam Neumann is reportedly taking advantage of his own unchecked position to make money off his own company in deals that appear to be heavily tainted by his serious conflict of interest.

Power corrupts, indeed.

Snap and WeWork both give their CEOs super-voting shares

Snap and WeWork are distinctly different companies, one public, one private, operating in separate sectors of the broader tech industry. What they have in common is a stock structure that gives extra votes to holders of certain classes of shares. In both cases — and at numerous other companies besides — those holders are the companies’ founders.

These dual-class stock structures effectively give the companies’ founders the votes needed to control them without having an equal amount of ownership in them. They essentially afford the founders unchecked power over their companies. They can appoint and remove board members at will, and they can decide the outcome of shareholder votes solely by themselves.

The tech companies that have increasingly adopted such structures have pitched them as a tool for allowing their far-seeing founders to realize their visions for their firms by focusing on the long term.

While some founders may be doing just that, the reality is that the dual-class structures also insulate those leaders from the legitimate concerns of their managers, directors, investors, and the public at large. And the structures give those leaders nearly unchecked power to do what they want, even if it might not be in the best interests of their shareholders, society — or even their own companies.

Snap is stumbling

Take Snap. The company has been reeling since it launched a redesign early last year that was widely panned by users. Its stock is trading well below its IPO price and its number of active users has been falling.

Evan Spiegel, CEO of Snap, which doesn’t give everyday investors any votes at all on corporate matters.

On top of all that, the company has been bleeding executives. On Tuesday, it announced that Chief Financial Officer Tim Stone is leaving after only eight months on the job. He’s the company’s second CFO to leave in less than a year, the second top official at the company to leave this week, and one of some 20 Snap executives who have left in the less than two years since its initial public offering.

It’s generally a bad sign when that many top officials leave a company in that short a period. It’s an even worse sign when two of them oversaw the company’s finances.

Snap was at pains to reassure investors about Stone’s departure. He had “confirmed,” the company said in a filing with the Securities and Exchange Commission, that his departure had nothing to do with “any disagreement with us on any matter relating to our accounting, strategy, management, operations, policies, regulatory matters, or practices (financial or otherwise).”

Maybe Snap’s right. Maybe there’s nothing to worry about when it comes to its finances or operations. Of course, a lawsuit by the company’s former head of growth suggests otherwise; he charges that the company gave investors false metrics in advance of its IPO. Snap denies his charges.

Spiegel seems to be driving managers away

Regardless, Stone’s departure is one more red flag after many more when it comes to Spiegel’s management style.

Stone left the company after clashing with Spiegel, in part over the scope of his job and his promotion prospects, the Financial Times reported. He also tried to circumvent Spiegel and appeal directly to the board for a raise, according to Bloomberg. His predecessor as CFO, Drew Vollero, also left after clashing with Spiegel, the Wall Street Journal reported.

Other officials left a fter Spiegel bungled an executive hiring and as he pushed through the company’s disastrous redesign. In a report about that redesign last month, the Journal painted a picture of Spiegel as an executive who operates in a bubble and doesn’t tolerate dissent.

Many CEOs have discretion to shape their teams, of course. What’s different about Spiegel is that no one can really question or check his decisions — not investors and not Snap’s board. He seems to be running Snap with that fully in mind, taking it where he sees fit, damn the consequences. And no one can do a thing about it — thanks to his super-powered shares.

WeWork’s Neumann is leasing the company his own buildings

WeWork’s Neumann seems to be using his own dual-class stock-enhanced power for a different end — enriching himself. He’s been buying up buildings in places such as New York and San Jose only to turn around and lease them to his own company, the Wall Street Journal reported. He’s made millions of dollars in the process, according to the Journal.

Such deals have an inherent conflict of interest. They raise questions about whether the company is doing them because they are in its best interests — or the best personal interests of its founder. For other investors, they raise obvious questions about whether WeWork could have gotten better terms or would have even signed the deals at all if Neumann didn’t own these buildings.

WeWork told the Journal that all deals are reviewed and approved by the company’s board of directors, and disclosed to investors. According to the Journal, the company’s investors had in fact blocked a similar deal back in 2013 involving a building in Chicago. But then investors gave him effective voting control over the company a year later by giving him super-voting shares. Now, according to the Journal, numerous investors are concerned about what on the surface looks like self-dealing by Neumann, but they can’t do much to stop it, because he holds the power.

WeWork and Snap aren’t the only companies where the inherent flaws of dual-class structures have become apparent. The most obvious case lately has been Facebook, where CEO Mark Zuckerberg has near-absolute authority. That Zuckerberg and Chief Operating Officer Sheryl Sandberg still have jobs at the company after the disastrous year the company went through last year attests to just how effectively dual-class structures can be at insulating insiders.

The tech industry revitalized dual-class stock structures

To be sure, dual-class structures aren’t exactly new. Like many of its innovations, Silicon Valley didn’t invent them. It just reinvigorated and perfected them.

Mark Zuckerberg has near absolutely control over Facebook, thanks to his super-voting shares.
REUTERS/Charles Platiau/File Photo

The structures were commonly used in the late 19th and 20th centuries. But they fell out of favor and common usage after the New York Stock Exchange in the mid 1920s stopped listing companies that had different classes of shares with disparate voting rights.

Although the NYSE dropped that rule in the mid-1980s, such structures didn’t really start making a comeback until 2004. That’s when Google held its initial public offering and convinced institutional investors to back it, despite the fact that it had given super-voting shares to its founders, Larry Page and Sergey Brin.

Actually, Google used its dual-class stock structure as something of a selling point for its IPO. The company argued by insulating its leaders from worrying about short-term concerns, they could focus on the company’s long-term needs and opportunities.

Facebook took a similar stance when it followed Google in 2012 with an IPO that cemented Mark Zuckerberg’s control over the company through his super-voting shares.

Such structures are becoming more common

At first such companies appeared to be the exception. It was thought that only the truly unique companies, those like Facebook and Google that had the prospect of dominating industries, could get away with dual-class structures.

But that assumption proved faulty. In the last two years, numerous tech companies have followed their lead, startups that in no way measure up to Facebook or Google. It’s not just Snap and WeWork, but Dropbox and even Roku.

Read this:Dropbox’s IPO is just the latest case of startup CEOs consolidating their power — and investors should be outraged

Although other companies with dual-class structures have gone public since Snap’s debut last year, the concept probably reached its most absurd epitome in the Snap IPO. The shares held by the company’s regular shareholders have absolutely no votes. None. Zilch. Their input matters so little that the company didn’t even have a formal shareholder meeting last year. Instead, it held a three minute webcast during which Spiegel didn’t speak and shareholders weren’t able to interject questions.

Roku allotted super-voting shares to its CEO, Anthony Wood.

What Snap and its dual-class cohorts have come to realize is that investors — whether the venture capitalists who provide their initial backing or the institutional investors who back their IPOs — only really care about near-term growth.

As long as a company has a great sales growth story, big investors don’t really care much about its stock structure and who ultimately has control. Indeed, in some cases, investors have been willing to concede more control to founders just to be allowed in on the action.

For example, WeWork’s investors created a new class of stock for Neumann that gave him effective control over the company as part of a funding round in 2014, according to the Wall Street Journal. In other words, even as his ownership stake in WeWork decreased, Neumann’s voting power increased.

That seems to be a common theme at the company. This fall, when SoftBank was considering investing $16 billion in WeWork, which would have given it a majority stake in the company, it was willing to leave Neumann with effective voting control over the commercial real estate firm, the Journal reported.

Early investors are cementing them in place

The biggest problem with dual-class structures is that many of them have no end date and there’s no way for ordinary investors to force companies to set one. The VCs and institutional investors who actually could bar such structures or force companies to set a sunset date are instead cementing them in place for all future shareholders.

They may buy into the idea that founders will always know and do what’s best for their companies. But, as we’ve seen, that’s not the case. And thanks to the stock structures those investors permit, there’s little the rest of us can do about it.

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