Why Some Investors May Boycott Snapchat’s IPO

Feb 07, 2017

Snap hasn't even set an IPO date yet, and already some investors are saying "nope" to buying Snap stock.

When Snapchat's parent company filed for an initial public offering last week, investors got the first glimpse of just how richly valued Snap stock is likely to be, making the highly hyped debut likely the most expensive tech IPO in history. Snap Inc. is reportedly seeking a $25 billion valuation in its IPO, expected to happen in March.

Still, the deal-breaker for many investors is not Snap's valuation, but rather a peculiar feature of its corporate governance that is unprecedented among public companies: Snap shareholders will receive no voting rights when they buy shares in the IPO.

Snap acknowledged in its IPO filing that it would likely be the first company to sell non-voting stock in an IPO on a U.S. stock exchange. Google (googl) and Facebook (fb), whose founders also preserved significant control when they went public, created two classes of stock, with different voting rights, but did not go so far as Snap in depriving shareholders of any say in corporate matters whatsoever.

That novelty is making big-money investors balk at Snapchat. The head of corporate governance for CalPERS, one of 18 pension funds and institutional investors who sent a letter to Snap on Friday objecting to the lack of voting rights, described Snap's vote structure as "a banana republic-style approach," according to the Financial Times.

At the very least, it's the stock market version of taxation without representation, in which shareholders who buy in to Snap can only hope that its soon-to-be-billionaire 26-year-old CEO Evan Spiegel will do what's right by them, and increase the value of their stock. Spiegel and his co-founder Robert Murphy each hold more than 44% of the total voting power of Snap, together representing a super majority of nearly 89% of the votes. Here's what Snap's other shareholders therefore won't be able to do:

  • Nominate, elect or replace board members
  • Submit shareholder proposals
  • Put pressure on the board to fire the CEO (or anyone else in management, for that matter)
  • Approve or block a merger or takeover of Snap
  • Find out when a hedge fund or another large investor has purchased more than 5% of the company

That last one is noteworthy because it highlights how Snapchat's owners are essentially building Snap as a fortress impervious to hedge fund activists. The non-voting stock structure means that shareholders who acquire more than 5% of the company are not required to file the usual 13D filings typical of when activist investors such as hedge fund manager Bill Ackman first buy into a company as part of a campaign to increase its value. Then again, such activists would likely have no interest in investing in Snap, given that the non-voting shares strip them of the tools that they would use to effect change, such as nominating their own candidates to the board.

As one macro hedge fund manager, who uses the Twitter handle @econhedge, tweeted (using an expletive we can't include in its entirety), "$snap can f*** right off with that voting structure."

Snap has rigged its governance structure such that even if the board did decide to fire Spiegel or his co-founder Robert Murphy, there would be little point in it: The executives would still retain all their voting power anyway, just as they would, for another nine months, even if they died. Shareholders generally value the ability to get rid of a CEO or replace directors as recourse in the event that management, say, refuses to entertain a takeover proposal or sell the company even when a buyer is interested in paying an attractive premium. Such disputes can lead to proxy fights, but Snap shareholders will have no such luck.

As Snap says in its IPO filing, its non-voting structure is "designed...to discourage certain tactics that may be used in proxy fights," but could also "have the effect of discouraging others from making tender offers for our shares." It also allows co-founders Spiegel and Murphy to further dilute other shareholders as they wish. What's worse, Snap has no intention of paying a dividend now or perhaps ever, according to its IPO filing, offering shareholders little consolation for staying silent for the duration of the ride.

Other shareholders' lack of control over the company that makes Snapchat, whose messages disappear after they are received, prompted hedge fund manager Mark Spiegel of Stanphyl Capital, no relation to Evan Spiegel, to quip on Twitter that Snap's "shares disappear 30 seconds after you buy them."

While that scenario may embellish the worst-case nightmare of Snap's corporate governance structure, there's little to stop Snapchat's founders from ghosting their shareholders' interests after the IPO. If that possibility haunts investors, they can always vote with their feet: by just not buying Snap stock at all.

All products and services featured are based solely on editorial selection. FORTUNE may receive compensation for some links to products and services on this website.

Quotes delayed at least 15 minutes. Market data provided by Interactive Data. ETF and Mutual Fund data provided by Morningstar, Inc. Dow Jones Terms & Conditions: http://www.djindexes.com/mdsidx/html/tandc/indexestandcs.html. S&P Index data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Terms & Conditions. Powered and implemented by Interactive Data Managed Solutions