By: Jennifer Kay
Snap Inc.’s February 2017 S-1 Registration Statement with the U.S. Securities and Exchange Commission reveals that the tech giant behind Snapchat intends to issue no-vote shares in its Initial Public Offering. With the advent of no-vote shares, start-up founders may be enticed to offer company equity to investors that would provide capital gain and dividend benefits without granting any voting rights to such shareholders. Although Snap’s no-vote share model is theoretically advantageous for company founders seeking to retain control over their brainchild, Snap’s unprecedented, unorthodox stock structure is unlikely to gain traction in the startup community, as most companies lack Snap’s level of bargaining power to convince potential investors to buy shares without voting rights.
While SEC and stock exchange rules permit issuers to sell no-vote shares as a means of allowing founders to retain control of their company, such stock is rarely issued and typically only issued after an IPO, as one company’s no-vote shares would theoretically be less valuable than their competitors’ single-vote shares. Still, the potential of the no-vote share model will be tested by the success of the shares’ sales in Snap’s IPO and Snap’s audacious proposal is presumably only possible because of its wildly-popular mobile app, Snapchat; the extraordinary, multi-billion dollar valuations of Snap in past financing rounds and as offered by rejected acquirers like Mark Zuckerburg; widespread public interest in the mobile app market; and the company’s seemingly-unbounded growth. These factors have contributed to the founders’ demonstrated belief that they will still be able to garner record-setting IPO stock sales without offering voting rights with company shares.
As articulated in the company’s February 2017 S-1, Snap will have three classes of common stock: Class A common stock, Class B common stock, and Class C common stock. Class A common stock will not be entitled to any votes, while Class B common stock will be entitled to one vote per share and Class C common stock will be entitled to ten votes per share. The S-1 further indicates that the only stock being offered in the IPO is Class A common stock with no voting rights and that “shares of Class B common stock or Class C common stock sold by existing stockholders will lose voting rights when such shares convert into Class A common stock or Class B common stock as such shares are sold.”
The S-1 indicates that Snap co-founders, Evan Spiegel and Robert Murphy, hold Class C common stock entitling them to 10 votes per share, but the publicly available version of the S-1 does not specify the number of Class C shares that each founder owns. Still, the S-1 explicitly acknowledges that “Mr. Spiegel and Mr. Murphy, and potentially either one of them alone, have the ability to control the outcome of all matters submitted to our stockholders for approval, including the election, removal, and replacement of directors and any merger, consolidation, or sale of all or substantially all of our assets. If Mr. Spiegel’s or Mr. Murphy’s employment with us is terminated, they will continue to have the ability to exercise the same significant voting power and potentially control the outcome of all matters submitted to our stockholders for approval.”
Accordingly, start-up founders may seek to mimic the no-vote share model to preserve company control and safeguard the company from activist investors or unfriendly takeovers. That said, start-up founders should understand that they would need to have colossal bargaining power in order to garner investor demand for no-vote, or even limited vote, shares. Still, start-up founders interested in retaining control should consider trends in IPO financing models like the Snap no-vote structure to ensure that their early-stage financing agreements allow for creative equity structures that would minimize founder decision-making dilution at later stages.