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The just completed IPO of Snap Inc. has received enormous buzz and plenty of press coverage, mostly about its eye-popping valuation and offering proceeds, the big winners among the founders and early investors and the millennials who bought shares. But not nearly as much attention has been given to Snap’s tri-class capital structure and the nature of the shares that were actually issued in the IPO: the shares of Class A Common Stock sold in the IPO are non-voting. By its own admission, Snap may have pulled off the first ever IPO of non-voting stock.

Snap’s capital now consists of the non-voting Class A shares held by public investors, Class B shares with one vote per share held by early round investors, employees and directors and Class C shares with ten votes per share held by the founders. As a result of the Class C common stock that they hold, co-founders Evan Spiegel and Robert Murphy will be able to exercise voting rights with respect to an aggregate of 215,887,848 shares, representing approximately 88.5% of the voting power immediately following the offering. Consequently, Spiegel and Murphy, and potentially either one of them alone (see below), have the ability to control the outcome of all matters submitted to stockholders for approval, including election, removal, and replacement of directors and any merger or sale of all or substantially all of the assets.

Multiple class structures are not unusual, and several high profile companies went public with them in recent years. What’s unusual here is that whereas the shares sold in those other multiple class structure IPOs had at least some voting rights (typically, one vote per share vs. 10 for the founder class), Snap’s public offering shares have no voting rights. Technically, Delaware law would permit holders of Snap’s Class A non-voting stock nevertheless to vote with one vote per share on any proposal to amend the certificate of incorporation in any way that would adversely affect the holders of the Class A. For example, if a proposed amendment provided for the Class A to rank junior to the Class B and Class C with respect to dividends or acquisition proceeds, a Class A vote would be required and the holders of a majority of Class A shares could defeat that amendment. Such a proposal would be extremely rare, however, and the Class A holders would have no say in the much more typical matters of board elections and any proposed sale of the company.

Multiple share classes are especially useful to public technology companies because they give them the freedom to innovate without the constraints of “short termism” and also serve as a deterrence to takeover bids because of activists’ inability to manipulate the voting machinery for election of directors.

Snap’s Class A common stock will be its only class registered under Section 12 of the Securities Exchange Act, and because the Class A is non-voting, Snap will not be required to file proxy statements except for a rare case where a vote of the Class A common stock is required (see above). Nevertheless, Snap indicated in its S-1 that it will provide Class A holders any information that it provides voluntarily to Class B and Class C holders.

What makes Snap’s structure even more unusual is survivability and portability.  According to Snap’s S-1, If Spiegel’s or Murphy’s employment is terminated (which, because of their control, could only happen if they turn on each other), they will continue to have the ability to exercise the same significant voting power and continue to control the outcome of all matters submitted to stockholders for approval. A founder’s Class C shares will automatically convert into Class B shares, on a one-for-one basis, nine months following such founder’s death or on the date on which the number of outstanding Class C shares held by such holder represents less than 30% of the Class C (or 32,383,178 shares) held by such holder at the time of the IPO. Facebook, on the other hand, amended its certificate of incorporation so that Mark Zuckerberg’s majority voting control is good only while he is an executive at the company.

Snap’s capital structure has drawn some criticism. In a New York Times piece, Cal Berkley law professor Steven Davidoff Solomon referred to Snap’s IPO as “the most stockholder-unfriendly governance in an initial public offering, ever.” In the Harvard Law School Forum on Corporate Governance and Financial Regulation, Rob Kalb and Rob Yates of Institutional Stockholder Services cited a 2016 ISS study that showed that controlled companies had weaker governance standards and tended to underperform “with respect to total stockholder returns, revenue growth, return on equity, and dividend payout ratios.” And the Council of Institutional Investors sent a letter to Snap’s co-founders objecting to the capital structure and urging them to adopt a single class structure. While acknowledging that similar emerging companies with dynamic leadership and promising products have successfully raised capital despite having dual class structures, Snap’s structure is unusual in that the investors would have no voting rights and dual class company performance has been mixed at best.

When Google, Facebook and Under Armour went public, they each did so with a dual-class share structure that at least afforded public stockholders one vote per share. Nevertheless, each company subsequently requested stockholder approval for the issuance of a third class of non-voting shares. In each case, the purpose of creating a new non-voting class was to maintain founder voting control while simultaneously providing insider liquidity.

Despite the overall positive outcomes achieved by Google and Facebook for their stockholders, going public as a controlled company with an unequal-voting-rights structure is no guaranty for financial success. Groupon, Zynga and GoPro each went public with a dual-class structure, received poor ISS corporate governance scores indicating the highest levels of governance risk, and the share price of all three dropped precipitously since their respective IPOs.

Adding salt to the corporate governance wound, Snap is taking advantage of emerging growth company status under the JOBS Act, meaning that it is not required to comply with the auditor attestation requirements under Sarbanes-Oxley and the reduced executive compensation disclosure requirements and may delay adoption of new public-company accounting principles.

In the final analysis, investors will need to decide which Mark the Snap founders better resemble, Facebook’s Zuckerberg or Zynga’s Pincus. And looking beyond Snap, it remains to be seen whether other emerging companies adopt the Snap IPO playbook by launching IPOs with multiple-class structures that preserve founder control and give public stockholders little or no governance voice.

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.

Dual or multi-class capitalization structures generally allow companies to sell large amounts of shares to the public while maintaining control in the hands of the founders and early investors. Popularized by the Google IPO in 2004, weighted voting rights have since been featured in the high profile IPOs of LinkedIn, Groupon, Zynga, Facebook, Fitbit and Blue Apron.  Snap then took them to a new level last year when it acknowledged (or boasted) that it was the first company to launch an IPO with shares having zero voting rights.  I blogged about Snap’s IPO here.

Dropbox, Inc. is now the latest to go public with a multi-class structure. Having submitted its registration statement confidentially in early January, Dropbox finally filed its S-1 publicly on February 23. Dropbox’s S-1 shows that its capital structure consists of three classes of authorized common – Class A, Class B and Class C – with the rights of the holders of all three classes being identical except with respect to voting. Class A shares (offered to the public) are entitled to one vote per share, Class B shares are entitled to ten votes per share and Class C shares have no voting rights, except as otherwise required by law.  Although the general rule in Delaware is that each share receives one vote, a corporation may provide in its certificate of incorporation that a particular class or series has limited or no voting rights.

Because of the ten-to-one vote ratio between Dropbox’s Class B and Class A, the Class B stockholders – basically the co-founders and lead VCs Sequoia, Accel and T. Rowe Price — will continue to control a majority of the combined voting power, and therefore be able to control all matters submitted to stockholders for approval. This concentrated control will limit or preclude the Series A holders from having an influence over corporate matters for the foreseeable future, including the election of directors, amendments of the certificate of incorporation and by-laws and any merger, sale of all or substantially all the assets or other major transaction requiring stockholder approval. The concentration of voting power may also discourage unsolicited acquisition proposals.

The concentration of power in the Dropbox founders will likely only grow over time. Under an automatic conversion feature, future transfers of Class B shares will generally result in conversion into the lower voting Class A shares, subject to limited carve-outs for estate planning transfers and transfers between co-founders. The conversion of Class B shares to Class A will have the effect, over time, of increasing the relative voting power of those Class B holders who retain their shares.  Moreover, any future offerings of Class C shares will increase the concentration of ownership and control by the founders even further than would be the case in an offering of A shares because the C shares carry no voting rights at all (except as otherwise required by law). Consequently, the cumulative effect of the disproportionate voting power of the B shares, the automatic conversion feature upon transfer of B shares and the possibility of issuance of C shares is that the founders may be able to elect all of Dropbox’s directors and to determine the outcome of most matters submitted to a stockholder vote indefinitely.

Dual-class structures have been the subject of a great deal of controversy.  Some stock exchanges had banned them, only to reverse course because of stiff competition for listings. See here for case in point regarding Hong Kong, the NYSE and Ali Baba.  Investors have loudly objected to this structure, both through the SEC’s Investor Advisory Committee and the Council of Institutional Investors.  As a result of that opposition, FTSE Russell and Standard & Poor’s announced last year that they would cease to allow most newly public companies utilizing dual or multi-class capital structures to be included in their broad stock indices. Affected indices include the Russell 2000 and the S&P 500, S&P MidCap 400 and S&P SmallCap 600.  Consequently, mutual funds, exchange-traded funds and other investment vehicles that attempt to passively track these indices will not be investing in the stock of any company with dual-class shares. Although it’s too early to tell for sure what impact, if any, these new index policies will have on the valuations of Dropbox and other publicly traded companies excluded from the indices, it’s entirely possible that the exclusions may depress these valuations compared to those of similar companies that are included in the indices.  Interestingly, just two weeks ago, SEC Commissioner Robert J. Jackson Jr. gave his first speech since being appointed, entitled “Perpetual Dual-Class Stock: The Case Against Corporate Royalty“, in which he expressed his opposition to index exclusions despite his serious concerns regarding dual-class stock, calling index exclusion a blunt instrument and worrying that “Main Street investors may lose out on the chance to be a part of the growth of our most innovative companies”.

And how do companies like Dropbox defend dual-class structures? They would assert that weighted voting rights enable management to make long term decisions that are in the best interests of the company and to resist the short-termism that typically results from pressure brought by major stockholders to maximize quarterly results which often means sacrificing long term interests and performance.  They would further argue that efforts to exclude companies with weighted voting rights from stock indices are counter-productive because they serve to discourage those companies from going public in the first place, thus denying public company investors the opportunity to invest in innovative, high growth companies.

Perhaps the sensible compromise here would be sunset provisions, under which dual-class structures would sunset after a fixed period of time, such as five, ten or fifteen years, unless their extension is approved by stockholders unaffiliated with the controlling group.  Snap’s muti-class structure has no sunset provision; the only way the two founders could ever effectively lose control of Snap is if both died.  By contrast, Google has a sunset provision on its dual-class shares. The Council of Institutional Investors sent a noisy letter to Blue Apron just before its IPO last year urging the company to adopt a five-year sunset.  And Harvard Professor Lucien Bebchuck published a paper last year called “The Untenable Case for Perpetual Dual-Class Stock”, arguing that the potential advantages of dual-class structures tend to recede, and the potential costs tend to rise, as time passes from the IPO, and advocating for finite-term dual-class structures.

2016 turned out to be a terrible year for IPOs, both in terms of number of deals and aggregate proceeds.

According to Renaissance Capital’s U.S. IPO Market 2016 Annual Review, only 105 companies went public on U.S. exchanges in 2016, raising only $19 billion in aggregate proceeds. The deal count of 105 IPOs was downrenaissance 38% from 2015 and the lowest level since 2009.  The $19 billion in aggregate proceeds was down 37% from 2015 and the lowest level since 2003.  In fact, if you remove the financial recession years of 2008 and 2009, the 105 IPOs in 2016 were also the lowest since 2003.  And the drop in deal activity was indiscriminate; both VC- and PE-backed IPOs were at their lowest levels by deal count and proceeds raised since 2009.

The temptation would be to blame the weak IPO market on political election 2016uncertainty, with Brexit and the U.S. election being the biggest culprits. But then how to explain the broader U.S. capital markets, which were hot in 2016. The Dow Jones Industrial Average hovered around 20,000 at year end, and the S&P 500 Index was up 9.5% for the year.  One would expect that the market for IPOs would be pretty strong, as bullish markets normally encourage companies to go public.  To be fair, much of the market gains took place in the latter half of the fourth quarter.  But market weakness doesn’t explain the two-year drought in IPOs for technology companies, considered the mainstay of the IPO market.

Another common theory is that over-regulation, particularly Sarbanes Oxley, has made it much more expensive to go and remain public, thus discouraging many growth companies from doing so. The 2012 JOBS Act tried to remedy this by creating an IPO on-ramp for emerging growth companies, allowing for confidential registration statement filings with the SEC, “testing-the-waters” and scaled disclosure.  The immediate results were encouraging: a dramatic increase in IPO deals and aggregate proceeds in 2014.  Yet IPOs plummeted in 2015 and even further in 2016.

Renaissance Capital’s report points the finger squarely at the public-private valuation disconnect. The tech startup space in 2015 was a mystifying series of mega rounds, sky-high valuations, unicorns and unicornbubble fears. But another trend has been IPOs being priced below the company’s most recent private funding round.  In its pre-IPO round, Square Inc. was valued at approximately $6 billion, but IPO’d at just over half that valuation and then plunged further post-IPO.  Etsy Inc. and Box Inc. both reported $5 billion plus private valuations, only to plunge in the days leading up to their IPOs.  Many, including Benchmark Capital’s Bill Gurley, have blamed the late-stage bidding frenzy on institutional public investors such as mutual funds rushing into late-stage private investing.  Another major contributing factor in the escalation of late stage valuations is the trend toward generous downside protections being given to investors in exchange for lofty valuations, such as IPO ratchets and M&A senior participating liquidation preferences.  The former is simply antidilution protection that entitles the investor to receive extra shares on conversion in the IPO if the IPO price is below either the price paid by the late-stage investor or some premium above that price.  The latter means that, in an acquisition, the investor gets first dollars out ahead of earlier series of preferred and then participates with the common pro rata on an as converted basis.

Renaissance maintains that VC-backed tech companies with lofty late round private valuations chose in 2016 to avoid inevitably lower public-market valuations and had the luxury of remaining private due to ample available cash in the private markets. Mergers and acquisitions offered alternate pathways for other tech companies, such as TransFirst, BlueCoat and Optiv, all of which had previously filed S-1s for IPOs.

Although the private-public valuation disconnect was a major impediment to IPOs in 2015 and 2016, Renaissance believes this phenomenon is close to correcting itself and is optimistic about 2017. Many growth companies have seen their valuations flat or down in new funding rounds to levels that will be more palatable to public investors.  Also, the election results will likely bring a dramatic change in fiscal, regulatory, energy and healthcare policies, all of which should be stimulative to equity markets, new company formation and, ultimately, IPOs.

Another reason for tech IPO optimism for 2017 is Snap, Inc.’s highly anticipated IPO in the first half of 2017. It filed confidentially under the snapJOBS Act, and has begun testing the waters with investors.  The Snap IPO is rumored to raise $4 billion at a valuation of over $25 billion. Another one is Spotify, which raised $1 billion in convertible debt in March 2016 which signals a likely imminent IPO. These two IPOs might raise more capital than all VC-backed tech IPOs in the last two years combined.