Lyft, Inc. last week completed its highly anticipated initial public offering, raising over $2.3 billion at a valuation of approximately $25 billion, and turning its co-founders Logan Green and John Zimmer into near billionaires on paper. But that’s not the only reason they’re smiling. Despite owning only 7% of the outstanding pre-IPO shares, Green and Zimmer will control nearly 50% of the voting power by virtue of their Class B shares having 20 votes per share and the Class A shares having just one vote per share.
Nothing that unusual so far. In three of the last four years, over one-third of the technology companies that went public featured dual-class shares, including Snap, Roku, Dropbox and Spotify. Snap went to an extreme by selling to the public shares with no voting rights at all, as did Alphabet, Under Armour and Blue Apron. I previously blogged here about Snap’s IPO of no-vote shares.
What makes Lyft’s dual class structure somewhat unusual is that it lacks a fairly typical sunset provision that would be triggered when the founders’ combined ownership falls below some threshold (often 10%) of the overall shares outstanding. In Lyft’s case, the founders’ combined ownership was already below 10% prior to the IPO. Lyft’s dual structure also has much larger disproportionality: 20 votes for every one vote held by all other stockholders, rather than the more standard 10:1. The Lyft structure will only terminate (by Class B shares converting into Class A shares) upon (I) a two-thirds vote of the Class B, (ii) the co-founders’ Class B shares representing less than 20% of the Class B outstanding, or (iii) the death or total disability of the last to die or become disabled of the co-founders.
Lyft readily concedes that its dual class structure poses a risk to investors. The first risk factor under the caption “Risks Related to Ownership of Our Class A Common Stock” in Lyft’s final offering prospectus states: “The dual class structure of our common stock has the effect of concentrating voting power with our Co-Founders, which will limit your ability to influence the outcome of important transactions, including a change in control.” It acknowledges that founders Logan and Zimmer will be able to control the vote on matters submitted to stockholders for approval, including the election of directors, amendments to the certificate of incorporation and any merger, consolidation, sale of all or substantially all assets or other major corporate transactions.
There’s an interesting debate surrounding dual class share structures, with valid arguments both for and against. Opponents assert founders shouldn’t have it both ways — access to capital markets without relinquishing control. Also, management that’s less accountable to public stockholders may pursue strategies that produce lower returns and lower value over time. Defenders contend the structure allows founders to make decisions that are in the best long term interests of the company without undue pressure from short-termist investors. Unless founders are able to control the vote through disproportionate voting shares, they may succumb to the pressure of producing quarterly results and may forego certain actions whose benefits may only accrue over the longer term like research and development and restructurings. Another argument in favor is that it neutralizes politically motivated vote initiatives such as “say on pay” or climate-change disclosures.
The New York Stock Exchange historically denied listing of companies with dual-class voting, primarily because of a general commitment to corporate democracy and accountability. But reacting to pressure from corporate boards at the height of the takeover battles of the 1980s and competition from other exchanges, the NYSE reversed course and today permits companies to go public with dual class structures.
Some opponents have advocated an outright ban on dual class structures or lobbied exchanges to refuse to list companies that have them. But the impact on IPOs must be carefully considered. Growth startups have been shying away from going public over the last 15-20 years for a variety of reasons, including regulatory burden, availability of late stage private funding and decimalization. Another reason is activist stockholder short termism, and founders may be even more reluctant to go public without the protection afforded by dual class shares, particular since other traditional defense mechanisms have fallen out of favor, including staggered boards and shareholder rights plans.
The Wall Street Journal Editorial Board, recognizing there are merits and risks associated with a dual class structure, argues that prospective Lyft investors who oppose it should simply not invest, or invest elsewhere; Uber’s IPO is rumored to be happening later this year.
A fair question to ask is whether dual-class structures, once adopted, should last forever. Research in this area indicates that the benefits of a dual-class structure for any given company decline over time, that the costs of letting management essentially entrench itself eventually outweigh the benefits of shielding the company from short-term investors. Last year, the SEC reviewed the stock market performance of companies with dual-class structures, comparing those that had time-based sunset provisions with those that allow them to last in perpetuity. It found that within two years of an IPO, companies with sunset provisions significantly outperformed those without them. Because of this and similar research conclusions, the Council of Institutional Investors has advocated in favor of time-based sunsets requiring multi-class structures with unequal voting rights to collapse to one-share, one-vote within a reasonable, specified period of not more than seven years after IPO.
Mandatory sunsets sound logical. After a certain number of years following an IPO, a company’s business model should have reached maturity such that it no longer needs protection from short termists in order to make long term changes. But here one size probably does not fit all. Companies often pivot differently in reaction to market trends and technological developments, and there’s no way to predict when companies will reach maturity. The better approach might be to give stockholders holding one vote/share stock the opportunity to vote after some period of time following an IPO as to whether or not to discontinue the dual class structure. Such a vote would ensure that founders aren’t insulated forever and would allow stockholders to determine when their company has matured to the point where the dual class structure is no longer needed or justified.