Or even worse, wait in line and pay a premium price?

FB is of course the new ticker for Facebook, Inc. when it goes public sometime in the next few months (still deciding between NYSE and NASDAQ). Everyone expects it to become the hottest IPO in recent memory, as investors call in favors from brokers to fight over scarce shares.

Others have studied the prospectus, and found many distinctly investor-hostile governance terms. Facebook and others like it offer a simple lesson about how investors can avoid activist situations before they ever become necessary, or can pick activist situations that are most likely to succeed.

FB h8s investors

It’s pretty bad:

1. ❖The CEO, founder Mark Zuckerberg, controls 57% of the votes but only 27% of the economic interest, through dual-class shares.
   

2. ❖The current directors defy any sense of independence, due to existing relationships among them and the CEO.
   

3. ❖This structure persists until Zuckerberg’s current 27% stake falls below 9%, which may never happen.
   

And these are just the highlights. Consult the preliminary prospectus for all the gory details.

Others h8 investors, too

FB is by no means the only new IPO to cement control with a founder. Others, including LinkedIn, Zynga, and Groupon, show similar disdain for investor rights. They variously have classified BoDs, dual class share structures, or both.

While about 24% of the S&P 500 companies have classified BoDs, 65% of the IPO companies from 2011, including Angie’s List and Pandora, have them. Zynga and Groupon have dual-class shares. LinkedIn has both.

It’s not just technology companies, too. Carlyle Group, the private equity shop, sought to limit all shareholder litigation to binding arbitration, instead of allowing conventional lawsuits in a court of law. The SEC halted that one.

And, investors h8 their predecessors

Of course, these companies didn’t invent disenfranchised investors, they just did it well last year. And, poor governance does not automatically lead to poor financial results. Google has some of the worst governance around, and investors seem pretty happy with how they’ve done.

On the other hand, investors at Yahoo and Research in Motion probably wish they had insisted on more representative and responsive directors at the time that these companies went public.

It’s hard, but just say no

Why do investors put up with this sort of thing? In the case of a hot IPO, it’s the cost of getting involved. The founders and their early investors have the power to impose these terms. Investors can avoid the shares until governance improves (if ever), or prepare to suffer if the company craters and the BoD refuses to push the controlling CEO. It’s not like we didn’t warn you.

The lesson extends to other companies, too, long past the IPO stage. Of course activist investors look at governance when analyzing a potential activist target, and select companies that allow at least a degree of activism. That’s just part of the basic drill.

But, what about an ordinary, passive investment? How often do investors consider dual-class shares, classified BoDs, poison pills, and all the other elements of poor governance? And, once considered, then have the discipline to pass on an investment in a company with poor governance? As with a hot IPO, either invest only in companies with acceptable governance practices, or suffer in silence (or sell the stake at a loss) when the shares dive and shareholders have little recourse to pressure the BoD and executives.

There’s plenty of companies to consider if an investor wants to avoid serious governance problems. In the S&P 500, about 375 companies don’t have a classified BoD, and between one-third and one-half of all public companies don’t have them. So, thousands of potential portfolio companies may not follow absolute best practice in corporate governance, but at least make activism easier if and when it becomes necessary.

Creative investors can take this even farther. Elsewhere we’ve shown how selecting investments based on concentrated ownership among a small number of institutions can lead to superior returns.

Selecting companies, even (or especially) passive investments, based on ease of activism represents a sober contingency plan. If a company does underperform, it only makes it easier to respond.