Thursday, 4 October 2012

Founders' Voting Rights decreases the value of YOUR shares

In this post I will be writing about founders’ voters rights.  This is not a concept that is present in all markets and so if you are an investor from a jurisdiction that does not have the concept of founder shares or different classes of shares then this is the post for you.  It is something that you need to consider especially if you are investing in markets such as the United States where this is relatively common.

So what are founders’ shares?

Simply put they are a different class of shares.  This necessarily involves the discussion of classes of shares.  In markets such as Australia different classes of ordinary shares do not exist.  One share is exactly the same as another and comes with the same rights, structure and benefits as any other share.

However some markets allow different classes of shares.  At the most basic level you can have, for example, one class of shares which is the equivalent of 10 of another class of shares.  You can see this with companies such as Berkshire Hathaway which has both Class A and Class B shares with the basic difference being that Class A shares are a multiple of Class B shares.  There is actually no real problem with this because it is pretty easy to value the difference in these shares and both classes of shares are tradeable.

Founders’ shares in their current form are a product of the second tech boom and started with Google’s IPO in 2004.  They create a class of shares which are held by the founder, founders or a group of insiders in the business which have super voting powers.  For example with Facebook’s recent IPO Mark Zuckerberg owns 18% of the company’s shares however controls 57% of the voting shares. 

What is the rationale behind them?

Let me say upfront that I do not buy the rationale given for founders’ shares however I will outline both what is the reasons given by the company and what I think the reasons are.

The rationale for founders’ shares or super voting shares controlled by insiders is as follows:
  • Share markets are notoriously short term driven with investors focusing on short term gains when if the business took some short term pain, in the long run shareholders and the business would be better off
  • The person or insiders that control the company and got it to the stage of being able to list is more likely to be able to take the long term view of the business and knows the best way of taking it forward (Amazon is the most cited example of this)
  • If the founder or founders are selling more than 50% of the company, it is in the interests of the whole company for the control of the company to rest with those shareholders who have the long run interests of the business in mind

Maybe I am more cynical by in my view it is more about founders wanting investors to come and board and not say anything.  It is an ego trip where the company needs shareholders but does not want their opinion because the ‘founder knows best’

Why do I have a problem with super voting shares?

There are several reasons I have a problem with them including
  1. It is paternalism gone mad.  The assumption that the founder ‘knows best’ and that I should hand over my money and stand back and not get involved is ludicrous to me
  2. It assumes that the founder will always do what is in the best interests of the business.  Often CEO’s and founders empire build.  That is they are driven by the power they wield through their corporation and not the returns they generate.  This means that they make decisions and acquisitions not based on what is best for shareholders in a returns sense.  If a founder controls the company and starts to do this there is no way they can get voted out
  3. As a shareholder you are the most subordinated interest in the company – the upside of this is that you get a say in the company.  You can vote your shares in a takeover or you can vote out the people that control the company if you do not think what they are doing is in the best interests of the company.  Super voting shares ruins this.

IF you were able to buy super voting shares on market (and thus they became a truly distinct class of shares with a different value) then you could probably value it and adjust your valuation of your own shares accordingly. 

If you are planning on buying shares in a company which has a dual class of shareholding like this make sure that you put a discount for the damage that a founder can do the company where you have no control.  The risks are high and you have limited recourse.  I would value your shares like a non voting share because effectively that is what it becomes. 

Note that there are many jurisdictions in the world where one share equals one vote.  If someone wants to control a company they need to put their money where their mouth is and have a big enough stake to be able to do so.  This aligns their interests better with that of other shareholders.

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