While most of the world is still struggling to cope with the effects of the pandemic, Silicon Valley tech companies are thriving. Investments into these companies are flowing both in the private and public markets. Perhaps most surprisingly, the U.S. stock market keeps soaring with a record number of IPOs including at least 160 SPACs raising almost $60 billion this year (accounting for ~40% of the money raised in IPOs), much of it buoyed by the tech industry.
To distill the governance zeitgeist in Silicon Valley, one must first distinguish between public and private companies from the startup ecosystem. In the first category, boards are typically composed by a majority of independent directors (approx. 85% of the directors of the S&P500 are independent) and since Google’s IPO in 2004, many of the leading tech companies have also adopted dual class share structures that give founders and other insiders greater voting rights. In the private company category, boards are typically composed only by founders, executives and investors, and to a much lesser extent, independent directors. In other words, board composition in public and private companies is diametrically different, each facing different governance challenges. Moreover, within private companies a subset of “unicorn” companies has emerged, originally called this way because private companies valued at $1 billion or more were “extremely rare, and magical.” But as of October 2020, there are almost 500 unicorns globally (mostly from the U.S. and China), cumulatively valued at $1.55 trillion. Not so rare and magical anymore, although valuations in these companies are most likely overstated.
While the governance (and increasingly antitrust) challenges of the Big Tech juggernauts such as Apple, Amazon, Alphabet, Google and Microsoft are better understood, it is perhaps the governance of private companies that has been less explored. Unfortunately, Silicon Valley’s “growth at all costs” startup mentality often comes at the expense of good corporate governance. There have been high profile failures in some of the most prominent unicorns, such as with Uber, Theranos, Zenefits, SoFi and WeWork. The stand-out case is perhaps Theranos, where its founder Elizabeth Holmes is facing criminal charges and potentially jail time, and the story serves as a quintessential Silicon Valley case study on board failure.
The new wave of SPACs is unfortunately also introducing a new set of problematic cases, such as with EV truck maker Nikola Corporation, where the founder resigned after the investment fund Hindenburg Research accused him of making numerous false assertions about Nikola’s technology.
- The End of the “Stay Private for Longer” Mantra?
Recently, a few prominent Silicon Valley investors claimed that the concept of SPL (“Stay Private Longer”) was “the worst advice in Silicon Valley.” For years, there has been a debate among tech companies on whether to stay private for longer or go public.
Some of the reasons that led to this “SPL” trend included the soaring investments in private markets, not only by traditional venture capital (VC) firms, but also from public investors such as mutual funds, sovereign wealth funds, hedge funds, private equity funds, plus other strategic investors and public corporations. The epitome of this trend was Softbank’s $100 billion Vision Fund, and some researchers found that companies have raised more money in private markets than in public markets in each year since 2009. For example, U.S. companies raised $3.0 trillion in private markets and $1.5 trillion in public markets in 2017.
Other reasons for this trend include the creation of secondary markets for private shares, the increase from 500 to 2,000 shareholders for the threshold rule for public registration mandated after the JOBS Act in 2012, the more favorable investment terms for public investors in private companies (including downside protections), and a general avoidance of the more onerous public market pressures from activist investors, short sellers, regulators and others.
But there has been a resurgence of public listings this year. Traditionally, the “exit strategy” for private tech companies included two options: IPOs and sales via M&A. Two additional “exit doors” have now been opened: direct listings (pioneered by Spotify in 2018, followed by Slack, Palantir and Asana) and, most prominently, the SPAC door. But with around $60 billion (and counting) raised on these blank check companies, the signs of a bubble and more trouble to come are just too hard to ignore.
2. Control and multiclass voting shares.
One of the most notable governance trends in Silicon Valley since the mid 2000s has been the shift to founder or common-controlled boards. While venture capital investors, who typically hold convertible preferred shares, had a much stronger upper hand over founders and often brought in “adult supervision”, the pendulum shifted towards more “founder-friendly” terms, particularly due to stronger competition among VCs to win venture deals. This resulted in the widespread adoption of dual-class or multiclass voting share structures among the top echelon of tech companies. Some founders also negotiated the power to cast more votes at board meetings, ensuring that they outvote other directors.
But as these private tech companies transitioned to public markets, they often included dual class share structures. This practice clashed against those who endorse the principle of “one share, one vote.” One solution that has since emerged to curb this trend is the adoption of sunset provisions, such as time-based sunset provisions which automatically convert the dual-class structure to one share, one vote, typically upon a chosen anniversary of the IPO, reducing agency risk for long-term investors. Companies have included time-based sunset provisions at IPOs on a range from 3 to 20 years.
The latest chapter in this dual-class share saga was provided in the direct listing of Palantir, which introduced a novel control structure with Class A shares (1 vote), Class B shares (10 votes), and Class F shares (variable votes) tied to a Founder Voting Agreement representing 49.999999% of the voting power of the shares. This is just one more example about how these control structures can significantly differ on a case-by-case basis. As usual in corporate governance matters, one size does not fit all and we will most likely see these trends evolve, for better or for worse.
Evan Epstein is the Executive Director of the Center for Business Law and Adjunct Professor at the University of California Hastings College of the Law, and the Founder and Managing Partner of Pacifica Global, a governance advisory firm based in San Francisco, California.