Not all IPO stocks are created equal; just ask Shopify (SHOP) and numerous other tech companies such as Facebook (FB) and Google-parent Alphabet (GOOGL). Thanks to a system known as dual-class shares, they all stayed safe during the coronavirus stock market tumble in March.
Shopify stock fell 48% during the sell-off, which might have made the e-commerce player vulnerable to a takeover from Walmart (WMT), Google or others. But it prepared for such an event during its initial public offering five years ago, when it issued dual-class shares that essentially granted its founders and insiders super-voting rights.
Though many issues are on hold amid the coronavirus emergency, a debate continues to brew over the use of dual-class. Supporters contend dual-class shares give visionary founders like Shopify Chief Executive Tobias Lutke the same long-term control that Facebook’s Mark Zuckerberg has used to build a social media powerhouse. Critics worry about creating permanent corporate monarchs that don’t answer to shareholders.
“I would expect dual-class or multi-class share structures to remain a popular vehicle — popular with entrepreneurs, that is,” RBC Capital analyst Mark Mahaney told Investor’s Business Daily. “And tolerable for public investors.”
The situation hasn’t hurt Shopify. The stock has bounced back as brick-and-mortar retailers pivoted to online marketing amid the coronavirus. Shares in the Amazon.com (AMZN) rival have soared more than 4,600% since the Canada-based company’s 2015 IPO. CEO Lutke declined to comment on the dual-class shares system.
- 1 Which Tech Companies Started With Dual-Class Shares?
- 2 IPO Market Cools Amid Coronavirus
- 3 Tech Companies In Driver’s Seat?
- 4 Slew Of Dual-Class IPO Stocks During 2019
- 5 Some Offer Zero Voting Rights
- 6 Tech Companies And Superman CEOs
- 7 Venture Capital Firms Give Super Voting A Green Light
- 8 Original Founders Play A Role In Dual-Class Shares
- 9 Direct Listings Use Super-Voting Structures
- 10 Long History For Dual-Class IPO Stocks
Shopify is no outlier on this issue. In 2019, a slew of companies launched IPOs with dual-class shares. Last year’s contingent included Lyft (LYFT), Pinterest (PINS), Zoom Video Communications (ZM), CrowdStrike (CRWD), Chewy (CHWY) and Datadog (DDOG).
Here’s how the system works: If you buy a share of Amazon, it offers the same voting rights as any share owned by founder and CEO Jeff Bezos. That’s not the case if you buy shares of Facebook, Google, Roku (ROKU), as well as many other tech companies. Those with super-voting shares could have as much as 20 times the voting power of regular shares.
Dual-class shares have been controversial. The practice makes it difficult for tech companies to be acquired unless a founder or CEO gives the nod. And, the voting structures ward off activist hedge funds seeking quick changes in market focus or strategy.
The failed WeWork IPO last year brought more scrutiny to the practice. Before that, the Snap (SNAP) IPO in 2017 sparked a backlash when it sold stock that had no voting rights whatsoever.
The Council of Institutional Investors, which represents pension funds and others, says dual-class IPO stocks need to be reined in. S&P Dow Jones in 2017 barred newly public companies with multiple share classes from joining the S&P 500 Composite — though it grandfathered in Facebook and Google.
At the Nasdaq 100 composite, though, the welcome mat remains out. And more exchanges abroad seem open to super-voting share structures. Hong Kong’s exchange lost out on the Alibaba Holdings (BABA) IPO in 2014 due to its then-ban on dual-class offerings.
Alibaba stock has flourished. Hong Kong’s exchange now permits dual-class IPOs, while the London Stock Exchange is mulling approval.
Right now, the debate is on hold as IPOs slow amid the coronavirus emergency. When more tech companies go public, IPO stocks with dual-class structures are expected to return.
Since March 11, there have been 15 listings on the Nasdaq, including health-care and special purpose acquisition companies.
The IPO climate seems to be improving, with Zoominfo Technologies and Warner Music Group poised to go public. With the market rebounding off March lows, the next thing to look for is the Cboe Volatility Index, or VIX, to come down a bit more, says Jeff Thomas, a Nasdaq senior vice president who oversees its new listings and capital markets businesses.
The VIX spiked to above 80 in March. It has pulled back to around 27. If the VIX falls to 20 or below, IPOs will pick up, says Thomas. He expects dual-class offerings to stay in favor.
“It’s an important option for entrepreneurs to have the flexibility to pick the share-class structure that works for them,” Thomas said. “It gives companies the benefit of having a longer-term outlook.”
Tech Companies In Driver’s Seat?
That means for those who want to clamp down on dual-class shares, it may be tough when the debate resumes. Fact is, fewer companies are going public generally. Plus, private equity companies are gobbling up many public firms.
Founders may simply choose not to take companies public if they can’t retain control. So investors could be deprived of the opportunity to invest in growth companies.
Private companies are well-positioned to push for super-voting structures when they launch IPOs, Thomas says.
“The No. 1 thing we hear from private companies when they talk about why they wouldn’t go public is about being forced to manage a company for the short term, to be focused on the next 90 days, not the next nine years,” he said.
Thomas added: “I’ve talked to CFOs of private companies, whose private investors tell them: ‘If you go public, we want you to keep a dual-class structure, because the last thing we want is for there to be a market downturn and all of a sudden you get acquired at a low price. We’d rather have you keep operating the company because we’re believers in the long term’.”
Slew Of Dual-Class IPO Stocks During 2019
Google and Facebook stand out as tech companies with dual-class shares that have outperformed. Other dual-class shares with big gains since their IPO include Roku, Trade Desk (TTD), Atlassian (TEAM), Alteryx (AYX), and Appian (APPN).
RBC Capital, meanwhile, says Twilio (TWLO) and Dropbox (DBX) are among other companies that might be acquisition targets. But dual-class structures that were set up when they were IPO stocks pose a hurdle.
“For the foreseeable future, I would expect second-tier companies with dual-class structures to have more challenges going public than top-tier companies that are assumed to have large, open-ended opportunities ahead of them,” said Doug Clinton, managing partner at Loup Ventures.
Consider the example of workspace provider WeWork.
The company pulled its IPO last year and its founder and CEO, Adam Neumann, resigned amid criticism over his use of corporate money and grip on the company. Even after Neumann’s departure, WeWork could not salvage the IPO because of burgeoning losses.
Some observers say that WeWork and Uber Technologies (UBER) show that “the market” works. Uber’s founder, Travis Kalanick, resigned as CEO in 2017 amid a wave of privacy scandals and criticism of the company culture. Investors brought in a new CEO to clean up the company.
Uber finally went public in May 2019 without a dual-class structure. Uber stock performance, though, has lagged.
Some Offer Zero Voting Rights
Meanwhile, photo-sharing app Snap pushed the concept of dual-class further when it gave investors zero voting rights during its $3.4 billion IPO in 2017.
The Snap IPO and a similar offering by Blue Apron sparked a backlash. Amid pressure from the Council of Institutional Investors and others, S&P Dow Jones and FTSE Russell in 2017 imposed restrictions on including companies with unequal voting rights in indexes.
Tech companies face a penalty for exclusion from major stock tracking indexes. Passive funds remain unable to buy the stocks.
That’s a problem because massive amounts of capital have been shifting. They’ve gone from active to passive management, said a Goldman Sachs report from September.
“Using multi-class voting to insulate management from its own shareholders comes at significant long-term costs,” the report said.
Even so, tech companies continue to plow ahead with tiered stock structures. They keep CEOs in the driver’s seat if the company hits rough waters. In addition, some tech companies have pushed unequal voting rights further.
Tech Companies And Superman CEOs
Lyft and Pinterest, for example, set aside special stock with 20 votes vs. one vote for regular shares. In most earlier dual-class offerings, a 10-to-1 super-voting ratio became the norm.
Critics worry that with dual-class structures, CEOs who screw up big time can’t be ousted. Even if they mismanage a company or make bad decisions, the CEOs don’t have to worry about losing their jobs. And, sometimes founders can lose sight of what made their company successful.
Ken Bertsch, executive director of the Council of Institutional Investors, says IPOs with super-voting stock will continue, despite a crackdown by S&P Dow Jones, FTSE and others. However, Bertsch sees progress underway.
He says more companies are including time-based sunset provisions. These retire super-voting shares after a number of years or if CEOs sell them.
Venture Capital Firms Give Super Voting A Green Light
Bertsch contends tech companies are less likely to go forward with IPOs with 20-to-1 super-voting ratios. In addition, he says no companies have floated a Snap-type zero voting rights offering since 2017.
Bertsch says the venture capital industry, private equity firms, and investment banks that advise on IPOs all play a role.
“Private equity and VCs who are going to be getting out of a stock don’t necessarily have that much interest in fighting founders (on dual-class) unless it’s clearly going to discount the value of all the shares that they want to sell,” he said.
David Erickson, senior fellow at the University of Pennsylvania and a former Barclays IPO banker, agrees.
“VCs have allowed it to proliferate,” he said. “We haven’t seen Silicon Valley push back yet.”
At the IPO stage, advisors tell companies whether a dual-class structure is feasible without a big discount. Nasdaq’s Thomas said that in most cases having the original founders around helps make the case for dual-class shares.
“I think companies that successfully come to market with a dual-class structure are those with a founding management team that has really set the vision and strategy (that) investors are willing to take a bet on,” Thomas said. “Those companies are far more likely to have a dual-class structure than one that has moved on from the founding team and now has a second or third executive. It’s a lot harder for a professional CEO that comes in later in the game to justify a dual-class structure.”
On the one hand, critics view dual-class structures as power grabs.
John Coffee, director of the Center on Corporate Governance at Columbia University Law School, says that fear also motivates startups.
“I think the motivating force for dual-class stocks is fear of activist hedge funds who have a very short-term focus,” Coffee said in an email. “Entrepreneurs have their vision and do not want activists to divert them from it.”
He added: “The IPO market has been chilled by WeWork. It is still premature to predict the end of dual-class capitalizations, but I think some firms will use a more moderate version.”
Direct Listings Use Super-Voting Structures
More tech companies that go public, meanwhile, take a nontraditional route called direct listing. In a direct listing, existing shareholders sell their shares, but companies don’t raise any cash. Spotify (SPOT) and Slack Technologies (WORK) went public with direct listings that granted super-voting rights to CEOs.
Profitable tech companies are more likely to have dual-class IPOs sail through, notes Erickson. So are those with dominant market share in an emerging category.
Before the coronavirus outbreak, Airbnb’s IPO had been highly anticipated. Every once in a while, though, there’s a red flag thrown.
“For most companies the chance is low that investors will be very concerned,” said Jay Ritter, professor of finance at the University of Florida. He says Uber and WeWork were different.
Ritter added: “In both cases the concerns not only led to a change in the dual-class structure, but the ouster of the CEO. And, in both cases, the CEO decided that if my shares are worth more without me being in control, I’d rather have more money by giving up control.”
At Loup Ventures, Clinton said: “The way for investors to force change with the dual-class structure is to vote with their dollars by not investing in companies that have those structures.”
He added: “Ultimately, if investors think they can make money on an investment over whatever their target investment horizon is, a dual-class structure is unlikely to stop them from investing. Markets are efficient in that sense.”
Long History For Dual-Class IPO Stocks
Dual-class structures have been around for decades. Warren Buffett’s Berkshire Hathaway (BRKA) (BRKB) uses one. So do family-run cable TV companies like Comcast (CMCSA).
Google’s 2004 IPO sparked more interest in the strategy. Google stock has thrived under the structure. Amazon went public in 1997, seven years before the Google IPO.
Tesla (TSLA) founder Elon Musk didn’t use a dual-class structure when taking the automaker public in 2010. However, Tesla uses a provision stating that anything requiring a shareholder vote needs approval by 67% of shareholders. Normally, it’s 51%. Musk holds 19% of Tesla stock. That gives him a large say in anything put to a vote.
Meanwhile, biotech companies stand out as an exception amid the dual-class IPO stocks wave. Nasdaq’s Thomas says a biotech succeeds via their drug development pipeline and trial data.
“Due to this dynamic, most biotech companies do not value a dual-class share structure as much as tech companies whose business models and competitive dynamics are far more complex,” he said.
Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.
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