The case for tenured voting

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It’s hard to get too worked up about unequal voting rights, which are seen by public market investors as giving founders too much control, while viewed by founders as necessary to protect their companies from short-term shareholders. The reality is that only a minority of companies can command these terms, most famously Google, Facebook, Zynga, Groupon and now Snap. The majority of other startups have far less leverage.

Still, the controversial structure seems to be growing more common. According to Dealogic, 27 of 174 U.S. IPOs in 2015 featured a dual-class structure. In 2014, 36 IPOs used the structure out of a total of 292 U.S. IPOs.

Why it matters: Research published last year by Institutional Shareholder Services suggests that companies with unequal voting rights underperform non-controlled companies over a one-year, five-year and 10-year period. Now Snap has taken the structure to an unprecedented extreme, even writing in its IPO paperwork that, “to our knowledge, no other company has completed an initial public offering of non-voting stock on a U.S. stock exchange.”

It’s too soon to know how Snap will fare. While its shares soared 44 percent on the day of its IPO last Thursday, they’ve since fallen about 16 percent, helped along by a growing chorus of skeptical analysts. The trend has some worried, though, including SEC Commissioner Kara Stein, who publicly raised questions yesterday about the rights of investors, and who suggested the SEC “focus on how some innovations may prove detrimental to investors.”

One alternative the SEC might discuss is tenured voting, a structure that was lightly used decades ago, halted by regulators in the 1980s, and of growing interest again to a small number of Silicon Valley denizens who argue it’s a lot better than what tech companies have come up with.

It works much like you’d guess based on the word “tenure.” The longer an investor hangs on to his or her shares, the more voting control he or she amasses. The idea is to protect founders from activist investors, while also giving public market shareholders some say.

It’s immediately easy to see the appeal. Carl Bass long served as Autodesk’s CEO and had to wrestle with activist investors last year. Somewhat unsurprisingly, he told us recently that he’d “like to see tenured voting, where there’s a premium based on how long you own the shares.” It makes sense to Bass that “one person who has owned a million shares for one year has less voting power than another person who has owned a million shares for two years.”

Managing partner Scott Kupor of Andreessen Horowitz is also a fan of the idea, saying that as “part of broader capital markets reform to better align the long-term interests of shareholders and management teams, tenure-based voting would be far more amenable as a solution than the more blunt-force application of dual stock.”

The challenge, says Steven Davidoff Solomon, a professor at the UC Berkeley School of Law, is that “it takes time and you need a first mover.”

While the structure would “motivate institutional shareholders by rewarding them,” tech companies can “be lemmings,” says Solomon. Just like Google opened the “floodgates” for dual-class voting structures, he notes, another breakout company would need to set the direction with tenured voting.

One of their biggest tasks would be to convince underwriters of its merits. Roadshow presentations last 30 minutes, and bankers don’t want to spend that time explaining what tenured voting means, says venture capitalist Greg Gretsch of Jackson Square Ventures. In fact, generally speaking, he says, “Bankers don’t want to bring anything to market that looks different because anything new — any strings attached — makes things harder to sell.”

Another gating factor, says Wilson Sonsini attorney David Berger, are U.S. stock exchanges, which determined in the 1980s that tenured voting was unnecessarily complicated and hard to track and don’t currently allow companies to feature the structure unless already a provision in their respective charter.

Berger says the exchanges can be “flexible in their interpretation” (he has apparently asked), but he thinks it’s a shame that they haven’t been pushed harder by the investor community. While institutional investors like to complain about unequal voting rights, he suggests they repeatedly allow themselves to be taken advantage of.

“The only reason [certain companies] get away with [unequal voting rights] is they’re the exceptional companies that everyone wants a piece of,” say Berger. While institutional investors “will say this is a bad thing from a governance perspective — and it is — they still feel like they need to own these companies to move the needle,” he adds.

Indeed, the broader institutional thinking seems to be that it’s better not to rock the boat. As a portfolio manager from California’s state teacher retirement system — which opposes tenured voting —  told NPR last summer, “A shareholder’s a shareholder’s a shareholder . . . It’s very dangerous territory when you start treating investors differently.”

No wonder that, like Solomon, Berger thinks it will take a pioneering company with the sizzle of Snap to get the ball rolling if we’re going to see this shift.

Considering that breakout successes aren’t so easy to come by, that could take some time.

“I’m sure there are a lot of other IPOs where the founders say, ‘I want to control the shares,'” says Gretsch.

“I’m guessing that nine times out of ten, bankers will tell them, ‘You’re barking up the wrong tree.'”

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