My 1st Million At 33 – yes, you can do it too

How many of you know that if/when you buy GOOG Google shares in the publically trading market, you are signing up to be a second class shareholder? I was surprised and disheartened to find this out when I read this article from MarketWatch. In fact, this is true for many companies (some 200 companies to be exact), and GOOG is definitely not the worst “violator”.

What do I mean exactly? It’s the two classes of shares that have different amount of voting power (class A and class B for that matter). With the exception of Berkshire Hathaway (Warren Buffett’s company), Class B shares are not available to public, but insiders and management, while having more voting power, often 10X. Class A shares are the ordinary shares that trade in the stock market for ordinary folks like us, and only has 1X voting power. In Google’s case,

With Class B shares having 10 times the voting power of Class A shares, the three executives together control more than one-third of Google’s voting power. Combined with the shares held by directors and management, the group controls nearly two-thirds of the voting power.

As argued in the MarketWatch article, there may be some few examples like media where this kind of structure makes some sense for maintaining media independence. But power always finds its way to money. And I am afraid that IPO to the stock market is becoming increasingly like an ATM machine for all the founders in these new companies. How does the whole scheme work?

1. Create a great company like Google, and then IPO. Through stock market valuation, your wealth immediately expands by at least 10X since annual profits of the company if valued at P/E ratio of 10 will get a market cap of 10X times the annual earning.
2. But you want to IPO and sell shares, and don’t want to give up controls. So you create two classes of shares with 1X and 10X voting power before or at the time of IPO. For example, if you only own 30% of the company, you can have 3% in class B, and 27% in class A. Selling off 27% of the company makes you immediately rich. And yet you still retain about 30% voting power.
3. Why not 50% or more voting power? You don’t want to be too controversial or too obvious to be appearing as greedy. You can partner with another founder, and/or people close to the top. With voting power over 50% or close to 50%, now you can make an ATM machine out of the stock market.
4. Since you are either the CEO, CTO, chairman, or essentially an employee of the “public” company, you will be granting stock options or restricted stock shares to yourself. How much stock option? Well, as much as you want to, since you plus all the people who have B shares can pretty much override any shareholders’ votes.
5. Since you have an unlimited supply of stock options of your own company (through step #4), you never need to hold your stock options for more gains. Just sell them whenever volatility of the stock offers you some gain.
6. Selling your stock options are also a great source of positive cashflow into your own company. For every share of stock option, the company gets the price paid for the strike price, and you get the rest. And of course, one invisible shareholder pays for those with his or her hard-earned cash.
7. If there are problems with share dilution through such process, your company can buyback the shares you sold. Essentially earnings of the company can be recycled through buyback programs into your own pocket. Suppose for every share of stock option that you sold, your company buys it back to create zero dilution, you will pocket all the option gain, while the earning of the company is effectively funneled into your pocket. Totally legal money laundering.

Now, if you are truly aggressive, you can grant or authorize large amount of additional shares of your company at a single time. For example, if you start with owning 12% of the company, with 2% class A, and 10% class B shares (10X voting power), with the rest of 88% sold to public and trading as class A share, your voting power is 100% + 2% divided by (88% + 100%+2%) = 53.7%, enough to always vote the things in the way you wanted. Now, if you just continually grants yourself options of some 10% additional of the company. After 10 years if you haven’t sold anything, you will have 10 years * 10% + 2% class A share + 10% class B shares out of a total of 200%, basically taking back 50% of your own company again after you IPO and sold off 88% of your own company.

How do I know this? Because I’ve seen at least one of those 200 companies (not Google, yet?) in action that did something similar to what I just described, except with different percentage numbers and number of years.

There is a saying: power tends to corrupt, and absolute power corrupts absolutely. I don’t know about you, but if I have an ATM machine that I can constantly withdraw cash without any deposit, I will almost definitely take good advantage of it. Won’t you? Certainly, I would appear to have some stake in my own company, but I don’t need it to be more than 50% to raise eyebrows, since I would have already more than 50% of the voting power.

I think this is the most pure form of greed if it is all acted out. Sadly our stock market system allows it. How can there be two classes of shareholders is really beyond me.