On September 26, 2017, proxy advisory firm Institutional Shareholder Services (ISS) released the results of its annual Governance Principles Survey, which showed that 43% of surveyed investors consider multi-class capital structures with unequal voting rights inappropriate for a public company under all circumstances. An equal percentage felt such structures may be appropriate in the presence of protections for low-vote shareholders. Only 5% supported this structure without limitations. In the typical dual-class structure, public investors are offered stock with one vote per share while pre-IPO investors/founders hold stock that is identical in all respects but entitles them to ten votes per share.
Multi-class equity capitalization in public companies is nothing new—giants such as Ford and Berkshire Hathaway have long utilized some version of the structure without controversy. A multi-class structure can provide insiders who are critical to the company's success with a structure that provides growth capital while retaining control that may be deemed critical to a successful long-term enterprise. Without this type of structure, some companies may reject the public markets altogether. Additional benefits of a multi-class structure include protection against hostile takeovers, relief from some regulation (if also taking advantage of controlled company status) and freedom from the short-termism that can result from the pressure to meet and exceed quarterly analyst expectations.
However, as the number of IPOs selling low-vote stock to the public has increased, so has public scrutiny of the practice. In December 2016, ISS announced it would recommend against directors at companies with multiple classes of equity having unequal voting rights. The Council on Institutional Investors (CII) publicly called for an end to dual-class IPOs, and an automatic five-year sunset or "one vote per share" review mechanism. Asset managers lobbied the SEC and exchanges to prohibit dual-class equity, and investment banks not to participate in these offerings.
Then came Snap Inc.—the company that brought us Snapchat. Snap's IPO did not offer investors low vote stock; it offered no-vote stock. For many in the investor advisory industry this was the proverbial straw that broke the camel's back. CII publicly urged Snap to abandon its plans and the president of CalSTRS called Snap's shares, "junk equity." Prominent corporate law scholars called for mandatory sunset provisions. In response, the Dow Jones banned future dual-class companies from the S&P indices. This S&P action, however, is the only response with any real practical impact on multi-class issuers to date.
Why the firestorm? Putting public shareholders into a "low-vote" class of equity, while insiders wield a restricted "high-vote" class to maintain control, eschews traditional corporate law principles once thought sacred, including "one vote per share," an accountable board and an equal say for those who provide capital. Despite this, U.S. exchanges actively solicit and compete for dual-class companies. Unless another company manages to offend institutional investors more than Snap, egregious insider behavior occurs and is definitively linked to a multi‑class structure, or investors suddenly stop opening their checkbooks when offered stock in a dual- or multi-class company, those crying foul are unlikely to move the needle in the current landscape. Given the success of many dual-class companies to date, that may not be a bad thing for investors.
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