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One Bright Spot in the WeWork Debacle: Turns Out Investors Actually Care About Corporate Governance

September 25, 2019, 4:43 PM UTC

If anything good has come from the disastrous WeWork IPO controversy that has been raging since its S-1 filing in mid-August and ended yesterday with co-founder and CEO Adam Neumann stepping down, it is this: the investing public looked closely at serious corporate governance lapses—not just the company’s financials—and deemed them too big a risk to invest at lofty private valuations.

“In the past, we had companies like Google and Facebook going public with big governance red flags, and everybody said, Well, that’s a feature, not a bug. That’s what you get with a founder-led entity,” says corporate governance expert Nell Minow, Vice Chair of ValueEdge Advisors. “But now it seems the market is understanding the risks of poor governance particularly with some of the self-dealing in this company.”

Neumann’s undoing

Despite his ouster as CEO, Neumann will remain nonexecutive chairman, and his voting power drops from 10 votes per share to three votes per share. Revelations last week about Neumann’s pot on a plane may have been the final piece of his undoing as investors show less and less patience with bad CEO behavior. (the recent downfall of another eccentric CEO who has been embroiled in controversy for decades: Overstock’s Patrick Byrne resigned after admitting to a romantic entanglement with Russian spy Maria Butina, who tried to infiltrate political groups to help Russian interests in the 2016 Presidential election.) But the hotly debated governance fumbles brought to light in the WeWork prospectus a month ago fueled the ire of investors who appear to be fed up with rule-breaking visionary founders who may be able to get a good disruptive idea up and running but do not have what it takes to bring the company to greater, solidly built heights. “The most important lesson here is for Wall Street,” says Minow. “Don’t take these companies public. Just don’t.”

Neumann apparently was so important to the company that it listed him as a risk factor in the public filing: “Adam Neumann, our Co-Founder and Chief Executive Officer, is critical to our operations. Adam has been key to setting our vision, strategic direction and execution priorities,” the offering states. “If Adam does not continue to serve as our Chief Executive Officer, it could have a material adverse effect on our business.” One thing for sure: Having him serve as CEO has been plenty adverse to the offering, which has been postponed.

Board oversight

But WeWork imparts crucial lessons about board oversight as well. The board and Japanese technology conglomerate Softbank, who owns the largest share of the company, were successful in getting Neumann to step down, but that result wasn’t guaranteed because directors weren’t given the power they should have had to oversee the company.  WeWork offered its shares to the public with a dual-class share structure—which means select shareholders have voting power that surpasses their economic interest in the company—as opposed to the one-share, one-vote tenet considered good corporate governance as far as most long-term shareholders are concerned. Neumann’s shares carried 20 votes each, which gave him control of the company, including the election of directors. 

Bottom line: Neumann held “all the cards because of the stock,” says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. The board could certainly have voted to fire Neumann, but Neumann had the power to replace the board. “If you think about it, this is really more of an indictment against the dual-class structures as opposed to him.”

WeWork’s amended S-1

After the public outcry over this and other unorthodox governance practices such as Neumann’s self-dealing business relationships and his non-board member wife picking his successor in the event of Neumann’s death or disability, WeWork amended some of its governance procedures. The amended S-1 filing changed Neumann’s supervoting shares from an obnoxious 20 votes per share to a merely irritating 10. The voting power would only fall to one-share, one-vote in the event of his death or disability and also if his aggregate number of shares fell to less than 5% of the outstanding stock. The modifications were major, but what kind of difference did it make? Not enough to keep the IPO train on its track.

The changes were welcome, says Amy Borrus, Deputy Director for Council of Institutional Investors, a shareholder rights organization. But it still didn’t “change the essential control problem,” she said, because it left Adam Neumann with “overarching control of the company.” For founder-led companies, 10 votes per share is a typical number assigned in order to keep control, but it’s still a super-voting class that allowed Neumann to do what he wanted—with no firm sunsetting provision in sight. CII likes to see a sunset of no more than seven years on supervoting shares. Lyft and Pinterest went public this year with 20 to one voting structures.

There were other positive changes in WeWork’s governance practices in the amended filing. Among them: Neumann giving profits he received from related real estate transactions to the company, appointing a lead independent director by the end of the year, having the board—not his wife—select any CEO who happens to succeed him, and appointing Harvard professor Frances Frei to the previously all-male board. Despite heading in the right direction, it didn’t erase the fact that the original governance lapses were beyond the pale. “To launch in the current environment with an all-male board was a huge red flag,” says Ric Marshall, a corporate governance expert with MSCI. “It speaks poorly of everybody on that board that they didn’t have more consciousness than that.”

The end of founder knows best?

The concept that founder knows best and should have the reigns to take the company in whatever direction he or she sees fit is not uncommon in the tech industry. But it is a newer trend. Use of such shares were generally seen in family-owned businesses like The New York Times Co. and Ford Motor. That changed in 2004 when Google went public with dual-class shares. Other tech companies like Facebook, Zynga, and Snap followed suit. Twitter, notably, did not. Facebook’s Mark Zuckerberg, despite major recent stumbles, has been immune to challenges to his leadership. “No founder is infallible,” says Borrus. “That’s the problem with dual class stock. It leaves founders with way too much control and leaves public shareholders and even the board in very weak positions to push for course corrections when there is a need.”

Shareholders and the board got lucky with getting Neumann to resign his leadership. Since they didn’t have the usual powers to oust him, they were able to make him see that it was in his economic interest, and the best interest of the company, to step aside. WeWork, which is not profitable, needed infusions of cash to grow—which surely made Neumann’s control tenuous as potential investors balked and the IPO became uncertain. It would have been difficult for him to raise the money he needed without Softbank’s contribution. Even still, it must have been difficult for Softbank to turn up the heat considering the strain it is under from its own investors thanks to big bets like WeWork and Uber that haven’t performed well. “They have the larger economic interest and stand to lose the most,” says Elson. “That’s the problem with the ownership structure.

Exit at Uber

Forcing out a founder-CEO with supervoting shares is not unprecedented. Uber provided a template. In 2017, after months of tumult at the company, including allegations of systemic sexual harassment and a video of CEO Travis Kalanick arguing with an Uber driver over fares, major shareholders, including Benchmark Capital, which is also a major investor in WeWork, wrote a letter demanding Kalanick exit or they go public with the letter. Kalanick surrendered while still keeping his supervoting shares. “I love Uber more than anything in the world and at this difficult moment in my personal life I have accepted the investors request to step aside so that Uber can go back to building rather than be distracted with another fight,” Kalanick told the New York Times. Later that year, Softbank agreed to purchase a stake in Uber in an arrangement that employed a one-share, one-vote model of corporate governance.

Public pressure and investor outrage went a long way in getting Neumann and the company to amend some of their dubious corporate governance.  It also worked well in getting him to resign. But this pattern shouldn’t be the prototype for future offerings. Going forward, boards shouldn’t get themselves into these messes because they may not be able to figure a way to get out.

“Don’t go on a pretend board,” says Minow. “You have to insist on some elements of independence to make sure you’re capable of providing the oversight role that you’re supposed to do. You’re not there to be a potted plant.”

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