IndiaCorpLaw

Facebook’s Capital Structure and Governance

In the wake of Facebook’s mega-IPO, the Deal Professor examines the capital structure of the company, whereby it has decided to follow suit from the earlier high-profile Internet IPO of Google and go with a dual-class share structure. He notes:

… an investment in Facebook is really an investment in Mr. Zuckerberg: Facebook’s offering documents show he will retain control over Facebook even when it becomes one of America’s largest publicly traded companies.

Mr. Zuckerberg’s control is based on the structure of Facebook’s shares. Facebook is proposing to go public with a dual-class share structure. Public shareholders will purchase Class A shares that have one vote apiece. Mr. Zuckerberg, Facebook employees and current Facebook investors will hold Class B shares, which have 10 votes apiece. This is a deviation from the one share one vote norm followed by most publicly traded companies.

Although this seems to provide too much control to the founder, there is nothing unusual in this except for the fact that in this case the control rests with a single individual rather than a group of persons. As noted on the Deal Professor column:

Mr. Zuckerberg is not alone in using this type of structure to maintain ownership of a prominent technology company. The founders of Google, Larry Page and Sergey Brin, set up a similar structure and retain voting control over Google.

Yet they are two people who counterbalance each other, not a single individual.

Three other prominent company founders, Andrew Mason at Groupon, Mark Pincus at Zynga and Reid Hoffman at LinkedIn, have also adopted similar dual-class voting structures at their companies. At the time of those public offerings last year, Mr. Mason controlled 19.7 percent of the votes at Groupon, Mr. Pincus controlled 37.4 percent of the votes at Zynga and Mr. Hoffman controlled 21.7 percent of the votes at LinkedIn.

These companies, however, are much smaller than Facebook. And while their stakes are sizable, they do not entitle any of the three founders to remove and replace directors at will.

It appears therefore that deviations from the one-share-one-vote rule are becoming much more common than one would ordinarily imagine.

In the Indian context, after much back and forth regarding the desirability of permitting shares with differential voting rights, the Companies Bill recognizes the need for flexibility to companies and their founders to structure their shareholding along similar lines. However, SEBI continues to deny the issue of shares with “superior voting rights”.

As far as the governance structure of Facebook is concerned, one aspect that is highlighted in the Deal Professor column deserves attention:

Unlike most public companies, Facebook will not have a nominating committee for its directors comprising the independent directors on Facebook’s board. Instead, all of the directors will be selected by the board itself, a group that will be appointed by Mr. Zuckerberg. He can also remove and replace any director at any time.

The company has sought to take advantage of an exemption under the relevant listing requirements to steer clear of some of the conventional corporate governance norms such as board independence and independent nomination of directors that act as a monitoring mechanism on the managers and controlling shareholders. Facbeook’s registration statement filed the SEC states:

We have elected to take advantage of the “controlled company” exemption to the corporate governance rules for publicly-listed companies.

Because we qualify as a “controlled company” under the corporate governance rules for publicly-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors has determined not to have an independent nominating function and has chosen to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Our status as a controlled company could cause our Class A common stock to look less attractive to certain investors or otherwise harm our trading price.

Given the high-profile nature of the company, its founder and the offering, it is not clear if such concerns regarding the governance of the company will either turn away investors, or force a discount on the valuation of the shares.