A dual-class stock is the same company offering two or more classes of shares to investors
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Not all shares are made the same, even if they’re shares of the same company. Since equity shares in a company usually come with voting rights, large companies and founders don’t want to give them away to investors willy-nilly. Hence, they create different classes of stocks with different claims to voting rights and dividends.
In this article, we’re going to understand more deeply what dual class stocks are, why they’re made, and why it is important for investors like you to know what they are.
Understanding dual class stocks
In the traditional model, companies issue a single class of common stock, granting all shareholders equal voting rights and proportional ownership claims. However, some companies in India utilise a dual-class stock structure, where they issue two or more classes of shares with different voting rights and privileges.
Although this approach can offer advantages for founders and controlling entities but also raises concerns about fairness for minority investors.
Why do companies issue dual class stocks?
Here are some reasons:
- For founders to keep control: Founders can maintain significant voting power through high-vote shares, ensuring their vision and long-term strategy guides the company’s direction. This can be particularly attractive for startups and companies with a strong focus on innovation. By giving out less voting power to passive investors, they retain the reins of the company while still being able to raise funds through equity.
- Faster decision-making: In fast-paced industries where swift action is crucial, high voting shares in the hands of management can be a boon. Management can take fast actions to steer a company through a crisis without having to wait for shareholder approval from the public, which will most-often be redundant in most day-to-day corporate decision-making.
- Attracting talent: Companies with dual-class structures can also attract and retain key talent by offering high-vote shares as part of compensation packages to executive-level employees.
Examples of dual-class shares
While not as prevalent as in some other countries, a few notable Indian companies have utilised dual-class structures:
- Flipkart: Before its acquisition by Walmart, Flipkart had a dual-class share structure, giving its founders more voting power.
- MakeMyTrip: MakeMyTrip’s founders hold Class B common stock with 10 votes per share, compared to the 1 vote per share for Class A common stock held by public investors.
The drawbacks of issuing dual-class stock
By issuing different classes of shares, there are some compromises the company might have to make, and some hard pills investors like you might have to swallow
- Reduced investor influence: Like is obvious, minority shareholders in a dual-class structure don’t get their way with the company’s vision and direction. While passive investors might not care very much about that as long as they get their returns, this could sometimes lead to concerns about accountability and potential conflicts of interest between controlling and minority shareholders.
- P/E impact: Studies suggest companies with dual-class structures might trade at lower P/E ratios due to the perceived reduced investor control. This could potentially affect their ability to raise capital.
- Fairness concerns: Lastly, the inherent inequality in voting rights can raise ethical concerns about fair representation for all investors in the stock market, which might impact fundamentals.
The regulatory landscape around dual-class stocks in India
The Securities and Exchange Board of India (SEBI) currently doesn’t have specific regulations prohibiting dual-class share structures. However, SEBI has expressed concerns about potential misuse and advocated for increased transparency related to such structures.
SEBI, in a paper in 2019, noted the following about companies issuing stock with multiple classes:
- Dual-class structures can make it difficult for shareholders to hold management accountable or influence major decisions, potentially hindering long-term value creation.
- Minority shareholders might not have access to all the information necessary to make informed investment decisions, particularly regarding the rationale behind control structures.
- The presence of multiple share classes with varying voting rights can make the stock less liquid and appealing to some investors.
Frequently Asked Questions
In most cases, no. DCS offerings are typically targeted towards institutional investors like venture capitalists or private equity firms who invest large sums and prioritise control alongside growth potential. Retail investors might have limited access to these offerings.
Yes, it can. The higher voting rights of controlling shareholders can give them significant influence over merger or acquisition negotiations. Minority shareholders might have less say and could potentially be disadvantaged if the deal prioritises the interests of controlling shareholders.
Angel investors: Startups can raise money from wealthy individuals who invest in early-stage companies and can provide crucial seed funding.
Venture debt: Debt financing from specialised lenders can offer startups growth capital without diluting ownership or voting rights. Debt, as opposed to equity, does not dilute equity holdings for any investor.
There are several things you can do, but they all apply fundamentally. The first thing you could do as an investor is evaluate the founders’ and management team’s experience and ability to execute their vision. Since they’re the ones who are going to be calling the shots, it helps to trust them with your money.
There are some who think that DCS might encourage entrepreneurship in a budding economy like India by allowing founders to maintain control of their companies while opening them up for equity investment. However, a different school of thought is of the opinion that overreliance on DCS could limit access to capital for startups that don’t fit the mould of venture capital interest too.