Archive for November, 2009

Class A/B Stock Structures

November 25th, 2009

News came out yesterday that Facebook has created a dual-class stock structure where Class B Common Stock has 10 votes per share compared to the ordinary 1 vote for Class A shares.  I certainly don’t know what Facebook plans to do with this type of stock, but Google has a similar deal (Cypress Semiconductor does as well), which has caused a lot of entrepreneurs to ask me about this type of setup.  Here’s what I think.

The Good – Voting Control
This type of structure allows founders to retain a lot of control over a company even as it grows enormously.  To use a very simple example, as founder of a company I could issue 1,000,000 shares to myself.  If the company grows rapidly and takes on a lot of employees I might want to issue 3,000,000 shares to them.

When I do that, I incur economic dilution and voting dilution.  This blog won’t speak to the economic side at all and will just assume the money all works out.  On the voting side, though, you can see that I went from controlling 100% of the stock to a mere 25%.  I have lost most of my control over the company.

I could issue more shares to myself to bring my percentage ownership back up, but there are a bunch of tax and logistical issues that make that hard to do.

Instead, I could convert my shares into supervoting stock.  If my shares all vote 10:1 and the other 3M shares are 1:1, then I keep control of the company because my 1M shares have 10M votes compared to everyone else’s 3M.

Google has said it adopted this system before going public because it wanted to think long-term and the founders did not want to risk being outvoted on shareholder matters.  B corporations can use similar structures to ensure that their companies’ core social missions can not be easily stripped away.

The Bad -Investors Hate it
My experience with these structures is that investors have a hard time getting comfortable.  Professional investors want to know that they can influence major decisions by the company, so it takes a while to get folks comfortable with the idea that founders have super-special voting rights.

My advice to entrepreneurs is not to rock the boat.  There are lots of perfectly good, non-investor-threatening reasons to create supervoting stock, but if the setup makes it harder to raise money then it’s a big gamble for a startup.

These things work for Facebook and Google because those are well-established, already successful companies.  They have negotiating leverage on their side.  Most startups are not so fortunate.

Reblog this post [with Zemanta]
Tags: , ,
  • Comments Off on Class A/B Stock Structures

On Zero-Sum Deals

November 20th, 2009

Most of my work is building connections between two companies or people, which sometimes means negotiating a software license agreement and sometimes helping a group of founders start a new company together.  In most of these cases everyone benefits in some way.

A few times a year I help people unwind difficult situations as well.  These are much harder deals to do- emotions run high and frequently the two sides don’t trust each other at all.  There is a tendency to look at these disputes as zero-sum situations: one side needs to lose something for the other to benefit.

Occasionally that is right.  I worked on a transaction a while ago where there was only 1 substantive issue between the two sides- one guy thought he was owed a bunch of money and the other thought the amount was much lower.  In the end neither side got what they really wanted out of it, which was unfortunate.  The deal later fell apart and I believe it was mostly because neither side got enough value from the agreement.

Most disputes don’t work that way.  Usually each side has something it doesn’t really need but the other side wants, and vice versa.  My job as counsel is (i) to help my clients figure out what the other side really wants and how to give it to them (this was a great quote from Hiten Shah– if only I could find the tweet), and (ii) help my clients figure out what they can give in order to get the deal done, move on and stop talking to me as much.   Some of the “give” items are material; frequently there are intangible items as well like reputational benefit and helping someone exit a bad situation gracefully.

So how do I help clients figure these things out? This post has been stuck in draft form all week because this is the hardest thing to do.  I talk to my clients a lot about all the facts in the situation, we use legal arguments as a backstop to think about what the result would be in litigation, and we spend a bunch of time assessing the other side’s needs.

We then make a series of offers intended to reflect our needs, the value we place on the things we want from the other side and the items we think the other side wants.  If we are lucky, the other side has done the same thing and we can find a small patch of common ground in short order.  From there, the thoughtful back-and-forth process lets us feel each other out and eventually find the key terms to avoid a zero-sum equation.

In other words, the alternative to a zero sum equation is probably something like: 40% part pragmatics (esp. how much money everyone is willing to spend on lawyers), 30% legal knowledge, 25% psychology, 10% intuition.  The rest is luck.

Tags: ,
  • Comments Off on On Zero-Sum Deals