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5/06/2008
  Andreessen Loves Leverage

Marc Andreessen has a post praising dual-class stock structures. To me this means he's recommending that public tech companies create shares that enable management to control the voting rights of the company, even though they may own a minority of the shares.

His post is extensive, and he admits he's going over to a new view (previously, he believed in the corporate version of one man / one vote). However, I think it's crazy talk and unsupportable with the arguments he's making. I think the downsides and unintended consequences are far worse than he admits.

Leverage Now Good for Marc

Andreessen spent the last half of 2007 posting a lot of sarcastic notes on how Wall St. bankers and corporate titans were basically lying about their exposure to over-leveraged debt & derivatives. He reveled in exposing these guys.

In short, the problems for Wall St. were caused by excessive leverage.

Now, Pmarca is arguing that to fight potential raiders, hedge funds, private equity and other Schumpterian-type attacks, Silicon Valley should adopt the same techniques.

I.e. they should LEVERAGE their stock voting power. Basically, give insiders stock that is 10-100X more voting power than what they sell to everyone else.

The keystone of his argument is that Google does this.

He proposes the following four "commitments" that should make it OK for tech companies to operate this way:

  • The key leaders of the company -- typically the founders -- who will own the controlling Class B shares, are also major economic shareholders in the company. They own a significant portion of the company and are therefore highly incented to maximize the value of the company over time.
  • The key leaders of the company who own the controlling Class B shares have a long-term goal of building a major franchise, and the commitment required to execute against that goal.
  • The controlling Class B shareholders have a commitment to treat Class A shareholders fairly and equally in all respects other than voting power.
  • All public shareholders understand what they are getting into up front -- no bait and switch.

I think all four of these are impossible to hold management to, and about as likely to be judged in good faith as a politician's campaign promises.

Seriously, can Andreessen name ANY Silicon Valley founder who wouldn't believe that they would be able to satisfy all four of these "commitments"? Remember to ask them this at the time they are about to go public.

At a simple level, once most founders companies' go public, they have more frickin' money than god, and are not really that incented to maximize the value of the company. Is Filo that excited to do that (would he really know how?), or would he rather spend his days reviewing hardware purchases of Yahoo's teams?

As Bud Fox once said: "How many yachts can you waterski behind?"

It Works For Warren

Citing Google and Buffett as the "good" users of dual class structure is like citing Michael Jordan and Kobe Bryant as good examples of why a kid should leave school early to pursue his NBA career - "Hey, it worked great for those two!"

Rather than go with Buffett, I'd lean towards Peter Lynch for the guidance: "Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it." Should those idiots have this leveraged control?

Should Terry Semel (who made about $500M from Yahoo in 4 years) really have had this kind of control?

For 95% of tech companies, which is more likely?

  1. Idiots have control.
  2. The CEO / founder is the second coming of Warren Buffett.

And really, are investors going to understand the implications of dual-class structures? Should they have to?

Andreessen is arguing for a great weakening of already weak corporate governance.

Should Yahoo have Dual Class shares?

Would it have been good for Yahoo to have such a class structure? I don't know, but I'm sure Yahoo would have judged itself to pass with flying colors on all four commitments.

In fact, I'd argue that Yahoo is proof that companies don't really need the dual class structure to achieve control. They can simply do what they've always done and pack the board with yes-men and women who couldn't care less if the founders were presiding over a controlled flight into ground.

Upshot: Weak Governance Considered Harmful

My belief is that this technique will become more common, and will hurt innovation in Silicon Valley more than help it. In general, the companies that do go public with this type of structure will look more like European companies of the late '80s and '90s, where management had almost no incentive to govern the company for anyone's benefit but their own.

And yes, the argument that Wall St. forces some companies to focus on the short term too much is true, but that doesn't mean founders should concentrate control so drastically. If the founders are magnanimous enough to be able to handle Andreessen's four "commitments", I'd think they'd be bright enough to run their franchise effectively without dual-class controls. After all, it has been done many times - eBay, Cisco, Oracle and many others seem to have done it.

Dual class structure would be an easy way out, and wouldn't promote healthy governance. It'd be yet more insulation from the real world for the management of most companies, and the temptation to abuse it would be huge.

I guess Andreessen doesn't think that Silicon Valley founders would be subject to that temptation, and they don't already derive enough benefits at the top of the tech-company pyramid.

Ask yourself: aren't their egos and wealth big enough already? Or do they need this leverage technique to compete with the East Coast mega wealthy in PE and on Wall St?

I don't think it'd be healthy to try.

Recommendations For Improvement

Before making it easy for insiders to isolate themselves, I'd argue that if you want more public tech companies, and more innovation, make it easier to go public. Repeal big chunks of Sarbanes-Oxley (SarBox). I think that could help without weakening corporate governance too much.

If Marc wants to recommend this dual-class technique to Facebook, where he is apparently becoming a board member, I'd add one suggestion: Give the Class B power shares to all the employees and early investors.

Or, if that doesn't sound good - how about this: Stay private.

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