Infighting at Uber puts governance risks in spotlight

BY ARLEEN JACOBIUS · AUGUST 21, 2017

The very public battle surrounding Uber Technologies Inc. is bringing to the surface venture capital investors’ concerns that the best and brightest of executives won’t work for even trophy portfolio companies when those companies have a reputation for poor corporate governance.

A portfolio company’s failure to attract top talent affects returns of venture capital, private equity and other investors. Hiring new talent will be the first step on Uber’s road to finally going public. An initial public offering is important for early investors like venture capital firm Benchmark Capital Partners that had been holding what might be its most valuable yet-unrealized investment for nearly 10 years.

Frustration over holding onto large unicorn investments that continue to stay private — with no signs of going public — could lead to more investor activism, especially from the venture capital and private equity investors whose funds’ lives are coming to an end, said Rohit Kulkarni, head of research at San Francisco-based secondary market private shares trading platform SharesPost Inc.

The value of private late-stage companies held by venture capital firms reached $1 trillion sometime during the second quarter, according to SharesPost analysis. At the same time, portfolio companies are expected to stay private even longer; estimates range up to 13 years in five years between founding and IPO. That is up from close to 10 years with firms such as Uber, Airbnb Inc. and Dropbox Inc., which are still private, and six or seven years when Facebook Inc. went public, he said.

“If you are a venture capital firm and you typically have a six- to eight-year time horizon from the first check … and you see that cycle set to expand over the next five years, it makes them (general partners) impatient (for an IPO), which could lead to activism,” Mr. Kulkarni said. Overall exits were down in the first half of 2017 to $25 billion in 348 transactions as of June 30 compared to $54 billion in 821 transactions in all of 2016, according to PitchBook data.

Watching the show

Uber is a unique situation that already has had an unprecedented history, he said.

“In Silicon Valley, it’s been movie-and-popcorn time,” Mr. Kulkarni said.

The show started with lawsuits and counter moves by early Uber investor Benchmark Capital and another investor faction supporting Uber’s founder and former CEO, Travis Kalanick.

Benchmark Capital, based in Menlo Park, Calif., closed its seventh fund — which invested in Uber and is the plaintiff in Benchmark’s lawsuit — in 2011 with total committed capital of $424 million.

The tumult also points to share-class structures that might no longer work in an era of venture-backed, still private companies growing larger than most publicly traded technology companies. Mr. Kalanick — like the founders of Lyft Inc., Snap Inc. and Alphabet Inc. — owns a special class of voting stock that gives him control over the company no matter what percentage of shares he owns. That leaves outside investors with diminished rights and influence.

Such a dual-class structure ensures the founders’ control of the companies. Anything the board would want to do would most likely have to be approved by Mr. Kalanick due to this kind of share structure, Mr. Kulkarni said.

Uber needs to fill out its C-Suite, including hiring a new CEO and its first-ever chief financial officer — both with experience taking a company public — before starting the clock ticking on going public. An IPO would give venture capital and other investors an exit, providing what could be a handsome payday for themselves and their limited partners.

An exit is especially important because unlike many private companies, Uber does not allow its private shares to trade without board approval, Mr. Kulkarni said.

The Uber drama started Aug. 10 when Benchmark Capital took the highly unusual step of suing Mr. Kalanick for fraud, alleging he withheld information and tricked the board to give himself control over three additional board seats. Mr. Kalanick appointed himself to one board seat, according to Benchmark’s complaint.

In court documents, Mr. Kalanick indicated he wants the court to move Benchmark’s lawsuit to arbitration, a process in which the parties could have more control over the proceedings.

The lawsuit also launched an epic verbal battle via a series of open letters by pro-Kalanick board forces and Benchmark. In two letters, pro-Kalanick investors are asking Benchmark to step off the board. In separate letters and statements, Benchmark executives have said the firm sued Mr. Kalanick to protect its investment and “to do what is best for Uber and for the thousands of employees working so hard every day.”

Benchmark executives, in a separate letter, said the firm was forced to sue because of Mr. Kalanick’s behavior and that Benchmark should have taken steps sooner.

Reputational risk

The risk for Benchmark, a highly respected venture capital firm that has long been able to pick and choose its limited partners, is that future entrepreneurs might decline to accept investments from Benchmark.

“In general, it has to be a really bad situation for a well-regarded investor to file a lawsuit against a portfolio company — usually because filing a lawsuit can damage your reputation in the market,” said David Fann, president and CEO in the New York office of private equity consulting firm TorreyCove Capital Partners LLC.

Such an unusual and public battle with an investor can also affect the portfolio company’s ability to hire the executives it needs to drive the business ahead.

“Recruiting top CEOs, where you have a board that is not in alignment, is pretty hard. (Candidates) would not want to step into a hornet’s nest,” said Greg Stento, managing director at alternative investment manager HarbourVest Partners LLC.

Added Kent Elliott, principal of RETS Associates, an executive search firm based in Newport Beach, Calif.: A company with a poor reputation as an employer or a company that is in the midst of a crisis will have difficulty attracting “A-caliber talent.”

Other priorities

Good corporate governance is not exactly top of mind for entrepreneurs, said Chris Sugden, managing partner of Princeton, N.J.-based Edison Partners, a growth equity firm. Roughly 75% of companies that have gotten venture capital funding involve first-time entrepreneurs, he said.

“We look at corporate governance as a strategic weapon for growing great companies,” said Mr. Sugden. “We think our (portfolio) companies should act as close to a public company as they can, and so we build a framework to great governance early on. The governance topic is interesting at Uber. With Benchmark’s lawsuit, various groups are saying ‘we should have stepped in sooner.'”

Investors so far are staying out of the line of fire.

“Uber has been a phenomenal success thus far and investors are still expecting more growth. In order to realize its full potential you have to have the right leadership,” said one investor with capital committed to venture capital funds that have invested in Uber.

“As an LP, we want to see venture capital firms utilize all the tools at their disposal to make the investment successful,” the investor said, declining to be identified.

Many investors declined to comment on the situation at Uber, including the $331.6 billion California Public Employees’ Retirement System, which is invested with Yucaipa, a private equity investor that has an Uber board seat. Likewise, Arthur R. Guimaraes, chief operating officer for the University of California‘s $77 billion pension fund and endowment, a Benchmark investor, declined to comment.