Mark Zuckerberg had his Facebook listing in May 2012. Upon completion, Mr. Zuckerberg held 57% of the listed company’s voting rights, while owning merely 18% of the company’s shares. 1 The tool to achieve this high degree of control surviving five rounds of pre-IPO investment over 1.8 billion U.S. dollars and an IPO worth 16 billion U.S. dollars 2 is Facebook’s dual class share structure. It allowed the visionary founder to avoid possible interference in his management of the company. An outside shareholder will have numerical disadvantage torpedoing his decision or choice of board members through a normal internal procedure of the company.
Under the dual-class share structure, Mark Zuckerberg and certain others were issued certain Class B Common Shares, endowed with 10 votes per share, 10 times the voting power that of Class A Common Shares. The arrangement, commonly known as super voting right, has certainly drawn attention.
Super Voting Right as Commonly Understood
In the U.S., super voting right was largely confined to family-run enterprises or media companies. It became popular among technology companies, especially internet companies since Google’s IPO in 2004, which adopted a dual-class share structure. From then on, during the past years, some big tech IPOs - LinkedIn, Yelp, Groupon, Zynga, Facebook - featured multiple class share structures. 3 Other big names include Ford Motor Company, Berkshire Hathaway Inc., Echostar Communications, and Hollinger International, etc.
Super voting rights are typically conferred on common shares, resulting in the shareholder holding more than one vote per share. Preferred shares, which grant priority over common shares in terms of dividend payment, liquidation or bankruptcy returns, generally carry subordinate or less (sometimes even no) voting right. When the two classes of shareholders vote together, which they generally do with some exceptions, the common share holders will enjoy a numerical share-to-share voting advantage, hence greater power to steer shareholder resolutions.
Super Voting Right Beneficiaries
Founders find super voting right appealing. Inserted at the right timing, it allows them to raise capital without substantially diluting their control over the companies they found.
From shareholder control and stability comes a higher probability of board and management stability, which arguably contributes to the long term strategizing of the company.
As an anti-dilution tool, dual class shareholding structure is effective against hostile takeovers or forced mergers. If a bidder is successful in acquiring all outside equity, the disproportionately high votes held by the founder may well outnumber the bidder. Its effectiveness is ranked as severe as poison pill. 4
Investors see this arrangement in a different light. Some cry unfair advantage. Some worry that it may result in the founder imposing on resolutions that may not take into full account interests of the investors. The founder, together with his family and friends are enticed to institutionalize their positions regardless of performance. Last resort measures by outside shareholders to remove them from management positions are stonewalled. 5
Where investors accept dual class shareholding and super voting right, they must have done so with a tradeoff.
For extra votes yielded to the founder, investors can argue for gains in other terms, such as longer than average protective provisions, more matters requiring super majority votes of the board or of shareholder meetings and more matters requiring separate majority or super majority votes of preferred share holders, etc.
By adjusting the balance of power in terms otherwise standard in transactions without super voting right, the deal an investor can strike may not look as a turnoff as it does when it is first proposed.
Timing and Terms
Timing of the introduction of dual class share ownership is in itself an art.
For the founder, an early and established dual class share structure will help set a good foundation for his future dealings with rounds of investors. It will also leave less room for further vote dilution and change of terms and conditions. On the other hand, for a start-up business with neither apparent growth potential nor a competitive business model, it may not have the power to set the rules. Financing may be off the limits should its insistence on super voting right be questionable. Some investors may even ask that it be dismantled before any investment can happen.
Somewhere down the road, when the founder’s business takes shape and commands a respectable market recognition and share, the balance of power may change so that there may be room for discussions with the investors. The drawback, on the other hand, is that the investors, old and new, are going to ask for some in return for revisions of the terms. While the founder cannot reasonably expect a landslide addition of voting powers, it may acquire some more votes to give himself the comfort of added counterweight.
The matter is different in each case, and a lot depend on the interaction and trust between the founder and investor.
Super Voting Right for Chinese Overseas Listings
Super voting right is not expressly allowed under the China’s legal context. For limited liability companies, Art. 43 of the Company Law, 1994 as amended appears to allow the articles of a limited liability company to provide for voting rights not in strict adherence to the underlying percentage of equity 6 while the allowance is removed for joint stock companies 7 . Whether allowed or not, a company duly registered with class B common shares is not foreseeable, not to mention floating of such share on the Chinese stock exchanges.
Overseas incorporations and listings, on the other hand, do provide a platform for dual class shareholdings. For example, Section 36 of the BVI Business Companies Act 2004 expressly provides “…shares in a company may … (c) confer special, limited or conditional rights, including voting rights; …”. Companies Law (2010 Revision) of the Cayman Islands has similar provisions to that effect. 8
To the extent super voting rights are permitted in offshore jurisdictions where SPVs are frequently incorporated for overseas financing, Chinese entrepreneurs are certainly not hesitant in adopting such arrangements. They did so well before the Facebook IPO. Examples of such incorporations with super voting rights include Baidu (Cayman), Shanda Games (Cayman), Soufun (Cayman), NetQin (Cayman), Youku (Cayman), Renren (Cayman), Qihoo 360 (Cayman).
All of the above found home for their IPOs either on NYSE or NASDAQ. Both U.S. stock exchanges allow listings by companies having super voting shares, but prohibit the listed ones with dual share structure to reduce or eliminate such arrangement or issue a new class of super voting shares. 9
For the Hong Kong Stock Exchange, unless it grants a waiver, dual share listing is barred. 10 It is certainly resolute in denying such waivers. 11
Singapore Exchange, on the other hand, clarified its position on September 20, 2011. After some public discussions, it issued a regulatory guidance 12 declaring that companies are not allowed to list dual-class voting shares in Singapore. 13
Should the U.S. continue to offer high earnings on its market, overseas listings by Chinese enterprises incorporated in the BVI or Cayman Islands may well offer a chance to their founders for super voting right. How that right is to be configured so that it is acceptable to future investors remains a balancing act that will play out pursuant to the comparative powers of the players involved.
At this moment, if the intention is to list in Hong Kong or Singapore, class B common shares, if existing, will have to be converted to all other common shares to qualify.
1 James Surowiecki, “Unequal Shares, Facebook’s IPO and Dual Class Share Structures”, The New Yorker, May 28. 2012, online: http://www.newyorker.com/talk/financial/2012/05/28/120528ta_talk_surowiecki.
2 JING, Hui, “Rounds of Investors Chewing Their Shares of the Facebook IPO Banquet”, Gesafe Wealth, May 25, 2012, online: http://www.gesafe.com/gsnews/news.aspx?id=13631.
3 James Surowiecki, supra, note 1.
4 Richard S. Ruback, “An Overview of Takeover Defenses”, in Alan J. Auerback (ed.), Mergers and Acquisitions (University of Chicago Press, 1987), 49, at 55, online: http://www.nber.org/chapters/c5821.pdf.
5 Ben McClure, “The Two Sides of Dual Class Shares”, Investopedia, Jan. 08, 2012, online: http://www.investopedia.com/articles/fundamental/04/092204.asp#axzz25lW9UlMw.
6 Art. 43 of the Chinese Companies Law provides: “[s]hareholders shall exercise their voting rights at a meeting of the shareholders assembly in proportion to their respective capital contributions, except where otherwise provided for by the company's articles of association.”7 Art. 104 of the Chinese Companies Law provides: “[s]hareholders attending a meeting of the shareholders general assembly shall have the right to one vote for each share held, …”.
8 Regulation 2, Regulations for the Management of a Company Limited by Shares, Table A, First Schedule, Companies Law (2010 Revision) of the Cayman Islands provides: “… any share may be issued with such preferred, deferred or other special rights, or such restrictions, whether in regard to dividend, voting, return of share capital or otherwise as the company may, from time to time, by special resolution determine, and any preference share may, with the sanction of a special resolution, be issued on the terms that it is, or at the option of the company is liable, to be redeemed.”
9 New York Stock Exchange Listed Company Manual §313 (A) Voting Rights Policy provides: “[v]oting rights of existing shareholders of publicly traded common stock registered under Section 12 of the Exchange Act cannot be disparately reduced or restricted through any corporate action or issuance. Examples of such corporate action or issuance include, but are not limited to, the adoption of time phased voting plans, the adoption of capped voting rights plans, the issuance of super voting stock, or the issuance of stock with voting rights less than the per share voting rights of the existing common stock through an exchange offer.” §313.10 further provides: “[t]he restriction against the issuance of super voting stock is primarily intended to apply to the issuance of a new class of stock, and companies with existing dual class capital structures would generally be permitted to issue additional shares of the existing super voting stock without conflict with this Policy.” NASDAQ under its Listing Rule 5640 has similar provisions.
10 Hong Kong Stock Exchange Main Board Listing Rule 8.11 provides: “[t]he share capital of a new applicant must not include shares of which the proposed voting power does not bear a reasonable relationship to the equity interest of such shares when fully paid (“B Shares”). The Exchange will not be prepared to list any new B Shares issued by a listed issuer nor to allow any new B Sharesto be issued by a listed issuer (whether or not listing for such shares is to be sought on the Exchange or any otherstock exchange) …”. Hong Kong Stock Exchange GEM Listing Rule 11.25 has similar provisions.
11 Nisha Gopalan, “Structure Key to Man U Listing, Soccer Club Chooses Singapore IPO For Dual-Share Option, Upsetting Favored Hong Kong”, the Wall Street Journal, Aug. 30 2011, online: http://online.wsj.com/article/SB10001424053111903352704576538260204904184.html?KEYWORDS=man+u.
12 Singapore Stock Exchange, Regulation, Regulator’s Column, “The Capital Structure of Listed Companies in Singapore”, Singapore, Sept. 20, 2011, online: http://www.sgx.com/wps/wcm/connect/sgx_en/Misc/regulations/Regulators/The+Capital+Structure+of+Listed+C ompanies+in+Singapore.
13 Mint Kang, “Dual Class Share Not Allowed in Singapore, Says SGX”, Inside Investor Relations, Sept. 21, 2011, online: http://www.insideinvestorrelations.com/articles/corporate-governance/18478/dual-class-shares-not-allowed-sing apore-says-sgx/.
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