Control Considerations on an Initial Public Offering - The story of Snapchat
The capital of a company is divided into shares, which represent units of ownership in private or public companies. Once a private company has become sufficiently established and is seeking to obtain fresh equity from public investors, perhaps in the hope of expanding the business, it launches an IPO (Initial Public Offering) offering its shares to the public. By doing so, it loses its status as a private company and re-registers as a public company.
Once a public company, along with having to comply with stricter regulations, the original owners or founders of the private company generally give up significant control over their business in return for an investment windfall. According to the London Stock Exchange listing rules, at a minimum, companies who are floating have to offer 25% of their shares to the market.
Entrepreneurs may decide to only float a proportion of the shares in their business to ensure they retain majority control, or alternatively they may only need to raise a certain amount of new equity. Over 50% of voting rights are required to appoint or remove directors and therefore control the day to day decision making of the company through the Board. In most cases, whether or not they do give up majority control, the founders may still decide to roll-over some of their shares into the public company so that they keep a stake.
Where to Float?
The rules and regulations of the stock exchanges in London, New York, Singapore and elsewhere around the world vary. Companies will base their decisions on where to invest according to what attracts them to a particular stock exchange. One thing which will in some cases influence the location in which a company decides to float is the type of shares that are offered, as this may influence how much control the original owners give away to the new shareholders.
Dual-Class Share Structure - The case of Snapchat
What we have seen recently with Snap Inc, the owner of Snapchat (the disappearing photo social media company), is a dual class share structure being created at the point of the IPO on the New York Stock Exchange. The IPO took place on the 3rd of February 2017. 200,000,000 shares were offered to the market at an aggregate price of $3.4 billion. The catch for investors was that these shares were a new share class that did not include the right to a vote, so all voting rights remained with Snap Inc and the original founders. Snap is not the only American public company to have multiple share classes. Other companies such as Google (Alphabet), Facebook and News Corp (Sky), also have multiple share classes that limit the vote for some classes.
This has been controversial for a number of reasons. Some say that where investors are putting their capital at risk by purchasing shares, they should be protected by at least having a vote as shareholders. Another argument is that the Board of dual class share public companies may be ineffective or compromised if there are only a handful of individuals holding the majority of the voting rights in a company. This may then lead to inertia and an inability to pursue a vision other than that of the founder. There have also been suggestions that by offering non-voting shares as a distinct share class, companies such as Snap, have reduced the effectiveness of their IPO by attracting fewer investors and raising less capital than if the shares had the usual set of share rights.
The usual set of share rights are generally:
1. the right to vote; 2. the right to receive a dividend; and 3. the right to receive capital upon a winding up of the company.
In the case of private companies, these rights may be altered, for example, so that a group of shareholders do not receive a vote or receive preferential rights on a winding up. For example, this may be because a type of share called a preference share has been issued to someone lending to the company. The preference share may give the lender priority when a dividend is issued and ensure they have a right to receive their capital back before the holders of ordinary shares. The preference shares therefore provide a mechanism to give greater protection to the lender's capital and their right to return of their capital than the other shareholders. Preference shares generally have limited voting rights to prevent the lender having a say on how the company is run and therefore how it spends the loan. Of course, other terms of the loan may specify how the loan is applied.
Snap's actions have proved particularly controversial in America, where the shares are listed. On the 31st of July an index provider, the Standard & Poor's (S&P) Dow Jones excluded Snap and other companies with more than one share class, from its main indexes, the S&P 500, S&P Mid Cap 400 and the S&P Small Cap 600. This followed a decision from another index provider, the FTSE Russell, to also exclude Snap. This means that for investors hoping to buy into index-linked funds and tracker products on these indices, Snap will not be used to determine the level of each index.
A Future for Dual Class Share Structures?
The listing rules elsewhere do not currently permit dual share classes. This is the case on the London Stock Exchange, the Singapore Exchange and the Hong Kong Stock Exchange, to give some examples. However, in each case, the regulators of each exchange have recently considered or are considering the listing of dual class shares, despite the controversy that has been seen in America. The rationale for this may be that the stock exchanges want to stave off companies from thinking twice about listing in one place purely because the listing rules there do not permit dual class shares for public companies.
In a recent FCA discussion paper titled, 'Review of the Effectiveness of Primary Markets: The UK Primary Markets Landscape' it was noted that arguments were put forward in the Government green paper published in January 2017 titled 'Building our Industrial Strategy' in support of dual class share structures. The reasoning for this was that companies' founders would benefit from enhanced voting rights so that they could "focus more on long-term performance and less on short-term market pressures". There was of course some opposition to this idea from others, but it is certainly on the agenda.
The upshot is that for entrepreneurs or founders who want to maintain control over their enterprises following a public listing, the New York Stock Exchange may be an attractive location to float, as this does permit dual class shares. Given that other stock exchanges are now warming up to the idea, we may see dual class shares around the world in due course, despite there being some real concerns as to whether it is acceptable to have public companies with multiple share rights.