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What are Dual Class Shares

Introduction:

Until a company is private, crucial management and business decisions lie solely in the hands of the director or founder. However, once a company becomes public, this structure changes. The director no longer has full control in the organization as shareholders get voting rights, and their votes are considered while making big business decisions.

For example, suppose a public company’s director wishes to reinvest the profits seeking long-term expansion, but the shareholders may want the company to declare dividends. To avoid being in such a situation, some companies issue dual-class shares.

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This article explores the concept of dual-class shares, their features, pros and cons, and the controversies surrounding them.

What are dual-class shares?

When a company issues two classes of shares, one for the general public and one for the directors and executives, they are known as dual-class shares. Usually, these shares are known as Class A and Class B shares. In some cases, companies can issue three classes of shares, with the Class C shares being issued exclusively for founding members’ family members and the company’s employees.

Significant differences occur between Class A and Class B shares in terms of voting rights of shareholders, dividends, and other aspects. Let’s learn the difference between Class A and Class B shares:

  • Class A shares

Class A shares are generally issued to the general public or common institutional investors. The shareholders have fewer voting rights, making them less potent in terms of corporate decision-making. This arrangement is also known as the Preferential Voting Rights (PVRs). The dividend payouts may also be lesser for Class A shareholders in some cases.

  • Class B shares

Class B shares are typically issued to a company’s founding members, directors, and those in the top positions. In some cases, these shares may also be issued to insiders and early investors. The shareholders enjoy greater voting rights, enhancing their influence over the company’s corporate decisions.

Advantages of dual-class shares

The advantages of issuing dual-class shares include:

  • Helps in organizing equity structure

The issuance of dual-class shares helps a company organise its structure. When there are two classes of shares – Class A and Class B – it allows the company’s founders and key executives to maintain control over critical business decisions even as they sell or issue more shares to raise capital from public investors.

  • Protects the vision of the company

Dual-class shares can help protect a company’s long-term goals and vision by allowing its founding members and key executives to control corporate decisions. Without dual-class shares, founders might be forced to make certain short-term decisions to satisfy the short-term needs of their investors, potentially compromising the company’s long-term vision.

  • Safeguards against hostile takeovers

Dual-class share structures act as a defensive mechanism against hostile takeovers. The shareholders of Class B shares enjoy greater voting rights in the company. This particularly helps when a company’s founding members feel worried about potential corporate strategy or culture changes.

  • Attracts long-term investors

Some investors prefer to invest in companies with dual-class share structures because they believe these structures allow a focus on long-term growth rather than short-term financial benefits. Investors with a similar vision to the company with a dual-class share structure can prefer to invest in it willingly.

  • Brings flexibility

Dual-class shares offer more flexibility for a company’s management team to raise capital from public investors without worrying about equity dilution or loss of control. These can be especially beneficial for launching Initial Public Offerings (IPOs) or subsequent funding rounds.

  • Stability and continuity

When founders and key executives can retain control despite equity dilution, there is a greater likelihood that the company can grow in the future. Leadership stability and continuity help in the long-term growth of the company.

Disadvantages of dual-class shares

While there are several pros of dual-class shares, they also have cons. They include:

  • Lack of accountability

Some investors refrain from investing in companies with dual-class shares because of the fear of a lack of accountability. Shareholders may not always want the company’s insiders to make all the decisions despite owning a stake.

  • Valuation and pricing concerns

Companies with dual-class shares often need help with correctly valuing or pricing their shares. The voting rights disparity between different share classes can complicate the task, making it difficult for them to determine a fair market value for their shares.

The final word

Dual-class shares are one of the most controversial aspects of the corporate world. While they offer a few advantages to the company, they may put off short-term investors. If you plan to invest in dual-class shares, you should do so only after careful evaluation and thorough research.

 

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