Shopify restructuring boosts Lutke’s power rather than curtailing it

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At first blush, the proposed restructuring at Shopify SHOP-T looks warm and fuzzy: Founder Tobias Lutke is accepting some restrictions on his stock ownership in exchange for a “founder share” that locks in his voting power at the company. For longer-term shareholders who’ve recorded remarkable gains on Shopify stock, it looks like everybody wins.

A dive into the documents, however, suggests that not all is so sanguine.

Shopify is actually hurtling toward triggering a corporate bylaw that would completely eliminate the company’s dual-class structure and Mr. Lutke’s special rights, turning it into a true shareholder democracy. The proposed changes, however, would enshrine 41-year-old Mr. Lutke as leader-for-life. Shopify stockholders should strongly consider voting “no” to this plan to cement the founder’s control.

Here are some of the facts, much of which can only be extracted via a deep read of the company’s recently filed proxy circular for the June shareholders’ meeting.

Shopify has two classes of shares. There are more than 114 million class A shares that you can buy on the Toronto and New York stock exchanges, which get one vote apiece on most corporate matters. And there’s just under 12 million class B shares, held by the early owners of privately held Shopify. They get 10 votes apiece.

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When Shopify went public in 2015, class B shares represented 88.3 per cent of the total outstanding shares, and Mr. Lutke held just 14.6 per cent of the class B. Combined with his class A shares, his total voting power at the initial public offering was 14.5 per cent, Shopify says.

Since then, a couple of things have happened. One is that a number of early class B shareholders have converted their stock to class A, the only way to cash out some or all of their holdings. And the other is that Shopify has issued tens of millions of class A shares for acquisitions and to settle employee stock options.

Today, Mr. Lutke owns just under two-thirds of the class B shares, and the company estimates his voting power at 33.8 per cent. The class B shares are now just 9.5 per cent of total shares outstanding.

That final fact is important. As currently provided in the company’s articles of incorporation, once the number of outstanding class B multiple voting shares represents less than 5 per cent of the total outstanding, all the class B shares automatically convert into the single-vote class A shares. That ends the dual-class, multi-voting structure.

And Shopify was at real risk of that in the medium term. Indeed, the proxy circular shows that more than a year ago, Shopify’s board began discussing the ramifications of continuing to issue shares for acquisitions and for stock options, ultimately triggering the end of the current structure.

The provision also makes it difficult for 71-year-old director John Phillips to sell a meaningful amount of his 3.75 million class B shares without further restricting Shopify’s ability to issue shares. The more B shares he converts to A for sales purposes, the closer Shopify comes to a forced B-to-A conversion.

The company’s board, most of whom have been with Shopify and Mr. Lutke since its IPO, clearly didn’t want that to happen. In a letter that leads off the proxy, the board special committee that recommends the new plan refers to Mr. Lutke as “a proven leader who has delivered significant shareholder value.”

In the negotiations between the board and Mr. Lutke, described at length in the proxy circular, the board seemed very concerned about the possibility that Mr. Lutke or other class B holders would pass the shares to family members along with the special super-voting rights. And who can blame them? If that happened, a founder’s child, deemed insufficiently competent to run the company, could suddenly and shockingly fire a long-term, successful CEO. Hypothetically, of course.

As part of the proposal, the board has removed Mr. Lutke’s ability to transfer super-voting shares to his children, but this came at a high price.

Once the negotiations centred around the concept of a single, mega-voting “founder share,” the committee suggested locking in the voting power at 34 per cent – about where it is now – and setting to-be-determined limits on the amount of class B shares Mr. Lutke could sell annually. If he sold more than half his stock in the aggregate, the company would terminate the founder’s share. (Mr. Lutke sold $623-million of stock in 2021; his remaining stake is worth more than US$5-billion.)

Mr. Lutke, however, rejected any annual limits on his stock sales, wanted to sell up to 80 per cent of his holdings without losing the special voting power and counteroffered that the founder’s share get 45 per cent of the votes.

The final agreement came closer to Mr. Lutke’s desires than the board’s: There are no annual stock-sale limits; Mr. Lutke can sell up to 70 per cent of his class B shares; and the founder’s share will be worth 40 per cent of the Shopify votes. That’s more power than Mr. Lutke has ever had since Shopify went public. The founder’s share will exist after Mr. Lutke leaves the company, so long as Shopify is his “primary engagement” as a consultant.

As long as he is sentient, he essentially controls the company. And many folks will think that’s just fine: Even with a remarkable decline – Shopify stock has dropped 67 per cent since its high in November – the shares have delivered tremendous value to shareholders, up 3,300 per cent from their IPO price.

The proposal before shareholders this June, however, does the opposite of what some think: It would entrench a dual-class, multiple-vote system that was set to disappear in the coming years. There have always been plenty of these structures in Canada, and their advocates continue to argue they promote long-termism that delivers superior shareholder value. But a company can produce superior returns until one day it does not. Then, its limited voting rights that did not matter suddenly do – and shareholders can be left wishing they could keep the business and discard the folks running it.

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