Snowflake Dual-Class Shares: What Investors Need to Know

Snowflake's Decision to Eliminate Dual-Class Shares

Snowflake recently declared its intention to relinquish its dual-class shareholder structure. This corporate governance model frequently provides founders and key executives with disproportionate voting power.

Typically, this involves granting them ten times the voting rights per share compared to common shareholders. Such a system allows founders to retain control even as their ownership stake is diluted through subsequent investment.

The Power of Supervoting Shares

For numerous organizations, these supervoting shares are a significant asset. They permit founders to benefit from both public market access and the ability to limit external shareholder influence over company operations.

Founders and investors often contend that these preferred shares shield them from short-term market pressures. However, this viewpoint is not without its detractors.

Controversy Surrounding Dual-Class Structures

Dual-class shares are a contentious governance arrangement. Concerns exist regarding the creation of an uneven competitive landscape, where a select group can exert excessive control.

The structure can potentially allow a small group to wield an outsized influence on company decisions.

Why Snowflake Made the Change

The decision by Snowflake to abandon this powerful tool occurred just six months after its initial public offering (IPO). This raises the question of the reasoning behind this move.

We will examine the concept of dual-class shares and explore the factors that may have led Snowflake to relinquish them.

Understanding the Implications

• Dual-class shares offer founders continued control.
• They can protect against short-term market volatility.
• However, they also raise concerns about fairness and governance.

Snowflake's action signals a potential shift in corporate governance practices. It demonstrates a willingness to prioritize broader shareholder rights over concentrated control.

The company’s decision is likely to be closely watched by other publicly traded entities considering similar structures.

Snowflake’s Strategic Decision

A key rationale behind implementing dual-class shares often centers on reinforcing CEO authority. However, Snowflake’s history suggests this wasn’t a primary concern for them, considering their pattern of CEO transitions. The company’s founders remain involved, but initially appointed Sutter Hill investor Mike Speiser as CEO.

Subsequently, they brought in Bob Muglia, a former executive from Microsoft, before ultimately selecting Frank Slootman, a seasoned CEO, to lead the company through its initial public offering.

Given the absence of a founder-CEO wielding significant control, the company may have determined that supervoting shares were unnecessary. Mike Scarpelli, Snowflake’s CFO, presented the decision as mutually advantageous when announcing the elimination of the special shares during the recent earnings call.

“We have announced that, as of March 1st, 2021, our Class B shareholders, in alignment with our governing documents, converted all Class B common stock to Class A common stock. This action removes the dual-class structure and ensures equal voting rights for each share,” Scarpelli stated during the call.

The motivations behind relinquishing this powerful control mechanism remain somewhat unclear. Casey Aylward, an investor at Costanoa Ventures, posits that the presence of an experienced CEO like Slootman could enhance market assurance in the company’s ability to operate effectively without a preferential voting arrangement.

“Snowflake’s decision reflects the board and founders’ collective belief in the company’s maturity and its capacity for long-term management with accountable governance for all shareholders,” Aylward explained to TechCrunch. “The board’s complete confidence in Frank Slootman, a three-time, highly successful CEO, is also a significant factor. This transition is also facilitated after the initial lockup period, allowing visibility into share ownership.”

Frederik Groce, a partner at Storm Ventures, suggests the move may be intended to bolster market credibility, particularly given Slootman’s established rapport with the board. “With a CEO and chairman who isn’t a founder, and who is likely effective in the role, there’s a desire to be perceived by the markets as collaboratively establishing the company’s vision and direction alongside the board and executive team,” Groce noted. “This perception might have been hindered by the previous structure.”

The Shifting Landscape of Dual-Class Shares

Within the startup ecosystem, the concept of dual-class shares is widely understood. Typically, preferred shares are allocated to investors, while common stock is distributed to founders and employees. However, the conventional distinction between preferred and common shares often centers on economic rights rather than direct voting authority.

High-growth startups frequently seek to maintain significant founder control through the implementation of differing share classes as they secure subsequent funding rounds. The extent of this control is often determined by negotiating leverage, and in the current founder-centric market, dual-class structures have become increasingly prevalent. But what prompted Snowflake to relinquish this arrangement?

Index Inclusion and Investor Appeal

One contributing factor could be the increased scrutiny from major market indices. For example, the S&P 500 has established a policy of excluding companies with dual-class share structures. This is significant, as inclusion in the S&P 500 is a desirable goal for many companies, and the index serves as a benchmark for numerous ETFs.

Furthermore, abandoning supervoting stock may enhance a company’s attractiveness to a broader range of investors. Capital providers often prefer to invest in companies where they possess a degree of influence. Consider the scenario of venture capitalists investing in startups without securing board representation or a portion of voting rights.

Founder Effectiveness and Governance Challenges

There's also the inherent risk that individuals holding disproportionate voting power through supervoting stock may make suboptimal decisions. While questioning founders is often discouraged in Silicon Valley, it’s crucial to acknowledge that not all founders are suited for indefinite leadership. Many leaders have a peak period of effectiveness within a company’s lifecycle.

Acknowledging these potential advantages, are investors now actively discouraging the granting of enduring voting control to founders? According to Storm’s Groce, each situation is unique, but a trend away from dual-class structures is observable in the companies his firm invests in. This aligns with the precedent set by Snowflake’s recent decision.

“Generally, we’re witnessing a shift away from these dual-class structures due to the unique governance challenges they present – a concern for every venture investor serving on a board. These structures are becoming less common in enterprise software, suggesting that removing them may be beneficial for appearing ‘standard’ to both private and public market investors,” Groce explained.

Differing Perspectives Among Venture Capitalists

However, not all venture capitalists share this perspective. Soma Somasegar, managing director at Madrona Ventures, reports an increase in the use of dual-class shares, particularly in later-stage companies. “Over the past five years, we’ve definitely seen more dual-class shares. It’s uncommon in the early stages; this feature typically emerges during the mid- or later stages of a company’s development,” he stated.

It’s important to note that some seasoned executives are critical of these setups. In his book, “The IPO Playbook,” Steve Cakebread, former CFO of Salesforce and current CFO of Yext, argued that founder control through voting shares can be detrimental to a company’s long-term health. He posited that founders who have already realized financial gains through share sales should relinquish control over the company’s future direction.

• Preferred Shares: Typically held by investors.
• Common Stock: Often distributed to founders and employees.

The Cost of Relinquishing Control

A growing number of rapidly expanding companies are abandoning conventional governance models, potentially to their disadvantage. Should financial difficulties arise, the decision to cede control can carry significant repercussions.

Box provides a compelling example. Following its 2016 IPO at $14, the company’s stock value quickly rose to over $23. Subsequently, it experienced a decline, falling to $10 per share. A report in the Wall Street Journal indicated the company was vulnerable to acquisition, a scenario that a standard governance structure might have facilitated.

The concentration of voting power likely afforded Box a period of stability. However, in 2018, the company opted to eliminate its dual-class share structure. The following year, activist investor Starboard Value acquired a 7.5% stake in the company.

Currently, this investment group is actively seeking to gain control of Box’s board of directors. The presence of dual-class shares could have shielded Box from such external intervention.

Nevertheless, the question arises: should companies be permitted to maintain indefinite protection from external investor influence?

According to Groce, this is a topic deserving of industry-wide consideration. “I believe an ongoing discussion regarding the phasing out of these structures as founders become less involved in the business is worthwhile, especially for publicly traded companies.”

Snowflake’s decision represents their chosen path. While it remains to be seen if other public companies will follow suit, Snowflake currently appears to be an exception rather than a pioneer of this trend.