Most companies operate with a single class of shares with proportional cash flow and voting rights: an equity structure that seeks to align and promote the interests of various stakeholders. A dual-class equity system refers to an equity structure in which a company issues two or more shares that differ in voting rights. Typically, shares with the larger voting rights are offered to company insiders such as executives, founders, and family members. The increased voting power allows majority shareholders to maintain control over the company while preserving their employees and investors right to profit.

The use of dual-class equity structures has become more prevalent in recent years. C-corps and LLCs may implement this structure before the initial public offering (“IPO”). Companies can adopt this structure to continue business developments while expanding access to capital. The entrepreneurial founders and key insiders retain control, insulated from the short-term pressures of the market. This structure not only allows for the pursuit of long-term value creation but also provides stability, a key factor in the company’s overarching success.

The benefits of dual-class equity structures, especially amidst a volatile market, can provide stability to the company as the focus maintains on long-term value creation goals rather than succumbing to short-term market pressures and short-term performance requirements. Companies with dual-class structures often have higher returns on assets, as controlling shareholders can make decisions that prioritize long-term value creation.

However, the dissonance between cash flow and voting rights highlights a potential for general agency problems related to ownership and control. When inferior shareholder interests do not align with those of the controlling shareholders, conflicts of interest can arise. Shareholders lacking voting rights cannot influence fundamental company decisions such as succession planning, dividends, policies, and acquisitions. Critics argue that majority shareholders with control rights are in a position to pursue personal benefits at the expense of other shareholders. Unwanted takeover attempts, while generally viewed negatively, can sometimes serve as a healthy check on management decisions. However, under the dual-class equity structure, takeover attempts are almost sure to fail, leaving shareholder checks on management to utilize the legal system, resulting in costly suits for breach of fiduciary duty – an outcome that could have been avoided under a single share structure.

Additional concerns highlight management’s removal from market discipline as consolidated control insulates them from the normal discipline of the market. The result is a risk of management complacency and suboptimal economic performance. Furthermore, the inferior shares often sell at a lower price due to the lack of a voting premium, which can lower overall shareholder value.

Under a dual-class system, the board of directors is accountable to shareholders with disproportionate voting rights, creating problems regarding the lack of accountability to the board of directors.  Executives retain the power to select successors, and in the event of sudden death, shares can be transferred through wills, potentially leading to less-than-optimal leadership in subsequent generations.

For example, Facebook established a dual-class share split in 2012 before going public. The structure established Class A and Class B stock. Class A retains one vote, and Class B carries ten votes in respect to all corporate governance matters. Under this structure, Facebook’s founder and CEO, Mark Zuckerberg, controls corporate governance. Through his voting power, Zuckerberg pursues the company’s strategic vision; ultimately, he makes swift and sometimes controversial decisions through his voting power. While this structure enables entrepreneurial management to move forward without pressure and the distraction of short-term market demands, it can also pose a risk of stifling flexibility and evolution in management over time.

The dual-class share structure offers a complex landscape of benefits and challenges. On one hand, it allows visionary founders and key insiders to steer the company toward long-term goals without distractions. This can be a particularly advantageous approach, especially in volatile markets where stability and long-term vision are critical. Leaders are deeply invested in the company’s success, and investors and employees still receive cash flow benefits from their shares. However, inferior shareholders may feel a lack of control over the company’s direction, as their voting power is significantly less than that of the controlling shareholders.

On the other hand, separating voting rights from cash flow rights can lead to problems. Inferior shareholders may feel a lack of control, as they cannot influence critical decisions or hold management accountable. For investors, understanding the benefits and challenges of a dual-class system is vital and must be carefully weighed. Do the benefits of constant and invested leadership outweigh the risks associated with less voting power?