Shareholder activists like to project democratic values onto corporate share structures. But multiple-voting shares can be useful - for common and controlling shareholders alike
Dual-class shares have been taking a beating as of late. In the Magna International case, the concern was over a hefty premium to be paid to the Stronach family, holders of the superior class, for relinquishing their 300:1 voting preference. More generally, activist shareholders seem concerned about disenfranchisement of holders of inferior classes of shares. Institutional Shareholder Services (part of the RiskMetrics Group) recently recommended that dual-class share structures be eliminated entirely for all future newly listed companies, and that corporate law be changed to require sunset provisions for companies with this kind of structure, causing all shares to revert to common shares after some time unless a majority of the inferior-class shareholders vote to reconfirm the dual-class structure.
Dual-class share structures are not without issues. But the answer should not be a blanket prohibition. Some dual-class structures have been created to favour Canadian ownership in economically or culturally sensitive fields (transportation, natural resources, communications, media). A dual-class structure allows Canadian shareholders to control the votes, and therefore the board and the company, while allowing equity to be raised and held on an international basis. Many foreign investors have happily "bought into" structures of this sort.
Besides their use in preserving national interests, dual-class share structures also provide advantages to company owners who may not otherwise choose to issue shares in the first place. They allow the control group to retain authority over a number of important issues, despite the dilution that may have resulted from financings or mergers. With substantially less than 50-percent equity ownership, for instance, the control group can determine the composition of the board of directors.
In addition, voting control may afford the company the luxury of ignoring the pet issue of the day for activist shareholders with their own interests and agendas, since the issue can always be voted down. This is a significant advantage, given the few effective anti-takeover tools under Canadian law: voting control through a superior share class is far and away the best way to address the prospect of an uninvited acquisition proposal.
The ability to exercise control through superior shares may lead to greater alignment between the controlling group and the other shareholders. For instance, an acquisition that may be advantageous to the business might not be pursued if the result were dilution to the point that the current equity holders would lose control of the company. That issue can be deferred considerably if the controller owns shares voting 10, 20 or 300 times more per share than the votes attached to the inferior class.
While some institutional shareholders have made a policy decision that they will not invest in companies with dual-class share structures, there are plenty of investors who will buy them. The empirical evidence is that quality initial public offerings of dualclass companies can be achieved despite the negative views of some potential investors, and that the performance of dual-class companies in the after-market appears to be determined more by business performance (and the character and quality of the board) than by the nature of the capital structure.
Dual-class share structures are well recognized in Canada, where some 5 to 6 per cent of listed companies have them. Examples include Metro, Bombardier, Gluskin Sheff, Air Canada, Exfo, Cossette and Celestica. But, perhaps surprisingly, dualclass share structures are also very common in the United States, where many prominent and highly valued companies have them. These include Google, Dolby, WebMD, VMWare, VISA, MasterCard, Clearwire and Blackstone Group.
The argument against dual-class shares seems mostly to rest on a one-size-fits-all democracy view (i.e., that certain rights should be inherent to share ownership) and the sense of occasional outrage at premiums paid to collapse dual-class structures. Some of the most significant concerns about unequal values have been addressed in Canada (though not in the United States) by the TSX's listing requirement that, in a dual-class listing, the superior shares must carry a "coattail right," pursuant to which any offer to buy control must include the inferior class at the same price per share as is being offered for the superior class.
Situations such as the one at Magna, where a huge premium was paid to collapse the dual-class structure, can only occur (in Canada) for a dual-class structure that was created before 1987.
That being said, several questions do remain for companies that are proposing a dual-class share structure.
What is the nature of the superiority?
Some dual-class structures have a class of one-vote shares and a class of no-vote shares. Others have a class of shares with 10-, 20- or even 300-vote shares and a class of one-vote shares. Much depends on the purpose and the extent of dilution protection that is desired and achievable.
Who gets the multiple-voting shares?
Typically, these are held by founders, who are the strategic visionaries of the company, and are intended to remain so. Multiple-voting shares are justified on the basis of allowing these driving forces to continue on their path, despite a reduction of their equity ownership. In some cases, private equity players who have restructured and reorganized the business may obtain multiple- voting shares on the same sort of visionary basis; however, dual-class shares tend to be created before an IPO and not after. In some cases, all existing shareholders at the IPO may become holders of the superior class, even though they include both strategically important founders along with others who may simply be earlier-stage financial parties.
Are the superior shares transferable?
Typically, superior shares are not transferable as such: they either convert automatically into common shares on transfer or must be converted before transfer. However, sometimes transfers are permitted between the holders of multiple-voting shares. Designers of dual-class structures must also consider sometimes complex issues of upstream transfers (such as selling shares in a corporate holder of the superior shares of an investee) that may be attempted as a means of getting around otherwise applicable transfer restrictions.
Will there be shareholder rights?
When several shareholders control the company through superior-class shares, they will often have a shareholders' agreement to determine how their control will be exercised. This sort of agreement may deal with board size and composition, and how major decisions will be taken, including how to respond to uninvited takeover proposals.
Even if the control shares are in the hands of a single shareholder, the impact of the controlling shares can be mitigated by statements or agreements about how control will be exercised. The holder of the control shares, for example, can agree to appoint a stated number or percentage of independent directors, or to give the holders of the inferior class the right to elect some percentage of the board. The controlling party can agree to limit control in respect of any other matter that might be addressed in a voting trust/shareholder agreement.
Should there be a sunset provision?
Although not required by any regulation, sunset provisions are often incorporated into dual-class designs. These provisions terminate the superiority of the superior class once the rationale for the dual-class shares has expired. For instance, it may be thought that a class of control shares is required during the company's phase as a newly public entity, to protect against opportunistic acquisitions when the stock sags because of bumps in the company's growth - one lost contract can have a major impact early on, but will be less significant later on when revenues are greater. So the superior class may terminate in, say, five or 10 years.
The superiority will often disappear when equity ownership drops below some threshold. The threshold can be stated as a percentage of equity (in which case care should be taken to consider eventualities - financings, mergers and acquisitions, share dispositions - that may breach the threshold, and to determine if each counts equally); or it can be expressed as a percentage of the holders' shareholding (thus, for instance, sunsetting if the holder disposes of more than 50 per cent of its initial holding). The superiority could also be tied to the continued engagement of the holder in a senior executive position in the company.
Sunset provisions are usually included at the instance of underwriter of the IPO. Their popularity seems to come and go. However, sponsors who wish to keep control and can make the case for doing so have been able to overcome the argument that sunsets are necessary to sell the deal.
DUAL-CLASS SHARE structures are not inherently bad. They may encourage some companies that would otherwise fear going public to do so, or to do so without including founder protection by more onerous provisions (such as poison pills or immensely rich employment deals that trigger on a change of control). They may serve to allow what so many opponents of these structures claim to want: a corporate strategy with a longer-term focus. While excesses have appeared in some cases, these are not inherent in the dual-class structure itself.
Barry J. Reiter, Partner, firstname.lastname@example.org
Barry Reiter is focused on corporate development, finance and governance.
As Chair of the Technology, Media and Entertainment Group, Barry's practice includes representation of start-up, growth and mature companies and private equity sources, international distribution arrangements, strategic alliances, partnerships and joint ventures, licensing, international corporate structuring, private and public financings, stock exchange listings, mergers and acquisitions, restructurings and the protection of intellectual property rights.
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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional.
Reprinted with permission from the October 2010 issue of Lexpert magazine as part of Barry Reiter's regular column. ¸ Thomson Reuters.