In praise of dual-class stock structures for public companies

A dual-class stock structure means that a company has two different classes of common stock. Each class of stock has the same economic ownership of the company, yet different voting rights.

In a typical scenario, Class A shares have a single vote per share, whereas Class B shares have 10 votes per share, for any shareholder vote.

Using this mechanism, for example, the Class B shareholders might only own 20% of the company in economic terms but have a clear majority voting position relative to the Class A shareholders.

In short, Class A shareholders have shares labeled with the earlier letter in the alphabet, but Class B shareholders control the company — in stark contrast to the more normal single-class stock structure which is more classically democratic: “one share, one vote”. Since Class B shareholders will typically be some set of founding management or founding investors in the company, in practice the presence of a dual-class stock structure means that the founders control the company and can overrule all other shareholders on a wide range of issues, including if and when to sell the company.

Both public and private companies can have dual-class stock structures, but the controversy around dual-class stock structures is usually confined to public companies, due to the presence of public shareholders. And so I will focus purely on public companies.

I used to be an absolutist against dual-class stock structures — I used to believe that dual-class stock structures were obviously a bad idea, that the democratic single-class approach of “one share, one vote” was more fair to public investors and more likely to lead to a healthy company in the long run, since total founder control of a public company can allow the founders to overrule normal market forces and the interests of their public shareholders.

And in fact, practically all investor advocates and shareholder activists agree with that stance — dual-class stock structures are at the top of the list of techniques that entrenched managers can use to foil the normal market discipline of a public stock, and to frustrate outside public shareholders who can easily become disenfranchised even when they have majority ownership of a company… with a long-run outcome similar to the kind of insularity and inbreeding you find in royal families. These days, the New York Times Company has of course become the poster child for entrenched bad management operating against the interests of their public shareholders due to its dual-class stock structure — how could anyone possibly be in favor of that?

And on the face of it, a dual-class stock structure simply seems unfair — how can someone own part of something but have a tenth of the rights of someone else who owns the same amount?

After 15 years in the technology industry, though, I have done a complete 180-degree turn on the topic — with some caveats.

I come not to bury dual-class stock structures, but to praise them.

I now believe that dual-class stock structures are a great idea for a technology company that is in the process of going public, under the following conditions:

  • The key leaders of the company — typically the founders — who will own the controlling Class B shares, are also major economic shareholders in the company. They own a significant portion of the company and are therefore highly incented to maximize the value of the company over time.
  • The key leaders of the company who own the controlling Class B shares have a long-term goal of building a major franchise, and the commitment required to execute against that goal.
  • The controlling Class B shareholders have a commitment to treat Class A shareholders fairly and equally in all respects other than voting power.
  • All public shareholders understand what they are getting into up front — no bait and switch.

The key to the whole thing is shared goals — particularly the shared goal of long-term value creation, particularly the creation of a long-term franchise, the kind of franchise that can require 10 years or longer to build.

With such goals, I now believe the interests of public shareholders will often be better served by ceding voting control to the founders and key leaders of the company.

This is a provocative statement, so let me back it up.

In practice, the world at large, the markets in which companies operate, and Wall Street in particular, throw up all kinds of short- and medium-term noise in the face of every public company, all the time.

And in fact, my sense is that the level of such noise is steadily increasing for about a dozen different reasons, including but not limited to the proliferation of hedge funds, buyout funds, arbitrage funds, corporate raiders, shareholder activists, shareholder representation firms like ISS, sell-side analysts, cable television financial news, financial web sites, Internet message boards, online stock trading, increased consumer interest in stocks and markets, and visibly shortening investor time horizons across the entire landscape.

When you are running a public company, here are some of the things that get routinely thrown at you that have practically nothing to do with building a long-term franchise:

  • Stock market booms and busts — the stock market is bipolar; it doesn’t matter what finance academics say about efficient markets, everyone knows greed and fear whipsaw the market around all the time.
  • Economic booms and busts — e.g. this ridiculous credit crisis and real estate fiasco. Modern economies are apparently characterized by one self-inflicted crisis after another. And even when you’re not directly affected by a particular crisis, if you’re running a public company, you’re probably going to be indirectly affected, often for no good reason aside from the universe’s desire to inflict collateral damage.
  • Hedge funds aggressively short-term buying and shorting stocks for the quick pop, and often spreading malicious and untrue rumors along the way. I’m no Patrick Byrne, but every CEO of a public company regularly contends with just silly rumors all the time that are obviously being spread by someone talking their book, or rather lying their book — and SEC oversight of such market manipulation is almost completely absent.
  • Leveraged buyout funds that make apparently attractive buyout offers financed with massive amounts of debt, and then strip-mine the company for fees and dividends before sending it back out into the public markets weaker than before. These guys are wonderfully skilled at paying themselves; on average, their franchise-building skills are questionable at best.
  • Corporate raiders of various stripes. I’ll certainly grant that corporate raiders as a category have probably been good for capitalism as compared to the clubby Fortune 500 status quo of the 1970’s, but when a raider gets his hooks into your public company, he’s only in it for the quick pop, and he’ll agitate to get it acquired as fast as possible.
  • Hostile takeovers — which may provide a quick payoff to current investors but which definitively bring to an end any opportunity to build a long-term franchise.
  • The intense quarterly earnings guessing game that you end up playing even if you don’t want to — even if you refuse to issue guidance, and perhaps especially if you refuse to issue guidance, in which case Wall Street just goes ahead and sets expectations for you without consulting you. The vertiginous stock drop that follows “missing your numbers” can actually damage your company — you wouldn’t believe how many customers check Yahoo Finance before each sales call.
  • Financial journalists — who can be outstanding writers with journalism degrees from the best schools, and in many cases know almost nothing about the companies they are covering or the products those companies make, which does not keep them from writing all kinds of nonsense. High-quality business journalism is distinctly the exception, not the rule; every CEO knows it, and the noise from inaccurate bad press can again actually damage your company.
  • And then, finally, pure good old fashioned company-specific fluctuations — sometimes things are going well, sometimes they’re going poorly. If you’re building a franchise, that’s OK, and even to be expected; you just need to power through the rough patch. However, if you’re subject to short-term market demands, a rough patch can kill your dreams amazingly quickly.

All of these things can meaningfully interfere with long-term value creation, particularly if you are trying to build a long-term franchise.

The huge advantage of a dual-class stock structure is that it lets the company’s core management simply ignore most of this stuff and stay focused on the long-term goal.

What’s the ideal situation for a public shareholder with a long-term time horizon? To invest in a company whose leaders are highly motivated to build long-term value — to grow the value of the company 10x or 100x or 1,000x — not flip it to the first interested acquirer for a quick pop, or even the fifth, or the tenth. And therefore to invest in a company whose leaders have the ability to pursue building for the long term, versus getting constantly compromised by short-term market noise.

At this point, if you listen closely, you can hear the howls of outrage. They are saying, how can shareholders expect to countenance being effectively powerless?

And of course the answer is alignment of goals.

Investors that have short-term goals, or even medium-term goals, shouldn’t invest in public companies with dual-class stock structures. Remember, I’m presuming no bait and switch. You are always free to not invest in any company for any reason, including this reason.

But, if you’re an investor with a long-term time horizon, you will, I believe, be best served investing in companies with a similar long-term time horizon.

The best part of taking this position is that I get to roll out the big gun: Warren Buffett similarly advocates dual-class stock structures for precisely this reason, and puts his money where his mouth is — he famously has been a long-term investor in the Washington Post Company, for example, which has a dual-class stock structure that gives the Graham family total control, and which has been a stellar long-term investment for Berkshire Hathaway.

Now, dual-class stock structures have been customary in the media industry for a long time, but are relatively new to the technology industry. The most prominent example of a public technology company with a dual-class stock structure is of course Google, whose structure puts total voting control of the company in the hands of Larry Page, Sergey Brin, and Eric Schmidt. Corresponding to that, Larry, Sergey, and Eric have made a 20-year commitment to Google, and are clearly pursuing the goal of building a long-term franchise.

As far as I can tell, shareholders haven’t exactly been scared off from investing in Google as a result.

If anything — and I haven’t done a statistical analysis of this, but just look at the charts and the stock prices of this decade — Google may actually be getting a premium in the market due to its dual-class share structure, as investors are able to make a clean bet on long-term value creation, and they know that the core team can just put their heads down and power through any short-term nonsense.

I think Google has changed the rules on this topic — I think many technology companies, certainly the ones with high potential, that go public over the next decade will have dual-class stock structures, due in part to the Google precedent.

On to some practical questions:

Don’t companies with dual-class stock structures risk limiting their access to capital if they are only attracting long-term investors?

Perhaps, but again, Google is a clear counterexample. You can hardly say it’s been starved for capital.

More generally, I would say that this question reflects the fact that companies with dual-class stock structures are still subject to market discipline. If the market overall doesn’t like the dual-stock structure, it can refuse to provide capital to those companies, and instead provide that capital to companies with shorter-term objectives and more outside shareholder control. But I don’t predict that will happen, and I would be willing to bet my own company on that.

Viewed systemically, dual-class stock structures are an alternative governance model that can compete in the open market for capital with other governance models. Capital will flow appropriately. All is good.

How would you apply this to the drama unfolding around Microsoft and Yahoo?

Well, clearly, if Jerry Yang and David Filo had dual-class-powered voting control of Yahoo, the whole situation there would be playing out very differently.

Microsoft would have been forced to negotiate a purely friendly deal from the very start, and at a price that would have caught Jerry and David’s attention from the start. Hostile threats would have been meaningless. Had a deal gone down, it would have been on Jerry and David’s terms, and the premium might have been even higher than a normal process would generate, since Jerry and David would have had the perfect walkaway option: we’re not selling, and there is no appeal — pay up or shut up. And the company could have been entirely focused on current operations the whole time — no distraction.

But what about the outside shareholders? Several of Yahoo’s largest outside shareholders — including one who owns 16% of the company, four times the amount Jerry himself owns — are in the national press tonight saying, we are furious Yahoo didn’t sell for $34/share when Microsoft was already offering $33/share.

The obvious answer: in the alternate scenario with a dual-stock structure and founder control, those outside shareholders would not have invested in Yahoo in the first place, unless they believed Yahoo had a valid plan for long-term value creation and building a franchise.

If, in that alternate scenario, investors didn’t believe Yahoo had a valid plan for long-term value creation, then that’s another matter. There would be no excuse for that. But that would be a very different problem that would apply regardless of stock structure.

In point of fact, many of Yahoo’s largest shareholders today are also, or have been in the past, major Google shareholders. Clearly Google’s dual-class structure didn’t scare them or their peers off at any point I could see — instead, Google shareholders seem delighted to be aligned with a core team that has the control to execute a long-term plan.

And here’s the kicker: it’s not like outside shareholders in Yahoo, even though they own over 70% economic and voting control in the company, can just make the company do whatever they want — as you can see from all their frustration in the press tonight. Sure, the outside shareholders as a group will ultimately get whatever they want, up to and including a sale to Microsoft, but they may have to put up a significant fight to do so, and that fight may require a significant amount of time and effort, with significant opportunity cost. And along the way, the process has been and will be characterized by confusion, ambiguity, and uncertainty. The whole thing is clearly a massive distraction to any form of long-term value creation to the point where even Microsoft believes Yahoo is risking damaging its long-term prospects by reacting to Microsoft’s hostile public bid. So it’s hard for me to see how a single-class share structure is nirvana for anyone in a situation like this.

So what about the New York Times Company?

Well, it is true that the New York Times Company and similar failing newspaper companies — most of them, except for the Washington Post Company with its superior diversification — with dual-class stock structures are not exactly good investments today, since their entrenched management teams can fight off shareholder activists and hostile takeovers indefinitely while riding their declining franchises straight into the ground.

But on the other hand, it’s not like you couldn’t have seen it coming. Every investor in any declining dual-stock media company today knew they were buying into that stock structure and did it with their eyes open. And any investor still holding stock in such a company has been aware of the Internet for 15 years and has been able to track the performance of the company’s management team in dealing with the Internet over that entire time. Certainly it’s possible to be delusional about your investment and think that recovery is right around the corner, but you can’t blame the stock structure for that delusion.

And remember, the New York Times Company had its dual-class stock structure for decades, and for much of that time, ordinary investors would have done very well to own its shares. It just so happens that the wrenching technology shift that is causing so much trouble coincided with a generation of managers who are unprepared to deal with it. That’s life.

So I think the fate of the dual-stock media companies has a lot more to do with the “media company” part of it and a lot less to do with the “dual-stock” part of it. The only investors mad about the dual-stock part — well, the non-delusional ones — are the ones who want the short-term stock pop from a sale to Rupert Murdoch. And those are not the investors you want if you are trying to build a franchise.

What’s your recommendation to technology companies that are going public?

Strongly consider implementing a dual-class stock structure, but only under the following conditions:

  • The founders are committed to run the company for the long term and want to build a real franchise.
  • The founders are also major economic owners of the company.
  • The founders have an absolute commitment to treat all other shareholders fairly, and to consider themselves entirely in the same boat economically.
  • All public shareholders starting with the IPO know exactly what they are getting into — no bait and switch.

Under these conditions, a dual-class stock structure is not only an outstanding idea — I think, for our industry, it may be the future.

Ning news: Series D investment round

We recently filed an SEC-mandated Form D for a new Ning investment round that we were not otherwise going to talk about — but VentureBeat discovered the filing and so the news is out.

The specifics are:

  • We have raised about $60 million net in a private Series D equity round.

  • The pre-money valuation was $500 million, making the post-money valuation about $560 million.

  • Our friends at Allen & Company helped us orchestrate the round.

  • The new investors are large institutions who are not particularly looking for publicity.

  • We raised the money to enable us to keep scaling given our accelerating growth (over 230,000 networks on Ning now, growing at over 1,000 per day) and to make sure we have plenty of firepower to survive the oncoming nuclear winter. At current growth rates, we don’t need it to get to cash flow positive, but having lived through the last crunch, it’s good to be conservative with these things.

 

Why you cannot believe banks’ audited financial statements

From the Financial Times:

Rules regarding how banks account for off-balance sheet interests are “irretrievably broken”, a senior group of international rulemakers has warned.

The rules, which have allowed trillions [note the “t” — not “m” or “b” but “t”] in assets to escape close scrutiny, have come under attack in the wake of the credit crisis as banks have been forced to disclose huge losses on these holdings.

But a report by a high-level group of accountants has warned that completion of the current overhaul of the rules would not be possible in the near future.

“Completing a final standard by mid-2011 will be extremely difficult, perhaps impossible,” says the report seen by the Financial Times and prepared by board members of the US-based Financial Accounting Standards Board and the International Accounting Standards Board.

While the report does not yet represent the official view of the accounting bodies, it is a sign of the turmoil within the industry in grappling with the off-balance sheet issue. [By “grappling”, they mean, “Holy s—, are we in trouble now.”]

Accounting standard setters are already under pressure for their support of marking assets to current market prices – a practice that has resulted in billions in writedowns and affected banks’ profitability seriously. [That’s not the issue with mark-to-market — the issue with mark-to-market is that it leads to a death spiral by which new downward marks lead to loan calls and fund redemptions which lead to panic selling which leads to new downward marks which leads to… you guessed it, banks’ off-balance-sheet entities going kablooey and suddenly showing up at the door like your unwanted uncle.]

The Financial Stability [ha!] Forum, a global body of regulators and central bankers, has asked the IASB and its US counterpart to consider the issue as a matter of urgency. Accounting standard setters are in the throes of discussing how to respond.

However, the report by the high-level group of accountants says the project to overhaul current rules on off-balance sheet interests has lost momentum because of staff turnover and “relative inexperience”.

Remember Enron?

Imagine Enron times a hundred.

This just gives me an excuse, after hyperventilating, to roll out one of my favorite New Yorker cartoons…

[Cartoon omitted] – Link here

Birth of Newspapers, part 1: The very first newspaper

Over the course of the next several months, I will walk through many of the interesting aspects of the creation of several of today’s major forms of media — including newspapers, magazines, television, movies, and books.

My motivation is threefold:

  • First, the true history of these forms of media is inevitably more fascinating, more amazing, and often more humorous than you would think.

    The idea of a newspaper, or a movie, or a television show, was not handed down on stone tablets from Mount Olympus and simply carried forward by people who said, “Oh yeah, great idea!”; rather, the forms of media we see today are in all cases the result of a mad and chaotic frenzy of experimentation, uncertainty, and enterpreneurial effort.

  • Second, understanding the drama, flux, and change that invariably accompanied the creation of traditional media will help put our current Internet revolution into perspective.

    All early forms of media had lots of people who suffered from doubt, were skeptical, were dismissive, or just didn’t get it — and in fact there were a lot of dead ends and failures from a lot of innovators before the true form of any medium and its business foundation became clear.

    But all of that doubt, skepticism, criticism, and failure were in each case accompanied by enormous social, cultural, political, and business transformations when things did finally become clear.

  • Third, understanding the flux and drama of the creation of traditional media, I believe, highlights the nature of the profound challenges facing today’s managers of traditional media companies.

    I think a lot of smart people are working very hard to transition traditional forms of media into the new Internet world order, but I also think their challenges are even more serious and dangerous than most people believe, and that today’s media companies’ primary strategy of defense is very challenging when the world shifts hard on its axis, as it has done in the past and as it is doing now.

Let’s start with newspapers. My source for this and several subsequent posts is Eric Burns’ outstanding book Infamous Scribblers: The Founding Fathers and the Rowdy Beginnings of American Journalism, which focuses on the role of newspapers during the American Revolution, but also covers the creation of the newspaper medium up to that point.

The world’s first [newspaper] seems to have been the work of a “Renaissance blackmailer and pornographer”…

And we’re off with a bang!

…the Italian Pietro Aretino, who set up shop [in the early 1500’s] a few years after the invention of movable type.

Now that’s an entrepreneur.

Aretino could have done something constructive with his little publication. He could have written about Florence under the Medicis becoming the center of art and humanism in the Western world. He could have written about the founding of the University of Palermo, which would soon be a major institution for the advancement of learning…

Aretino did none of this.

Instead, he “produced a regular series of [anti-religious] obscenities, libelous stories, public accusations, and personal opinion”. The opinion was boldly, and often vulgarly, expressed. It was also for sale, with Aretino running a kind of protection racket on those who were the subjects of his stories: pay what he asked and he praised you; refuse and you were slathered with abuse.

No comment from me on whether that practice continues in certain circles today. Nope, no comment…

Either way, you were a commodity for him; he would tell the tale that suited him best and profit from you as much as he could.

Still no comment.

But few people in Renaissance Italy read Aretino’s rag, and it did not stay in business long.

Few people read the British broadsides [single-sided newspapers] of the early 17th century [either]; they, too, were ephemeral in duration and impact.

It was not that Europeans disliked these nascent attempts at journalism; more fundamentally, they did not understand the reason for them, living as they did in a world in which news could not thrive as a commodity because it barely existed as a concept.

How could it? The Almighty was what mattered to men and women in ages past, but they could speak to Him directly. Their families were what mattered to them, but husbands and wives and sons and daughters lived in the same room. Their livelihood was what mattered to them, but they tended their shops or worked their fields from dawn until sunset…

…What mattered to a person in the 16th and early 17th centuries was what happened to him and to those closest to him between one sunrise and the next… but he could see that for himself. He could interpret it for himself. No intermediary was required to give voice or meaning to the events in his life.

As for the events that were not in his life, those that occurred in the lives of other people in other places, of what possible interest could they be to him? The idea that a human being could be instructed or amused by the fortunes of a stranger was as foreign to a European back then as a land across the sea. The world outside one’s immediate ken was a place of mystery, not a source of enlightenment.

Right there we get a foreshadowing of what was about to happen… the rise of newspapers, among the other early communication and information networks such as postal systems, was driven by and drove major transformations in the basic concepts of society and culture.

Don’t let anyone ever tell you that what we do, and what our industry does, lacks significance — without new forms of information distribution and communication, we’d all still be living as subsistence farmers in a feudal hell on earth.

But I’m getting ahead of myself…

Occasionally there was something from afar that a person needed to know. There might be an edict from the king ordering his subjects to provide an even greater share of their harvest to the royal granaries… [or tax increases or religious declarations].

But this kind of thing did not happen often, and was so unwelcome when it did that it did not inspire an interest in the wider world. On the contrary: better ignorance than tidings that brought even more hardship to an individual than was already his lot.

Kind of like a lot of recent election results.

But even if the news had been relevant to men and women of an earlier age, they would not have had time for it — which was, of course, a further reason for their indifference. They led… lives of toil and repetition. They fed and milked and slaughtered their animals. They cleared and plowed their fields and dammed their streams… They prayed to a strict and sometimes capricious God, wanting to please, and He was ever watching, ever judging.

Which is all to say that they led the kinds of lives even a greed-besotted, hedge fund-managing workaholic of the early 21st century would have found punishing, every minute of every hour accounted for, every second of every minute. And journalism… is to some extent a function of leisure.

Not much of it existed when Aretino first inked up his press.

And then shifting to colonial America, it gets even worse:

For [anyone] who thought about publishing a newspaper in colonial times… or the man of means who thought about financing the [publisher], there was a further disincentive to journalism.

Put simply, there were not enough customers — too few English speakers in America, too few towns and villages that were too widely scattered to allow for news to be gathered efficiently and a paper to be distributed economically. In addition, as… Sidney Kobre points out, “trade, commerce, and industry were undeveloped. Settlers for a long time made their own clothes and furniture and raised their own foodstuffs. Advertising would not have been profitable, especially since money was scarce and the general income level low.”

The consumer Internet in 1995!

But then there was the distribution problem:

As early as 1639, Massachusetts had attempted the delivery of mail [obviously the only way to distribute newspapers at that point and for a long time to come] on a regular basis. It was irregular at best.

The main problem was roads, which either did not exist or were so rocky, rutted, and circuitous that they were as much obstacle courses as lanes of conveyance.

28 kilobit modems in 1995!

Or Comcast today.

The mail was often delayed, sometimes lost, and sometimes delivered to the wrong place.

“In the early days,” Kobre writes, “if one wanted to get a letter to a relative or friend in another colony, he waited for a ship captain or a traveler passing through, perhaps a merchant sending a package or a cargo of goods. Sometimes, if it were urgent, one employed a friendly [Native American] to deliver a letter for him.”

In January 1673, the Boston Port Road opened for the specific purpose of transporting letters, parcels, commercial goods, and newspapers from Boston to New York, a distance of 250 miles. A horse could travel it without breaking an ankle… The mail did not always arrive within two weeks, as promised, but it almost always got there eventually.

56 kilobit modems in 1996!

And then there’s the issue of production:

There could, of course, be no news… without presses on which to print it, and the first such machine did not appear in the New World until 1638 [at Harvard]… but by 1685, almost half a century later, the grand total of printing presses in the New World had risen to a mere four, and they were essentially what they had been in Gutenberg’s time, which is to say cumbersome apparatuses that were as likely to break down as to grind out a story…

For the most part, they turned out Bibles…

But five years later, and more than eight decades after the first British expatriates had set foot in Jamestown, one of those presses would begin printing the first American newspaper.

So just in this first post in the series, we get a sense of the profound wonder that the newspaper was even brought into existence, much less became widespread or had an impact on the world.

And we see the nature of the birthing pains of a new medium — any new medium — and obviously, all of the birthing pains of the modern consumer Internet are trivial in comparison to the mind-boggling headwinds the original newspaper entrepreneurs faced.

In the next post, I’ll focus on the creation of newspapers in America.

Examining Microsoft’s and Yahoo’s unspoken concerns

In this post, I discuss what I believe are some unspoken concerns that weigh on the decisions both Microsoft and Yahoo are making during this very exciting takeover battle.

Quick status update, largely derived from the excellent Wall Street Journal and its role as official public go-between:

     

  • Various forms of backchannel communication and price negotiation have been happening between the Microsoft and Yahoo teams this week — including via the press.
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  • Microsoft and Yahoo still disagree on price — Microsoft is at about $33/share and Yahoo is holding out for about $36/share, maybe more — and probably other issues, some of which I discuss in this post.
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  • Microsoft is threatening to launch its first truly hostile volley tomorrow unless the Yahoo board agrees to whatever deal is on the table now.
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  • Yahoo is still working hard to convince its institutional investors — who control the company’s ultimate destiny — that it can thrive standalone. Most notably, Yahoo is apparently close to an ad pact with Google that could significantly boost Yahoo’s independent revenue and margins.
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Now, reading a lot of the press coverage, you would think that the current standoff is all about Yahoo’s desire to stay independent, plus price. I think that misses the unspoken and quite complex issues that are likely bedeviling the boards of both companies as they wargame the various scenarios that could play out from here.

First, I think there is a very big and very real nonobvious concern that is a major roadblock to Yahoo accepting a Microsoft offer at almost any price:

A deal could be negotiated and announced and then fail to close.

The consequences of this scenario to Yahoo would be devastating, and it very well might happen.

Big mergers and acquisitions, particularly among public companies, particularlyamong public companies that have large shares of their respective markets, can take a year or more between the day the deal is signed and announced, to the day the deal is actually executed and closed.

During that year plus, all kinds of things can happen that could cause the deal to fall apart.

Microsoft and Yahoo will have to get approval from various US regulatory agencies, including some combination of the Federal Trade Commission and the Department of Justice. This approval process will likely be rigorous, due to both companies’ large market shares and because of Microsoft’s historical antitrust issues. The US government could disallow the merger entirely, like when Microsoft tried to buy Intuit in the 1990’s, or impose conditions on the merger that would render it infeasible, and the deal could collapse.

Microsoft and Yahoo will also, as global companies, presumably need to get approval in other jurisdictions — certainly the European Union. The EU is currently harsher on these issues, and on Microsoft in particular, than the US government. If the EU refuses to approve the merger, or imposes various adverse conditions on it, the deal could collapse.

Microsoft shareholders could revolt. Opinions among the Microsoft employee ranks, executive team, and shareholder base vary wildly on the pros and cons of this takeover. Microsoft stock has been flat for years. A shareholder revolt could cause all kinds of changes at Microsoft, and the deal could collapse.

The broader economy could cave in and we could enter a serious recession.Some people think that’s fairly likely. If that happens, it could significantly change all kinds of assumptions that are built into the business rationale for this takeover, and the deal could collapse.

Microsoft could simply get cold feet for its own reasons. Perhaps during the closing process it discovers new information about Yahoo and decides the deal is a really bad idea. A conspiracy theorist might even say that Microsoft could choose to walk away at the last minute in order to permanently and deliberately cripple Yahoo — and such a conspiracy theorist could point to a few almost-mergers in Microsoft’s history that could justify such a fear. I am not saying that I am such a conspiracy theorist, but in all seriousness I bet there are at least a couple of them on Yahoo’s board right now. In such scenarios, the deal could collapse.

Typically, an acquisition target tries to wrap the merger agreement as tightly as possible to prevent any scenario where the deal collapses. For example, one can specify a large breakup fee, which the acquiror would have to pay to the target. In a merger like this, the breakup fee could be in the billions of dollars. And of courselitigation is reasonably likely in the wake of a deal collapse, especially if one side believes the other side has explicitly violated a binding contract.

However, none of those protections actually protect Yahoo all that well in the event that the deal collapses because it is disallowed by a government. And further, none of those protections actually do that much to protect Yahoo all that well even if the deal collapses for other reasons. Here’s why:

The minute a merger agreement is signed, an enormous amount of focus, time, and effort at the target company is redirected towards the implications of the merger. Legally both companies are supposed to continue to operate as fully independent companies with independent strategies until the merger closes, but in practice, a lot of people in the target company are going to be highly preoccupied — whether with formal roles in integration planning, or just due to the general distraction and anxiety that would be prompted in the halls at Yahoo at the prospect of actually being merged into Microsoft. It is extraordinarily difficult for a management team at such a time to keep an employee base focused on the standalone business — in fact, I think it’s basically impossible.

So imagine what happens if the deal is signed, a significant percentage of Yahoo’s internal bandwidth over the next 12 months refocuses onto the implications of the merger, and the deal collapses. Yahoo would be simultaneously behind in many of the key initiatives it would have normally pursued to be competitive as a standalone company, and highly disorganized, fragmented, and demoralized for the Microsoft-less road ahead.

Suppose the deal collapse triggers a big breakup fee — suppose $3 billion in breakup fee cash drops into Yahoo’s lap. So what? A traumatized corporate victim of merger interruptus is going to have far larger problems than cash, even a large amount of cash, can fix. Same with a lawsuit.

There are other things that Microsoft could do to offset these concerns.

The most obvious thing Microsoft could do is execute a commercial agreement with Yahoo simultaneous with a merger agreement. The commercial agreement would require Microsoft to shut down its own Internet efforts and instead use Yahoo’s — completely independent of the merger. Microsoft Search would shut down and Microsoft would point all of its users at Yahoo Search, and so on for all of the various overlapping product lines. Yahoo would of course share revenue with Microsoft in return.

This would almost completely protect Yahoo from all of the collapsed deal scenarios. Even if the deal collapses, Yahoo still has an enormously valuable commercial contract to be Microsoft’s de facto Internet arm — in essence, that contract is Yahoo’s compensation for taking on the risk of the merger going through.

You can also see why Microsoft wouldn’t want to agree to this.

Other than that, the Yahoo board may be simply trying to get Microsoft to pay a higher price than even Yahoo thinks their company is worth, in order to offset this risk. There obviously would be a price that would be so good that the merger close risk would be worth taking. I’m not sure what that price is, I’m not sure whether Yahoo’s institutional shareholders are willing to hold out for it, and I’m not sure whether Microsoft will be willing to pay it.

But we’re probably going to find out.

There is another, related, enormous issue in Microsoft’s mind.

That is the issue of timing of the regulatory approval process.

If the entire merger could be approved and closed before the new US president takes office in January 2009, that would be wonderful for Microsoft.

I think that’s one of the reasons why Microsoft made their offer when they did — in January 2008, a full year before the US presidential handover.

I also think that’s one of the reasons Microsoft is so frustrated with Yahoo’s apparent sluggishness — dragging this into May at the very earliest for a negotiated deal.

also think that’s one of the reasons why Yahoo has been so apparently sluggish — Yahoo is probably thinking that the longer this gets dragged out, the less likely the deal could be approved before the US presidential handover, and therefore the less likely Microsoft is going to consider it a clean deal, and the less likely Microsoft is going to want to go through with it.

Because just like Yahoo is worried about the consequences if the deal falls through — so is Microsoft, one would imagine, for many of the same reasons. Merger interruptus bites both ways.

What’s the big deal with the US presidential handover? The Bush administration is known to be quite friendly to large companies, large mergers, and Microsoft. Any Democratic administration would probably be notably more hostile to this kind of merger than the current regime. And even a McCain administration might have different views from the current government — who knows? That very uncertainty is the issue.

The most likely outcome of the arrival of a new US administration is that a merger like this certainly won’t become more likely to be approved, and will possibly, or probably, become less likely to succeed.

There are a few other implications one can draw from this.

One is that Microsoft probably would have been willing to pay more for a friendly deal early in this process, when there was more time to get the deal closed before January 2009.

Yahoo may have operated against its own best interest in getting the optimum friendly price by delaying so long.

On the other hand, Yahoo may be pushing the timing out so far that Microsoft will become increasingly disincented to proceed.

Or, perhaps this is why Microsoft hasn’t yet gone fully hostile — they don’t want to risk prolonging the approval process, and a hostile takeover will certainly take longer than a friendly one.

And, correspondingly, if Microsoft does go hostile, it will be a very real expression of Microsoft’s need to do this deal despite considerable risk that a new US administration, particularly a Democratic one, would not permit it to proceed.

More to come!

The New York Times covers blogging

Actual New York Times headline for Sunday, April 6, 2008:

In Web World of 24/7 Stress, Writers Blog Till They Drop

Reworded for brevity:

Blogging Causes Death

Future New York Times headline submissions from yours truly:

Blogging Causes Herpes

Bloggers Shorter than Normal People

Want To Contract Malaria? Try Blogging

Bloggers Have Bad Breath

Leprosy and Blogging May Be Connected

Hitler Probably Blogged

Now Bloggers Aren’t Even Wearing Pajamas

Blogging Fad Almost Over

And of course, the inevitable, perennial favorite:

Child Abuser/Serial Killer/Campus Shooter Had a Blog

p.s. The Judy Miller memorial New York Times blogging story headline:

The Bloggers Have WMD

Benjamin Franklin, blogging role model?

A personal friend has lately been expressing concern that I have been descendinginto sarcasm too frequently on this blog of late.

He suggests that I study Benjamin Franklin as a role model for how to write in a way that amuses and persuades, rather than startles and offends.

So, to that end, I am reading Walter Isaacson’s outstanding Franklin biography:

[Writing anonymously as “Pacificus Secundus” in a British newspaper, Franklin] resorted to his old tactic of scathing satire by pretending to support the idea that [British] military rule be imposed in the [American] colonies…

“It may be objected that by ruining our colonies, killing one half the people, and driving the rest over the mountains, we may deprive ourselves of their custom for our [manufactured goods]; but a moment’s consideration will satisfy us that since we have lost so much of our European trade, it can be only the demand in America that keeps up and has of late so greatly enhanced the price of those [goods], and therefore a stop put to that demand will be an advantage to all of us, as we may thereafter buy our own goods cheaper.”

The only downside for England, [Franklin] noted, was that “multitudes of our own poor may starve for want of employment.”…

And:

Franklin also produced a politican cartoon… that showed a bloody and dismembered British Empire, its limbs labeled with the names of colonies. The motto underneath, “Give a Penny to Belisarius,” referred to the Roman general who oppressed his provinces and died in poverty.

He had the cartoon printed on notecards [and] hired a man to hand them out in front of [the British] Parliament…

And:

[Concerned that the British did not fully understand the potential consequences of further alienating the American colonies, Franklin] published a parable in January 1770 about a young lion cub and a large English dog traveling together on a ship.

The dog picked on the lion cub and “frequently took its food by force.”

But the lion grew and eventually became stronger than the dog.

One day, in response to all the insults, it smashed the dog with “a stunning blow,” leaving the dog “regretting that he had not rather secured its friendship than provoked its enmity.”

The parable was “humbly inscribed” to Lord Hillsborough [a senior British official in charge of colonial affairs]…

And:

[Franklin later] reverted to his youthful love of satire in two anonymous propaganda pieces he wrote for the English papers in September 1773. The first one was entitled “Rules by Which a Great Empire May be Reduced to a Small One.”

Noting that “an ancient sage”… had once boasted that he knew how to turn a little city into a great one, the essay listed twenty ways to do the reverse to an empire. Among them:

“In the first place, gentlemen, you are to consider that a great empire, like a great cake, is most easily diminished at the edges.”

“Take special care the provinces are never incorporated with the Mother Country, that they do not enjoy the same common rights, the same privileges in commerce, and that they are governed by severer laws, all of your enacting, without allowing them any share in the choice of legislators.”

“However peaceably your colonies have submitted to your government, shown their affection to your interest, and patiently borne their grievances, you are to suppose them always inclined to revolt, and treat them accordingly. Quarter troops among them, who by their insolence may provoke the rising of mobs… you may in time convert your suspicions into realities.”

“Whenever the injured come to the capital with complaints… punish such suitors with long delay, enormous expense, and a final judgment in favor of the oppressor.”

“Resolve to harass them with novel taxes. They will probably complain to your Parliament that they are taxed by a body in which they have no representative, and that this is contrary to common right… Let the Parliament flout their claims… and treat the petitioners with utmost contempt.”

The list, reflecting the indignities that had been perpetrated on America, went on at length: send them… “petty-fogging lawyers” to govern them, “perplex their commerce with infinite regulations”, appoint “insolent” tax collectors, and garrison your troops in their homes rather than on the frontier where they can be of use.

If you follow these rules for diminishing your colonies, the essay concluded, you will “get rid of the trouble of governing them.”

It was signed “Q.E.D.”…

And:

Two weeks later, Franklin published an even broader parody of Britain’s treatment of America, “An Edict by the Kind of Prussia.” A thinly disguised hoax, it purported to be a declaration issued [about England] by King Frederick II [of Prussia].

Whereas the Germans had long ago created the first settlements in England and had lately protected it in the war against France, they had decided “that a revenue should be raised from said colonies in Britain”.

So Prussia was levying 4.5 percent [taxes] on all English imports and exports, and it was prohibiting the creation of any further manufacturing plants in England [as England did in the American colonies].

The edict added that the felons in German jails “shall be emptied out” and sent to England “for the better peopling of that country” [again, as England did in the American colonies].

Lest anyone be so thick as to miss the point, it concluded by noting that all of these measures should be considered “just and reasonable” in England because they were “copied” from the rules imposed by the British Parliament on the American colonies.

I do indeed have a new blogging role model: Benjamin Franklin!