How founders can retain control of their companies using dual-class stock structure
Facebook is Mark Zuckerberg and Zuckerberg is Facebook. And the same applies to Evan Spiegel and Snapchat. We’re not just relating these big brands with their founders here, but talking about the supreme power that each founder wields over his startup-turned-global networking giant. Thanks to the unique stock structures of their companies.
Give this a thought. Facebook’s class B shares controlled by Zuckerberg have 10 votes per share, while class A has one vote per share.
At Snapchat, Spiegel and co-founder Bobby Murphy own class C shares that give them 10 votes per share, with the other share classes having limited or no voting rights.
While experts say this can be beneficial to a start-up though, in a limited manner, a similar scene does not dominate the Indian start-up ecosystem.
Says Pankaj Karna, founder and MD, Maple Capital Advisors, “Dual voting is an important and interesting concept, especially when start-ups have scaled up and have attracted significant capital. Often this balances the economic interest vis-a-vis operational business control and agility. ”
An entrepreneur starts a venture with a vision and as he seeks capital to grow, he is often open towards diluting his shareholding.
“Dual voting rights allow start-ups to be managed by the founder(s) without going through multi-level holding company structure to retain management control, despite minority shareholding on a fully-diluted basis,” says Sunil K Goyal, managing director, Your Nest, an early stage fund house.
Often, investor priorities are not aligned with those of a founder. Therefore, the upper hand in voted decisions may help the founder to steer the company to the direction he wanted it to sail, says Nandu R Kumar, CEO of management consulting firm, Spice Route Business.
“The continued presence and control of the entrepreneur is often critical to a business. There are companies where founders were removed and the company lost direction in the aftermath (e.g. Steve Jobs and Apple),’’ says Mukund Ranganathan, executive director, Motilal Oswal Investment Banking.
Moreover, start-up employees will have greater clarity with the one leader/entrepreneur to drive the venture, says Goyal and “investors will not really be able to change the course by voting out a founder who became a minority shareholder while aspiring to make a larger impact.”
But the drawbacks of such a stock structure equal the benefits, say experts.
A founder who exercises tremendous voting power can vote directors in and out of the company, tear down proposals for reforms, manipulate M&A proposals, and most importantly, kill any attempts to diminish his commanding powers, say experts.
“If the founder(s) wield sweeping powers, they can end up running the company like their personal fiefdom, at times discounting stakeholder interests.”
Kumar says it can create “dictators’’, which is against the interest of any fair business. “I feel differential class of shares shouldn’t be allowed once a start-up reaches the stage of becoming public.”
Thiagarajan Rajagopalan, founder & CEO of start-up Tripeur.com, says one share, one vote should be the policy for all publicly-listed entities. “If dual voting class shares are allowed in public companies, the investors buying shares are disadvantaged. They are reduced to spectators simply betting on a racehorse, without any influence on the outcome of the race.”
Will Indian entrepreneurs be able to emulate the likes of Zuckerberg or Spiegel and gain dominant voting rights? According to Ranganathan, in India, while the law has permitted the use of stock with differential voting rights, this has not been accepted by investors in the stock market. “So it is difficult for entrepreneurs currently to plan their strategies on the basis of the differential voting stock.”
Kumar says if a founder manages negotiating power over investors, it means he has got a super performing company. “Then structuring a different class of shares and ensuring his control becomes a real possibility. The stellar products of Google and Facebook with crazy traction gave the founders immense negotiating power, which might not be the case with start-ups in our ecosystem.’’
Rajagopalan agrees this can be possible only after a founder proves the start-up is a pot of gold. “In such cases, investors will want a piece of the company at any cost. In cases where the founder raises money from the seed stage, this is not possible since investors have the upper hand.”
ALL IS MINE
- A founder who exercises tremendous voting power can vote directors in and out of the company, tear down proposals for reforms, manipulate M&A proposals, and most importantly, kill any attempts to diminish his commanding powers
- One share, one vote should be the policy for all publicly-listed entities. Experts are of the view that if the founder(s) wield sweeping powers, they can end up running the company like their personal fiefdom, at times discounting stakeholder interests
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