Monday 22/07/2019

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Snapchat flouts shareholder democracy

Responsible Investment Strategist

How should we look at governance practices when it comes to companies that advocate innovation and creativity? Let’s focus on the situation with Snapchat, a company that innovated by scrapping all shareholder voting rights when it went public in March of this year.

Key takeaways:

  • Snapchat’s IPO is not compliant with a number of best practices regarding corporate governance.
  • Eliminating shareholder voting rights is not easily defendable and has prompted a debate on respecting shareholder democracy.
  • The makeup and quality of the board of directors is not compliant with best practices with regard to independence, and they reinforce the absolute hold the founders have over the company.
  • Apparently, no member of the board of directors has any specific skills relating to cyber security. And yet, protecting personal data is a key challenge in the sector.

Quite often, founders of technology companies want to retain control over the company they founded. For instance, when they went public, Facebook and Google also issued multiple classes of shares. Nevertheless, they had still granted voting rights to the public shares, in contrast with Snapchat, which has simply eliminated all voting rights for its shareholders. The innovative start-up’s IPO has led to much debate on the respect of shareholder democracy.

What are the consequences?

For listed companies, shareholders have the right at shareholder meetings to appoint and dismiss the board of directors, which is responsible for defining corporate strategy and for its implementation by the management committee. When this right is abolished, shareholder democracy is violated as shareholders no longer have any say about the board, and they may not file any shareholder resolutions about other topics they consider important. In other words: they have nothing to say.

Absolute power to the founders

Snapchat’s two co-founders are keeping full control over their company by retaining 89% of the voting rights, meaning that it in actual fact remains a private company. Hence, the co-founders have full discretion over the appointment, resignation and replacement of directors, decisions regarding M&A, capital increases, consolidation and the partial or full sale of corporate assets.

Broadly speaking, to remain at the vanguard of technological innovation, attracting and retaining top-level engineers and software developers is critical to Snapchat. Its co-founders understand this quite well, and want to make sure key staff members participate in the company’s capital. Moreover, executives also receive bonuses and other regular incentives. However, the CEO being present on the remuneration committee once again violates best practices with regard to the independence of this committee, thereby further reinforcing the hold the co-founders have over the company.

Ensuring proper checks and balances

When shareholders are unable to speak up, the composition and quality of the board of directors are key to ensuring that there are checks and balances on management’s decisions. Nevertheless, Snapchat’s board currently has nine members, seven of whom are considered independent. Independence is a touchy issue here as the mandate of these directors is entirely dependent on the voting rights held by the two co-founders, whose capabilities may be questioned as well. After all, only one director is said to have experience in the industry, and two of them are said to have financial know-how.

What about data protection?

According to company disclosure, no director in the company has any specific skills relating to cyber security. Nevertheless, protecting personal data is a key challenge in the sector, especially as Snapchat wishes to further develop data storage in markets where regulatory risks in terms of personal data protection are mounting. In an update of Snapchat’s Terms of Services in October 2015, the company reserves the right to reproduce, modify, republish and save pictures of users posted in ‘live story’. The revision of these terms and conditions has already generated many complaints from users, or at least from the ones who have carefully read the terms and conditions for their apps.

Conflicts of interest

In addition to the imperfect balance of power and sub-par checks and balances, which are key themes in corporate governance, we should also look into possible conflicts of interest between the company and its founders. Although relatively common when launching start-ups, it must be noted that the company has granted loans to its two co-founders. However, the two loans that were taken out in August 2014 and February 2016 were repaid in full in September 2016.

Reconciling innovation and governance best practices

It cannot be disputed that Snapchat’s IPO is not compliant with a number of best practices regarding corporate governance: independence and expertise of the board of directors, effectiveness of internal controls, checks and balances to curtail the powers of a few omnipotent shareholders, etc. Although its start-up status accounts for the flaws in the structures and the flat hierarchy with two powerful founders in charge, one has a difficult time accepting that the democratic rights of minority shareholders are being massively violated.

Snapchat is, moreover, clearly the type of business that will be successful in the years to come. Yet it is still unclear how the company will reconcile the flexibility which is required for its dynamic business model with corporate governance principles. After all, investors and civil society are paying ever-greater attention to such aspects.

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