Why Don’t Companies Issue Non-Voting Stock To Employees / Investors?

Question: A founder who plans to take several rounds of dilution (Seed, Series A, etc.) and to have a decent sized employee option pool has to plan carefully if he/she also wants to retain control. But equity and control are not the same thing. They can be separated by issuing non-voting shares to employees and perhaps to early friends/family and even seed investors. This seems like a sensible option. It doesn’t divest control to those who are less likely interested in it, and makes it possible for the founder to be far more generous in allocating equity/upside. Why is this not more common? Did the Google founders do something along these lines?

Our Take: Few companies do this. To my knowledge, neither did Google. There are a number of reasons why companies don’t issue non-voting stock. First, despite the small amount of equity in each employee’s hands, it’s well accepted that employees like voting stock. Why, you ask if their vote isn’t material in the grand scheme of things? Probably because everyone else they know has voting stock and therefore they want the same. In short, it’s the regular practice and people like to have what others have. An employee offered non-voting stock is basically being told “we don’t trust you.”

Second, Investors are going to want to have a voice in company decisions and therefore are going to want to have voting stock. I don’t know anyone willing to write a check that doesn’t want some control over the company and this usually comes in different forms, from board rights to voting stock, to preferential stock rights, etc.

Third, if I was dealing with a founder who was really caught up in keeping control and only offering non-voting stock, I’d at least pause and wonder what was going on. The fact is few founders have greater than 50% of the equity at the time a company is sold or goes public and I’d want to explore exactly what that founder had in mind. It would strike me as a “red flag.”

Lastly, keep in mind that some founders don’t stay with a company indefinitely. Let’s take the case of a company with 3 founders who only issue non-voting stock to angel investors and employees. Let’s assume that the founders each own 20%, the angels 20% and a 20% employee pool is created. Each founder has 33% of the voting control since none of the angel stock or employee stock can vote. If two founders leave, the remaining founder, the angels and the employees are stakeholders in a company that they have no control over. If everyone had voting stock, there would be 60% of the capital stock in the hands of folks still with the company (assuming the option pool is granted). Worst case, there would be a 40% stalemate. What might seem like a good idea day one, can have some perverse effects later down the road.

  • Jason–there’s another reason that companies with California connections, either by incorporation or operations, don’t issue employees non-voting stock under option plans. Under California’s corporations code, common stock underlying employee options needs to carry equal voting rights. See 25102(o), 260.140.41 and 260.140.1. (Actually, it somewhat unhelpfully says “should normally carry equal voting rights”)
    And, Google went almost the opposite route–it issued “light voting” stock to the public. That is, stock issued in the IPO carried one vote per share, and the existing common, plus that issued on conversion of preferred, carried 10 votes per share. So there was an effort to retain control even while issuing equity to the public. Not an uncommon structure, particularly with media companies, I think.