What are dual-class shares?

Imagine you founded a company, worked hard for years to make it successful. Until you take your company public, you have all the control in the organisation, where every decision you take is always towards taking your company to new heights. However, once you take your company public, the shareholders can exercise their voting rights and you have to consider their votes.

The above situation was famous in the case of Steve Jobs and how he was voted out of the company he founded. It was because the shareholders had the majority of the ownership and could vote on internal matters. Generally, a company does not oppose shareholders having voting rights. However, problems arise when the founders, directors are looking to expand the company thinking about the longer term, but short term investors oppose the idea and want the company to declare regular dividends.

What does a company do to fulfil the obligations of a listed company but still ensure they have the last say? They issue dual-class share.

What are Shares?

In simple words, a share indicates a unit of ownership of the particular company. These shares are listed on the stock exchanges through the means of an Initial Public Offering, and investors can buy and sell them based on their current price.

The entities (individuals or corporations) who buy the shares of any company become the shareholder. As a shareholder, you are entitled to receive a portion of the profit of the company. You will also have voting rights as per the legal model of the company and can participate in the company’s decision making.

About Dual-Class Shares

A dual-class stock is when a company has two different share classes that are offered to the public. Generally, dual-class stocks are seen as Class A and Class B. Under dual-class stock, one class is restricted to the company directors and executives while the other class is offered to the general public. The central idea behind offering dual-class stocks is to limit the voting rights of the common investors and let the company executives have the last say in decision making. Dual-class stocks allow the top tier executives of the company to have the majority of the voting rights and the decision-making power.

How do dual-class shares work?

A company believes that the shareholders are more concerned about the dividend payout than being a part of the decision-making process through voting rights. Furthermore, companies fear the situation where the executives of the company and the shareholders think differently, and the shareholders can outvote the executives. For example, the executives may consider using the profits to open a new factory. However, short term investors may not worry about future expansion but use the profits for dividend payouts. Here dual-class stocks help the most.

Dual-class stocks are designed to designate the company shares based on the benefits they provide. In this case, they are differentiated based on two factors: Voting rights and Dividend payout. For example, if a company has ‘Class A’ and ‘Class B’ dual-class stocks, it may be that as a retail investor, you can only buy ‘Class B’ shares. The purchase will entitle you to future dividend payouts but not give you any voting rights. Generally, ‘Class A’ shares are allotted to the company executives, which does not come with the benefit of dividend payout but gives them a majority of the voting rights.

However, the investors choose Class B stocks depending on the financial performance of the company and the potential dividend payout resulting from the performance. They do not worry much about getting a say in the company decisions but want to make a profit by buying and selling the company shares based on the price fluctuations.

Advantages of Dual-Class Stocks

One of the best advantages of dual-class stocks is that it allows the company to retain ownership and not be outvoted in its decisions. In this way, companies can think about long term growth and not be forced to offer their profits as dividends.

As companies do not always have a short term financial focus, dual-class stocks allow them to focus on their long term financial goals, even if that means less profitability to woo potential investors. Furthermore, as Class A shares can not be traded and do not come with dividend payouts, the companies issuing them can ensure that their employees are always loyal and focused on improving the performance of the company.

Final Words

Dual-class stocks ensure that the company executives have all the voting rights and can take integral decisions that common investors may not be well equipped to take. To safeguard the long term sustainability of the company, issuing dual-class stocks will work well for both the executives and the company.

However, dual-class stocks aren’t without their controversy. Numerous investors believe that issuing dual-class stocks is executive-centric and disregards the money put in by the shareholders. Furthermore, they argue that issuing dual-class stocks allows companies to always look towards long-term financial goals without giving equal efforts to achieve the company’s short-term financial goals. With no voting rights, there is no way investors can ensure they receive dividend payouts even if the company makes good profits.