We (Didn’t) Work
A Corporate Governance Disaster
By Lyndon Park
The recent debacle that was the We Company’s planned IPO serves as a clear and ominous warning to all potentially aspiring public companies that have operated in the sanctuary of private ownership for many years – be prepared for the scrutiny and standards of the public investment community. And by the way, they aren’t exactly what they used to be.
While financial performance, growth prospects and overall economic opportunity will always be the primary measuring stick for public market investors, the substance and quality of a company’s corporate governance practices are increasingly driving decision making – largely because many public investors believe there is a very clear nexus connecting the quality of a company’s corporate governance and its ability to create value over the long term. The public markets have rapidly evolved and expect emerging companies – be they “unicorns” or not – to operate by a set of standards that they apply to all public companies.
In We’s case, the company was caught off guard by the push-back from prospective investors that refused to accept many of the company’s practices resulting in a reported massive reduction in its expected equity valuation. Not only did the Wall Street rebellion cause the company to make sudden and drastic changes to its governance just prior to its planned offering, but it set off a chain reaction that cost Founder & CEO Adam Neumann his job. It doesn’t get more real than that. Some of the changes included:
- Commitment to appoint a lead independent director
- Commitment to maintain independent-majority board, without membership by the Founder/CEO’s family members
- Decrease Founder/CEO’s super-voting shares from 20 votes-to-1 to 10-to-1 (with his resignation, this ratio declined further to 3-to-1)
- Ban conflicted transactions involving real estate investments
The moves represent an explicit acknowledgment by the company that the “governance discount” was a major driver of the valuation decline.
The Investor Stewardship Group (ISG), founded by powerhouse investors including BlackRock, Vanguard and State Street, established 6 common principles for corporate governance that it applies to all issuers, and which every aspiring issuer would be well-served to review. They are:
Principle 1: Boards are accountable to shareholders.
Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.
Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.
Principle 4: Boards should have a strong, independent leadership structure.
Principle 5: Boards should adopt structures and practices that enhance their effectiveness.
Principle 6: Boards should develop management incentive structures that are aligned with the long-term strategy of the company.
As we can see, We did not live up to these standards, particularly as it relates to proportional voting rights and independent leadership structures. But why did a massive “governance discount” kick in for We’s IPO valuation whereas other loss-making IPO companies also adopted such governance structures? Certainly its lack of profitability, related-party transactions and reports of questionable personal activities by Neumann figured prominently in investors in minds, but it was apparent that the lack of governance enabled these issues in the first place.
In We’s case, the S-1 disclosures make clear that not only will public investors give up their voting rights, the founder-CEO engaged in self-dealing behavior (e.g., receiving loans from the company to buy properties, which he would then lease back to the company) that could also imperil the investors’ economic interests as well.
There are many lessons here for company founders, private equity sponsors and early investors, and IPO advisors, but the overall conclusion is that it is critical to start to think and act like a public company, well in advance of the IPO process. Here are some practical recommendations:
- Begin to treat and assess board members and executives according to Securities Exchange Act Section 16 standards for directors and officers of SEC-reporting public companies
- Set agendas and hold ‘public company’ type board meetings with the help of advisors
- Hold executive sessions with non-executive board members
- Establish a board self-evaluation process
- Hold mock earnings calls and investor meetings to pressure test against scrutiny
- Set up Enterprise Risk Management and controls framework leveraging public company-type protocols (e.g., SOX compliance)
- Adhere to NYSE/Nasdaq listing standards (e.g., NYSE 303a director independence criteria), but also understand the policies and voting histories of key public investors as they are more stringent in requirement than listing standards, which set “bare minimum” thresholds
- Understand how proxy advisors ISS/Glass Lewis will view the governance structures
- Level-set S-1 disclosures against public company disclosure expectations on 10-K and proxy
- The SEC is now expecting disclosure of board’s role in risk oversight of the company per Item 407(h) of Reg S-K, including ESG risks
- Align business overview, corporate mission and risks/opportunities disclosures to avoid contradictions
- Elevate ESG/sustainability materiality knowledge and compliance roadmap to public company standards
- Common frameworks/rating agencies/public investor policies
- Assess related party transactions/conflict of interest policies through the prism of public company requirements and expectations
- Know your (future) shareholders by recognizing that the proxy voting decision makers at many of the largest institutions are not the portfolio managers, but the proxy group analysts> understanding their role is key to success post IPO.
In summary, companies in the process of going public or contemplating the steps should prepare a corporate governance structure and shareholder engagement plan not only for the IPO but for the period of years following the listing.
Lyndon Park is head of governance advisory solutions with ICR, a communications and advisory firm.