Facebook Investors Can’t Remove Mark Zuckerberg. That’s a Problem
Founders get to eat their cake and keep it, even after their companies go public.
Founders get to eat their cake and keep it, even after their companies go public. And that’s causing long-term damage to investors.
It is a theme of recent high-profile, tech IPOs that founders keep control of their company through the use of share classes even after they go public. The list of companies that have floated with privileged voting power for their founders is long. Facebook, Snap and Lyft all went public with their founders still retaining control. Is this practice fair?
A multiple share class structure splits shares into different classes. A Class A share, for example, might have the voting power of 10 ordinary, or Class B, shares.
Though the financial benefit for owning a share remains the same, voting power is not. Though, in a futile attempt at better branding, it is often only Class A shares that regular folk can buy.
One place that has thought them not to be fair is London. Or was, depending on when you’re reading this. The financial capital of the world has long rejected multiple share structures. This has seen it lose out to other exchanges in the race for high profile public offerings. That might change soon. Brexit, of course, rears its head here.
The British government is looking at scrapping rules barring IPOs with different share classes. They want to protect the City of London as a financial destination. Brexit, as always, is a factor here. It’s also looking relaxing quarterly earnings reporting requirements.
Founder-led companies love this structure. Founders will be able to retain control over the company and still be able to raise funds from public markets. Their long-term vision for the company is protected. This guards against the quarterly outlook of normal investors. It entrusts the people who have grown the company from the beginning with the ability to guide it in the future.
Facebook’s chairman, CEO and founder Mark Zuckerberg enjoys this type of privilege (among many others). Mr Zuckerberg owns around 28.2% of Facebook. That’s split between 8.75m Class A shares and 393m Class B shares. With those Class B shares (and with an irrevocable proxy over another 50m Class B shares) he controls around 60% of total votes in Facebook. Enough to do whatever he wants.
In 2012 Facebook went public. Before that Facebook was the frequent target of takeovers and acquisitions. Both Viacom and Yahoo! tried to buy Facebook early on in its life. The dual-class structure was in place at the time, even though Facebook wasn’t traded publicly. Mark Zuckerberg rejected all attempts to buy up Facebook, helped by his disproportionate voting power.
After rebuffing these advances, Facebook debuted on May 18, 2012. Launching at $38, the company was valued at around $90bn. Despite an early surge, the IPO was a disappointment. By the beginning of June that initial $38 share price had dropped to $27.72.
As you know, though, things turned around for the social media firm. It acquired WhatsApp and Instagram, possibly the best acquisition in history. Now it is trading at around $190 and has a market capitalisation of over $500bn.
Many social media sites came and went before Facebook cornered the market. Friendster, MySpace, Bebo all enjoyed success early on. They were not able to sustain it. Facebook was different.
Could it have bounced back from the disappointing IPO if it was taken over by institutional investors? No doubt the fundamentals of Facebook were strong, but Mr Zuckerberg deserves credit for consistently growing his social media site and its portfolio.
A strong hand on the tiller can help ride out rough seas. The positives for the dual-class share structure end there though.
Facebook has garnered a lot of well-deserved criticism. The fallout from the Cambridge Analytica scandal is still being felt. It is accused of not doing enough to combat the spread of misinformation on its platform. And that’s not forgetting the egregious privacy violations it has perpetrated. It was fined $5bn for the Cambridge Analytica scandal alone. More is to come.
These scandals are wide-ranging, constant and systemic. Both Mark Zuckerberg and COO Sheryl Sandberg have failed to fix Facebook. Mark Zuckerberg is protected by being both CEO and chairman. He controls the majority of shareholder votes. Facebook is essentially his personal fief.
Governments around the world are looking at regulating Facebook. Some argue that it should be broken up. These conversations are coming about because of Mr Zuckerberg’s failure to address the problems endemic in Facebook. Faced with this threat any normal board of directors, there to protect the interests of shareholders, would look to at least rein in, if not replace, the CEO who got them in that position.
Facebook’s board cannot do this. That is as a direct result of the dual-class share structure. Ordinary shareholders, who own more of Facebook than Mr Zuckerberg, do not control what they own.
The financial incentives for a dual-class structure also don’t last. Studies have found that companies that launch with such a structure typically underperform other similar companies.
Proper corporate governance, though, remains the biggest casualty of dual-class structures.
Adam Neumann recently got done for pushing his luck too much. Potential investors baulked at the control Mr Neumann, and his heirs, could exert over the company for generations. It was part of the catastrophic unravelling of WeWork following their plans to IPO. Is this the beginning of a pushback against the structure?
It isn’t clear. London might soon be allowing them. This would give an arena for the UK’s stable of unicorns to float in the same way as their counterparts in Silicon Valley. It would create a market that could see more European unicorns emerge but it could also create high-profile failures like WeWork.
But investors can make their concerns known. They can withhold funding until there was proper oversight. SoftBank is going down this route. After the WeWork fiasco, they are enforcing tougher rules on corporate governance and dual-class share structures. So, there is hope.
Dual-class share structures are ultimately unfair. They provide some short term protection for a company during its growth phase, but they should be discarded once a company reaches maturity. Facebook’s shareholders deserve to have control over a company they have poured billions of dollars into. But unless there are more big failures, nothing will change. The only morality that markets understand is money.
Founders want to control their creations. And there will be backers lining up to give them their money, if not their opinion, if they continue to see big returns. Cash still reigns supreme.