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Start-ups go public to get your money — your input on how it's spent is now optional

  • A new crackdown on multiple share classes, exemplified by Snap, might seem like a much-needed reset of the trend away from shareholder power.
  • But experts said — at least as things stand now — new rules are unlikely to deter other major technology companies from going public with special treatment for the founders.
  • Fundamentals and valuation, not voting rights or index listings, are still the main mission-critical metrics for investors and founders alike.

Financial watchdogs are trying to force Silicon Valley founders to give investors more control over their companies when they go public.

In the latest case, two index providers have banned Snap shares from their indexes because it sells only shares that give investors no votes, meaning they have zero control.

But experts say that the changes will probably do little to discourage start-up CEOs from demanding, and receiving, special treatment from public market investors.

Snap is the latest extreme example of a trend seen in technology stocks like Facebook and Google, where the companies' founders are able to retain a disproportionate level of control compared to how many shares they have.

A woman wears Snapchat's Spectacles on the floor of the New York Stock Exchange during the company's initial public offering in New York, March 2, 2017.
Brendan McDermid | Reuters
A woman wears Snapchat's Spectacles on the floor of the New York Stock Exchange during the company's initial public offering in New York, March 2, 2017.

Snap's co-founders, CEO Evan Spiegel and chief technology officer Bobby Murphy control "all stockholder decisions," according to regulatory filings, while shares listed on the stock exchange are non-voting stock.

Index providers like S&P Dow Jones and FTSE Russell have grown concerned over this trend, worrying that shareholders in major indexes might not be able to influence the direction of companies in them. Both index providers said they would exclude shares of Snap from major indexes over the issue.

Fundamentals more important than governance

The new crackdown on multiple share classes from FTSE Russell and S&P Dow Jones might seem like a much-needed pump on the brakes.

But it probably won't matter. Despite a rocky start, founders like Spiegel have good reason to be confident that investors will buy into an IPO. Take Facebook, Google and Berkshire Hathaway: All three companies have special share classes and are lauded as wild successes with legendary leaders.

"Each situation is so company-specific that usually companies looking at the IPO market their own situation and their own fundamentals, more so than they're observing every single IPO that goes ahead of them," Myers told CNBC's "Closing Bell" this week. "Governance has a different level of importance for different companies."

David Brown, head of U.S. Equity Capital Markets at Ernst & Young Capital Advisors, said it can be hard for investment bankers that advise IPOs to quantify the risks associated with introducing a special share class. Even with the new rules — which could reduce the level of support for stocks that comes with passive investing — it might not be a clear-enough reason for a founder to relinquish control, Brown said.

"This is the first shoe to drop," said Brown, who declined to comment on any specific company. "If a larger percentage of indices follow them, and then that kind of emboldens current investors to say, 'I need to lower my valuation expectations.' If the bankers and lawyers can then say it does impact value, I think you will see a shift. Right now it's almost a free option, so if they want it why not take it?"

Even if the special treatment of founders does catch up with Snap, the company can always change, according to Kathleen Smith, principal at Renaissance Capital. (Snap declined to comment, citing a quiet period ahead of its quarterly earnings report.)

"We think companies will figure it out," Smith said. "There's no reason why Snap can't hold a vote to change [its share structure]."

Smith also argued that even if they don't stop tech companies from being stingy with voting rights, the stricter requirements at S&P Dow Jones and FTSE Russell are good for the public markets, and send a message to private companies that there's a higher standard for public companies.

"A stock like SNAP should be in the index due to its market cap," said venture capitalist Duncan Davidson of Bullpen Capital. "Future IPO candidates that are index-worthy should adjust their cap structure prior to IPO."

But Smith said that whether the big start-ups decide to go public this year or not has more to do with "excess valuations in the private sector than with the voting structure of shares."

While some of the high-profile companies, like Snap and Blue Apron, have mounted an uneasy transition to the public markets, 2017 has still been a "big and happy" year for a slew of smaller IPOs, said Liz Myers, ‎managing director at JPMorgan. The Renaissance IPO ETF, which tracks recently public companies, is up more than 20 percent year-to-date, and Myers said healthcare and technology companies are generally seeing growth.

"Access to private capital continues to improve every year," Myers said. "But the incremental increase in public companies this year has been significantly greater."

— With reporting by CNBC's Fred Imbert.