A dual-class structure involves two different classes of shares with differential voting rights. This means that founders and other pre-IPO holders are able to maintain voting control of the publicly listed company through holding shares with enhanced voting rights compared to the shares held by public shareholders. For example, the shares held by founders may have 10 votes per share, while the shares held by public shareholders have one vote per share. Higher vote shares convert into low vote shares when sold, so control is held by the early holders that continue to hold shares once public.
Who wants dual-class structures?
The structure is particularly attractive to rapidly growing companies, especially in the technology sector, where founders wish to retain voting control following an IPO and would argue that the traditional "one-share one-vote" capital structure is not appropriate for companies on their trajectory. One key argument in favour of dual-class structures is that they allow visionary founders to concentrate on the business' long-term strategy, growth and performance without having to focus unduly on short-term targets and being subject to shareholder activism while they are still in the high-growth phase.
What's the position in the UK?
Dual-class structures are possible as a matter of English company law. For example, Cooley acted for Endava plc, an English public company, on its IPO on the New York Stock Exchange in 2018, which involved putting in place a dual-class structure (see press release for additional details).
However, in the UK, a company with a dual-class structure would not be eligible for a listing on the premium segment of the Financial Conduct Authority's (FCA) Official List as that requires a "one-share one-vote" capital structure. A company with a dual-class structure could only seek a listing on the standard segment of the Official List. This is significantly less attractive to investors and does not allow for entry into the main FTSE indices (i.e., the FTSE 100 and the FTSE 250).
What's the position elsewhere?
The capital markets are increasingly global and UK companies have a choice of listing on a number of stock exchanges, including in particular the London Stock Exchange, New York Stock Exchange, Nasdaq Stock Market and the Hong Kong Stock Exchange.
Dual-class structures are permitted and relatively common in the United States, especially for technology companies. High-profile examples include Facebook, Google, LinkedIn, Zynga and Snap.
Since 2018, companies with dual-class structures have been able to list on the Hong Kong Stock Exchange in certain circumstances and subject to certain requirements and restrictions. Following these rule changes, Alibaba dual-listed in Hong Kong (alongside its existing NYSE listing) raising HK$88 billion (US$11.2 billion) in late 2019. Singapore also changed its rules in 2018 to allow for dual-class structures. Cooley's view is that certain of the provisions of the Hong Kong and Singapore rules could form part of a useful blueprint for how the UK premium listing regime could be amended to permit dual-class structures while maintaining the gold standard for corporate governance and investor protections.
Other European countries are also looking at this. For example, in May 2020, the Recovery Decree in Italy introduced the ability for Italian listed companies to issue multiple voting shares expressly to enhance competition with foreign jurisdictions, discourage the transfer of the corporate seat to and listing in countries permitting such voting structures, and protect the Italian markets. These changes allow listed companies to provide for multiple voting shares of up to three votes, which can be limited to certain matters or be conditional upon non-discretionary conditions.
Why does this matter?
The number of companies listed in the UK has been on a downward trend since 2015. Currently, there are around 2,025 companies with shares or depositary receipts admitted to the London Stock Exchange's main market and AIM, significantly lower than the 2,429 as of January 2015. As a leading capital markets firm in the US and the UK, at Cooley we can attest to the fact that the ability, or not, to list with a dual-class structure can be a significant element of the decision making process for certain founders and investors when considering the merits of becoming a publicly listed company and choosing a stock exchange on which to list.
In our view, the blanket prohibition on companies with dual-class structures listing on the premium segment limits UK investors' access to high-growth dynamic technology companies and deprives them of opportunities for returns. There have been reports stating that, towards the end of 2019, the UK government held discussions with the investment industry to explore the possibility of amending the Listing Rules to allow for dual-class share structures on the premium segment and to be eligible for the FTSE indices. In the wake of the UK's exit from the European Union, we hope that the UK government is further incentivised to try to boost London's competitiveness as a listing venue for the most exciting UK, as well as European and international, technology companies.
We note that in 2018 the FCA created a new premium listing category for sovereign-controlled companies and suggest that a similar approach and level of flexibility could be utilised for dual-class structures.
What are the UK objections to dual-class voting structures?
In the UK, the "one-share, one-vote" principle has long been seen as a core bedrock of investor protection. There are concerns that founders with enhanced voting rights can dominate decision making, with little or no representation on policy or strategy for those that provided much of the company's capital, and that there are risks of conflicts arising between entrenched founders and management and other shareholders. There are also concerns that allowing dual-class structures would taint the so-called "gold standard" for listings on the premium segment.
What can be done to assuage these concerns?
Our view is that protections could be considered in six key areas to assuage these concerns and allow for companies with a dual-class structure to be listed on the premium segment and eligible for the FTSE indices: limiting eligibility to innovative and high-growth companies; imposing time limits and sunset provisions for the enhanced voting rights; setting out circumstances in which the enhanced voting rights would be lost; carving out certain decisions from the enhanced voting rights (which would instead be decided on a "one-share one-vote" basis); ensuring there was sufficient information and transparency to allow investors to make informed decisions; and enhanced corporate governance protections.
A number of core protections would be required for dual-class structures, as follows:
- the dual-class structure should confer enhanced rights only to vote at general meetings; in all other respects the rights attached to the class of shares conferring enhanced voting rights must be the same as the class of publicly listed shares;
- these provisions would need to be put in place and fully disclosed at IPO and there should be restrictions on a company's ability to convert to a dual-class structure after listing; and
- the relevant provisions should be enshrined in the company's constitution as far as possible and any amendments should only be on a one-vote-per-share basis.
There are also certain structural limitations for dual-class structures in Hong Kong and Singapore, which are worthy of note. For example:
- the class of shares with enhanced voting rights is capped at not more than 10 times the voting power of the publicly listed class of shares;
- holders of the publicly listed class of shares must be able to cast at least 10% of votes at general meetings; and
- a shareholder holding 10% (or such lower percentage as is prescribed under applicable company law) on a one-vote-per-share basis must be able to convene a general meeting and to propose resolutions.
Limiting eligibility to innovative, high-growth companies
Consideration could be given to restricting any premium listing of shares with a dual-class structure to certain innovative, high-growth companies. For example, in Hong Kong, there are eligibility requirements for companies with enhanced voting rights which include:
- minimum market capitalisation requirement (HK$10 billion at listing) and minimum revenue requirements (HK$1 billion in the most recent audited financial year) if market capitalisation is below HK$40 billion at listing;
- qualification as an "innovative company"; and
There are also specific requirements that the holders of shares with enhanced voting rights must have been materially responsible for the company's growth by way of skills, knowledge or strategic direction and, in addition, the holders must be directors of the company at the time of listing (in Singapore, either the holder of shares with enhanced voting rights must be a director, or the holder must have a "responsible director" appointed to the board of directors). In addition, to be eligible, the company must have received meaningful third-party funding from a sophisticated investor (including financial institutions), retaining at least 50% of investment at time of listing, with a minimum six-month lockup post-IPO. In addition, in most cases the holders of shares with enhanced voting rights must beneficially collectively own at least 10% of the underlying economic interest in total issued share capital at the time of listing.
Time limits and sunset provisions for enhanced voting rights
Consideration could be given to mandating defined "sunset" provisions for dual-class structures. The dual-class structure could be in place for a fixed period of time (for example, 7 or 10 years) after which the enhanced voting rights would automatically sunset. Alternatively, minority shareholders could have a vote at that point as to whether to extend the dual-class structure, with the onus on the board of directors to explain why the dual-class structure should be maintained. The other common sunset provision in the United States applies where the high-vote shares become less than a specified percentage (this is often 10% but can be higher) of the total issued share capital - when that occurs, the enhanced voting rights cease to apply. In each case, these provisions would be enshrined in the company's constitution.
These provisions are consistent with the argument that dual-class voting structures have clear advantages while innovative technology-focused companies are young and fast growing, while providing a set way to dismantle them once companies have had time to establish themselves as mature publicly listed companies. However, we note that neither Hong Kong nor Singapore has included any mandatory time limits or sunset provisions.
Circumstances in which enhanced voting rights are lost
In addition to, or as an alternative to, a time-defined or percentage of total ownership-defined sunset clause there may be other circumstances in which enhanced voting rights are lost. For example, where a founder ceases to be involved with the business on a day-to-day basis and/or ceases to be a director, dies or is incapacitated.
Enhanced voting rights should not be transferable to an independent third party. Subject to limited exceptions (for example, with respect to trust structures or estate or tax planning), the company's constitutional documents should provide for an automatic conversion of shares from the enhanced voting class to the publicly held voting class on transfer.
It should not be possible to issue further shares with enhanced voting rights other than as part of a secondary share offering made on a pre-emptive basis (such as a rights issue or open offer) or pursuant to a corporate action such as a bonus issue, scrip dividend, share sub-division or other share capital reorganisation. In addition, a mechanism should be included whereby if publicly listed shares are repurchased by the company the enhanced voting rights would be reduced pro rata so as not to increase the overall proportion of votes that can be cast by the enhanced voting class as a result of share repurchases.
Carving out certain decisions from the enhanced voting right
In order to assuage corporate governance concerns, certain matters could be carved-out of the enhanced voting rights and approved on a "one share one vote" basis. For example:
- approval of related party transactions involving persons holding shares with enhanced voting rights and their associates;
- approval of the directors' remuneration report and directors' remuneration policy (where directors hold enhanced voting rights);
- approval of the most significant corporate transactions (potentially a "super class 1" regime);
- changes to the company's constitution;
- appointment and removal of independent non-executive directors;
- appointment and removal of auditors;
- winding-up the company; and/or
- cancelling the company's listing or transfer to a different listing segment.
These would overlap in certain respects with, and be an enhancement to, the existing requirements for a premium-listed company that has a controlling shareholder (a shareholder, or group of shareholders acting in concert, holding 30% or more of the voting rights).
Information and transparency
Dual-class companies admitted to a premium listing would need to be capable of being clearly identified. For example, in Hong Kong companies with dual-class voting structures (known as weighted voting rights companies or "WVR") have the marker "W" for the stock name.
Additional warnings, rationale for the dual-class voting structure and very clear disclosure on the associated risks would need to be included in the IPO prospectus, annual and half yearly reports, shareholder circulars, AGM notices and announcements, as applicable.
Enhanced corporate governance protections
Specific enhanced corporate governance protections could be considered for companies with a dual-class structure. For example, in Hong Kong there is a require to establish a mandatory corporate governance committee composed entirely of independent non-executive directors with mandatory terms of reference. This corporate governance committee is required, amongst other things, to:
- review and monitor whether the company is operated and managed for the benefit of all shareholders;
- check and confirm compliance with the relevant requirements of the Hong Kong rules;
- review and monitor the management of conflict of interest involving any beneficiary of weighted voting rights; and
- review and monitor all risks relating to the dual-class structure (including connected transactions involving any beneficiary of weighted voting rights) and make recommendations to the board of directors on any such transaction.
All or certain aspects of compliance with the UK Corporate Governance Code could be made mandatory for companies with dual-class structures (rather than "comply or explain" as it is at present), in particular in relation to the requirements to have an independent Chair, sufficient independent non-executive directors and the requirements relating to composition of the audit, remuneration and nomination committees.
In addition, certain aspects of the UK Corporate Governance Code could be enhanced for companies with dual-class structures, for example having the nomination committee made up solely of independent non-executive directors and shortening the period after which a non-executive director is deemed to no longer be independent from nine to six or even three years.
The UK risks missing out on having high-growth, innovative companies list in London as they cannot have a dual-class structure and be admitted to a listing on the premium segment, whereas listing with a dual-class structure is an option on other major stock exchanges (notably, the New York Stock Exchange, Nasdaq Stock Market and the Hong Kong Stock Exchange). There are a number of different ways in which concerns around dual-class structures could be assuaged and certain of the protections recently put in place in Hong Kong and Singapore could form a useful blueprint for a new "premium listing (dual-class company)" listing category. We would urge the Government and the FCA to look closely at this issue.
Originally published May 21, 2020
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