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Corporation Classes of Stock, Control, and Money: Lessons From Facebook

On July 26, 2018, Facebook, Inc. lost nearly $120 billion in market capitalization value as stock prices plunged more than 19%. According to news reports, that was the largest total single-day drop in market value ever recorded. See here. As a result, activist investors have intensified their efforts to force a change in the governance structure of Facebook. These efforts have been ongoing for several years. See here.

Activists and institutional investors have complained that Facebook’s control structure and various classes of stock prevent the board of directors from truly managing the company. In particular, the activists argue that the stock structure prevents the board from removing Mark Zuckerberg, one of the founders of Facebook, who serves as the board chairman and also as Chief Executive Officer (“CEO”). The huge drop in stock value will spur efforts to remove Zuckerberg, but, as discussed herein, those efforts will likely fail.

Facebook’s corporate structure provides an interesting example for San Diego corporations of how control and economic value can be separated by classes of stock. This has advantages for closely held family businesses and can be a valuable tool in estate and business succession planning.

San Diego Corporate Law: Facebook’s Corporate Structure

Facebook “went public” in 2013, which means that it made its stock shares available for sale to the general public by being listed on a national stock exchange. Like many large tech companies, from the start, Facebook was structured with two classes of stock — Class A and Class B. The different classes of stock had and continue to have different voting strengths. Class A shares were set at one-vote-per-share while Class B shares were set at 10-votes-per-share. Since the founders of Facebook, like Zuckerberg, held most of the Class B shares, this dual class voting system allowed Zuckerberg to maintain control of Facebook even while his share of the economic value of the company became diluted. See discussion here.

Further, in 2016, the board of directors — essentially Zuckerberg — approved the creation and issuance of a third class of stock — Class C — which were issued as non-voting shares. The Class C shares were issued to existing shareholders as dividends on a 3-to-1 basis. That is, each holder of one Class A and/or Class B shares were issued two shares of Class C stock. The new Class C stock was given its own separate listing on the stock exchange. This did not change the total market value of Facebook or the total value of stock held by any given stockholder. However, the creation of a new non-voting class of stock further increased the concentration of control held by Facebook insiders and founders. This was done partly because Zuckerberg had promised publicly to donate his Facebook shares to charity. However, while willing to donate economic value to charity, Zuckerberg was not — and is not — willing to donate control over the company to charities. Creating a class of non-voting shares allowed Zuckerberg to accomplish this charitable purpose without losing control of Facebook.

As a result of the classes of stock, as of early July 2018, it was reported that Zuckerberg controlled over 52% of the voting stock but held only 14.36% of the economic value of Facebook shares. Consequently, Zuckerberg controls the vote on who becomes a director, which means that Zuckerberg controls the company. Zuckerberg’s board has elected him Chair of the board and has also hired him as the Chief Executive Officer. Activists and critics of Facebook have argued that Zuckerberg’s dual role violates their vision of proper corporate governance — the board is the “boss” and the CEO should be the “employee.” However, there are plenty of counter-arguments supporting Zuckerberg’s dual role.

As can be seen, efforts to oust Zuckerberg are very likely to fail. Zuckerberg owns a majority of the voting shares and there is no indication that he is going to give up control.

Contact San Diego Corporate Law

If you would like more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a full panoply of legal services for San Diego and California businesses. Mr. Leonard can provide advice and counsel on starting up a new business, with respect to forming a new corporate entity, assist with corporate formalities, and can help review and draft business contracts. Mr. Leonard can be reached at (858) 483-9200 or via email.