In a paper titled, “The Importance of Inferior Voting Rights in Dual-Class Firms,” author Dov Solomon focuses on companies with a class of non-voting stock. By offering non-voting stock to the public and listing that class of securities on a national securities exchange, an issuer is not subject to a number of disclosure and related securities law requirements that are tied to voting rights. For example, an issuer with non-voting stock is not subject to the proxy rules. Holders of the class of non-voting stock are not entitled to vote on matters that typically would be raised at stockholders’ meetings or to put forward stockholder proposals for consideration at such a meeting. An issuer with non-voting stock also would not be subject to Schedule 13D or 13G filings for that class of shares. Holders, including insiders, also would not be subject to Section 16 filing requirements. The author suggests that the Securities and Exchange Commission impose such disclosure and governance requirements on issuers with a class of non-voting stock.
Authors Brian Broughman and Jesse Fried study founder control in their paper titled, “Do Founders Control Start-Up Firms that Go Public?” In their paper, the authors observe that many founders of startups lose control through the process of raising capital from venture capital funds. The authors debunk the notion that founders regain control over their companies in connection with their companies’ IPOs (referred to as the “call option on control” theory). The research shows that the frequency of founder-CEO control at the IPO is around 20% during the sample period considered. After three years following the IPO, 25% of founder-CEOs exit the CEO position for the companies that are still public. The authors also considered voting control held by the founder-CEO. Their research showed that the average founder voting power is 11.1% at the time of the IPO and 6.3% three years following the IPO. Founder voting power was higher for those companies that had received less pre-IPO financing, had undertaken fewer rounds of VC financing, undertook an IPO more quickly from receipt of initial VC financing, and had dual-class structures. Based on the review of more than 18,000 startups that received initial VC financing between 1990 and 2012, the authors concluded that it is highly unlikely that a founder will reacquire even modest control at the IPO that would be durable (lasting more than three years).
In his essay, referenced above, author Kirby Smith considers the effects of the equal treatment clause in acquisitions of companies with dual class structures. In the charters of many such companies, there are equal treatment clauses that require that any merger consideration be distributed pro rata. The presence of such a clause may make the control person less likely to pursue a strategic transaction. The clause also might have the effect of requiring a buyer to pay more than the value ascribed to the company by the control person, since the control person effectively holds a veto over the potential strategic transaction. The author suggests two approaches to addressing the issue: first, eliminating equal treatment clauses and relying on the Delaware entire fairness framework, or second, embedding a control premium in the articles of incorporation or charter.
The MSCI released its Consultation on the Treatment of Unequal Voting Structures in the MSCI Equity Indexes soliciting input on index inclusion criteria relating to the shares of companies having a dual class structure. Many commenters have responded by releasing their views publicly. While many institutional investors have taken the opportunity to comment on their concerns regarding dual class structures, particularly those with no sunset provisions, and have voiced a strong preference for a one share-one vote model, some of the same institutional investors have advocated that MSCI indices continue to include the securities of companies with dual class structures. Some have suggested that the MSCI consider offering bespoke indices and broad-based indices. The broad-based indices would reflect the investable market, including the securities with unequal voting rights. By contrast, bespoke indices might be tailored to include only the securities of companies having certain characteristics. Along these lines, a bespoke index might omit the securities of companies with dual class voting structures.