Snap, Inc. Reportedly to IPO with Unprecedented Non-Voting Shares for Public

SnapChat’s ghostly logo represents the “There, then gone” nature of the company’s photo sharing service, but it also might ominously foreshadow the soon-to-be-public parent company’s plan to offer “phantom” voting rights to its post-IPO investors. On Nov. 15, 2016, Snap filed for a confidential IPO. Filing confidentially, a process allowed under the JOBS Act, shields Snap from the public financial disclosure scrutiny a traditional S-1 filing would entail. While the company has been able to keep most of its IPO plans close to the vest, recent reporting by the Wall Street Journal indicates that the company intends to sell exclusively non-voting shares to the public. By doing so, Snap would implement a three-class share structure. Snap’s founders would retain super-voting shares, pre-IPO investors’ shares would have a lesser voting power, and no votes for IPO shareholders.

The reported Snap plan to offer its IPO shareholders solely non-voting shares is an extreme. The sheer act of going public as a controlled company with a dual or multi-class share structure is not a new occurrence, but many multi-class share companies give at least token voting rights to public shareholders. The most common structure is to give ten votes per share to insiders, and one vote per share to non-insiders.

Recent history reinforces this; for Russell 3000 companies holding their first annual shareholder meeting in 2016, ISS identified 20 companies with a dual-class share structure. Of these, an unequal voting-rights structure with a ratio of one vote per share for public shareholders versus ten votes per share for insiders was used at 11 companies, such as Match Group, Inc., Square, Inc., and The Madison Square Garden Company. By comparison, for companies holding their first annual shareholder meeting in 2015, ten companies utilized a dual-class share structure with one vote per share for public shareholders versus ten votes per share for insiders. A one-to-ten voting-power dual-class structure was also implemented at both Google (now Alphabet) and Facebook at the time of their IPOs in 2004 and 2012, respectively.

At the biggest companies, the practice of dual- and multi-class share structures is in decline, as indicated by the trend since 2013. While the total percentage of R3000 companies with multi-class structure has remained the same in that period, ISS QualityScore data shows that no R3000 company since 2014 has adopted a multi class-structure; rather, companies with existing multi-class structures have moved into the index, companies have IPO’d multi-class, or there was a corporate transaction, like the spinoff at NewsCorp. QualityScore data also shows that 42 companies in the R3000, including seven companies in the S&P 500 (with names such as Visa and PepsiCo on the list) have completely done away with multi-class share structures.

There is no doubt that Google and Facebook have garnered significant positive returns for shareholders since their respective IPOs, but going public as a controlled company with a dual-class unequal-voting-rights structure is not an assurance for positive returns. Within the technology industry alone, Groupon, Inc., Zynga, Inc., and GoPro, Inc., for example, each came public with a dual-class share structure. Fraught with governance concerns, all three companies had ISS QualityScores of 10, indicating the highest levels of governance risk, and the share price of all three has tumbled precipitously since their respective initial public offerings.

Governance Concerns at Controlled Companies

Studies Show Lower Performance and Weaker Controls in Multi-Class Control Structures

Not all of the concerns at controlled companies are extreme examples of behavior that culminate in share price crashes. The lack of external accountability under which controlled companies operate leads to underperformance in a number of key governance and financial metrics. For example, according to a 2016 ISS/IRRC study on controlled companies, “Controlled companies underperformed non-controlled firms over all periods reviewed (one-, three-, five- and 10-year periods) with respect to total shareholder returns, revenue growth, return on equity, and dividend payout ratios.”

Further, governance standards are generally weaker at controlled companies. There is less gender and ethnic diversity in the boardroom, directors have longer average tenures with less board refreshment, and there are more related-party transactions and they are larger in size, as a few examples.

The study found one key point that is particularly relevant to the multi-class offering that Snap, Inc. is reportedly considering—which may portend other IPOs to come in 2017 in the tech sector—companies with a single class of stock and a controlling shareholder were more like non-controlled firms than they were like multi-class controlled companies. “Board and key committee independence levels, the prevalence of annually elected boards and majority vote standards for director elections, the frequency of supermajority vote requirements, and the thresholds for shareholders’ right to call a special meeting at controlled firms with single-class capital structures all continue to resemble those at non-controlled firms more so than at controlled multi-class stock firms.”

The documented penchant for secrecy from Snap’s founders, exhibited not only though the confidential IPO filing but also as a company culture, may draw an almost natural comparison to another secretive tech company, Apple. At Snap, however, this lack of forthrightness mixed with little to no ability for IPO shareholders to hold management accountable may not lead to a storybook outcome for investors.

Executive Pay is Higher as Well

Additionally, using data from ISS’ ExecComp Analytics database, the study found that CEOs at multi-class controlled firms are granted significantly more compensation. Average granted chief executive pay at controlled companies with a multi-class capital structure is three times higher (by some $7.2 million) than that at single-class stock controlled firms and is more than 40 percent ($3.3 million) higher than average CEO pay at non-controlled firms. The average CEO pay package at all controlled S&P 500 large-cap firms surpasses that at non-controlled firms by $6.9 million; however, at controlled multi-class stock large-cap firms, average CEO pay exceeds that at controlled companies with a single stock class by $16.2 million and that at non-controlled firms by $9.5 million.

With Less Accountability to Shareholders Comes Greater Risk

Investor Risk Concern Reflected in Investment Considerations and Share Price

Not all controlled firms are created equal, even among companies that have similar control provisions through their respective share structures. Some companies, such as Alphabet, where founders hold near-absolute control, have thrived and outperformed peers, sector, and index while improving in other areas of governance. However, the lack of accountability inherent to a controlled company creates a risk that can make investors nervous, and with good reason, as demonstrated through the aforementioned stock price crashes. In its 2016 policy survey, ISS found that 56 percent of investor respondents consider controlled status before making an investment decision.

Additional investor comments in the survey period indicated an extra layer of concern when it came to investing in controlled companies, especially those of the multi-class variety. Investors who said they distinguish between controlled and non-controlled companies when making investment decisions commented that the presence of a controlling shareholder would result in closer attention paid to board composition and the protection of minority shareholder rights, or, in some cases, result in a decision to forego the investment altogether. A number of investors stated that control via super-voting shares is considered much more problematic than control via majority ownership, as the latter ensures an alignment of economic interests among shareholders while the former does not.

Beyond incorporating the cost of additional risk in a non-voting share, investors have real financial reasons to be wary of these company stocks beyond calamitous price drops. Numerous studies have shown that there is a non-voting share “premium” where these share prices are lower than comparable voting shares. The value of that premium varies by stock and company, and most recognize that performance is ultimately more important than voting rights, but related studies looking at differences in share price for non-investment purposes have assumed a 5-percent difference for shares with no voting rights attached.

ISS Policy Changes Follow Investor Concerns

Due to these shareholder concerns, ISS included a question in the 2016-2017 policy survey asking about companies that come public with multiple share classes with disparate voting rights. A majority of investor respondents, 57 percent, supported negative recommendations for directors at companies that implement such a share structure. Among non-investor respondents, a majority supported negative director recommendations only in cases where provisions for the multi-class share structure were put in place permanently. As implemented for the 2017 proxy season, ISS will review the share structure of newly public companies and may issue negative vote recommendations when companies put unequal voting right structures in place.

Snap, Inc. Unique in the Extremity of its Reported IPO Plans

A Harbinger of Things to Come?

A decision to issue non-voting shares in its IPO would set Snap apart from other recent dual-class IPO examples. When Google, Facebook, and Under Armour each came public they each did so with a dual-class share structure that at least afforded public shareholders one vote per share. Nevertheless, each company subsequently requested shareholder approval for the issuance of a third class of non-voting shares. In each of these three cases, the purpose of creating a new non-voting share class was for insiders to maintain their voting control while at the same time providing insiders access to liquidity. If Snap goes public exclusively with non-voting shares, its options may be limited for new classes, but insiders will not have to worry about losing control of the company.

As investors await more definitive disclosure from Snap regarding its plans to come public, certain questions remain:

• Will Snap’s founders issue themselves non-voting shares as part of the IPO? If so, how much?
• While it appears certain pre-IPO investors will receive shares with limited voting power, what happens to these shares when they are sold or transferred? Do they convert to non-voting shares or maintain their voting rights?
• Is the dual-class share structure at Snap subject to a sunset provision?
• Does Snap’s non-voting class offering become the standard for other large anticipated IPOs in 2017?

If and when the details of the S-1 become public, ISS will provide further insight into the structure under which Snap plans to issue its first public shares, and any potential concerns of which investors should be aware. Perhaps more concerning, it remains to be seen whether other companies adopt the Snap IPO playbook, and if there is a new standard for tech companies to launch IPOs with multi-class share structure that give public shareholders little or no say in the governance of the company, and that leave management accountable to no one but themselves.