Mar 8, 2019

Startup founders want control but few spring for dual-class stock

Illustration: Aïda Amer/Axios

Since Google's IPO in 2004, some Silicon Valley entrepreneurs have sought ways to retain control of their companies via dual-class stock with super-voting rights, including at the earliest stages of startups.

Yes, but: It’s still only found in a minority of startups, and founders often end up using alternative routes to retain control. Super-voting stock, several lawyers tell Axios, is most useful once a company is public.

The goals of special structures likes dual-class stock fall into two buckets, says startup attorney Jared Verzello.

  • Economic: Alternative structures like "FF preferred" stock or setting up two classes with different liquidation preferences can help with taxes (capital gains instead of income), or in cases where founders put in significantly different assets into the business.
  • Control: Founders often look to these legal tools to make sure they retain control of their companies even as they sell off more and more of their business to investors.

Private vs. public: While public company founders turn to dual-class stock that gives control of their company and their own continued employment, other legal tools can arguably be more effective.

  • "If you’re trying to maintain control, pay very close attention to your board composition," says Atrium's Verzello. "Board dynamics are misunderstood by early stage founders.”
  • Founders' biggest bargaining chip will always hinge on how successful their company has become."If you’re seeing success, whatever that means, you’ll have leverage to negotiate and you can retain," says Goodwin's Joshua Cook.
  • Most notably: Dual-class stock structure often get ripped out during a startup's first (or second) institutional financing round. Other provisions like board seats "are much easier to justify in your VC term sheet negotiations because you're not just asking for blanket voting rights," says Grellas Shah partner Mital Makadia.

Despite being increasingly popular among tech companies going public — ride-hailing company Lyft disclosed a dual-class stock structure in its IPO filing — these still remain rare among early-stage startups.

  • Only 10% of Atrium's startup clients choose some form of special stock structure. Makadia says that only about 20% of her clients have dual-class stock structures, typically putting in about 10% of their stock into a super-voting class.

Still, some early-stage startup founders do opt for one of these alternative structures.

  • One founder of a consumer mobile app says he went with a two classes of common stock with equal voting rights as an early precaution, and as a bargaining chip he can give up in his next funding round with VCs.
  • "When I raise money, my question to VCs is 'how are you gonna screw me?' he says, admitting his decision stems from a lack of trust that investors' incentives will be in line with his own.

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Coronavirus dashboard

Illustration: Aïda Amer/Axios

  1. Global: Total confirmed cases as of 9 p.m. ET: 932,605 — Total deaths: 46,809 — Total recoveries: 193,177Map.
  2. U.S.: Total confirmed cases as of 9 p.m. ET: 213,372 — Total deaths: 4,757 — Total recoveries: 8,474Map.
  3. Business updates: Small businesses are bearing the brunt of the coronavirus job crisis.
  4. World update: Spain’s confirmed cases surpassed 100,000, and the nation saw its biggest daily death toll so far. More than 500 people were reported dead within the last 24 hours in the U.K., per Johns Hopkins.
  5. State updates: Florida and Pennsylvania are the latest states to issue stay-at-home orders — Michigan has more than 9,000 confirmed cases, an increase of 1,200 and 78 new deaths in 24 hours.
  6. Stock market updates: Stocks closed more than 4% lower on Wednesday, continuing a volatile stretch for the stock market amid the coronavirus outbreak.
  7. 1 future thing: Shifts to telemedicine, at-home diagnostics, and drone delivery are all likely lasting consequences from this pandemic.
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Data: The Center for Systems Science and Engineering at Johns Hopkins; Map: Andrew Witherspoon/Axios

Positive cases of the novel coronavirus passed 213,000 on Wednesday — nearly twice as many as Italy, per Johns Hopkins — as more state governors issued stay-at-home orders for Americans to curb infection.

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Two planes with protective equipment arrived to restock Spain’s overloaded public health system on Wednesday as confirmed cases surpassed 100,000 and the nation saw its biggest death toll so far, Reuters reports.

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