Dual class shares and their implications

Me You

SGX recently announced that they will be allowing companies with dual class share structures to list on the SGX with immediate effect. This prompted a friend to ask me what this meant, so I thought I’ll write an article about it this week.

What are dual class shares?

Singaporean investors should be familiar with the traditional company share structure – the concept where owning 1 share entitles you to 1 vote. This essentially means there’s only 1 class of shares. On the other hand, dual class shares means there are 2 or more classes of shares in the company, with the main difference being in the voting entitlement per share.

The concept of dual class shares is not new, it has been a structure that has been allowed in the US for the longest time. Traditionally, it had been the share structure of choice for family owned businesses who seek to float their shares on the stock market. Examples of this include the New York Times and the Ford Motor Company. In more recent times, this structure was popularised by Silicon Valley unicorns like Google (now Alphabet) and Facebook who have strong founder-led cultures.

To illustrate the concept of dual class share structures, let’s take a look at Alphabet’s share structure.

Alphabet Example

Equity share is computed assuming each share was issued at $1 per share

Class A and C are publicly traded, while Class B is held in the hands of Google founders Larry Page and Sergey Brin. As you can see, despite only putting up 7% of the company’s equity, the founders have 61% control of the company. Even if you exclude Class C shares from equity calculations (since Class C shares were issued free in a 1 for 1 stock dividend exercise back in 2014), they have only put up 14% of the company’s equity.

Implications

1) Inequality amongst shareholders

As you can see from the Alphabet illustration, dual class share structures are unfair to the “lesser shareholders”. Despite putting up most of the equity, they do not receive the proportionate amount of voting power at AGMs.

2) Founders can sit pretty on their throne

This can be a boon or a bane. If you have founders with foresight and morality, giving them absolute control of the company through such shares can eliminate a worry of theirs and allow them to focus on running the business. On the flip side, if you have founders who are terrible or are just out to cheat investors’ funds, “lesser shareholders” are not able to vote them out of the company due to a lack of voting power. Of course, you can vote for or against by buying or selling the company’s shares, but you would probably incur losses doing so.

3) Price differential between the different share classes

The difference in number of votes per share creates price differences between each class of shares. Naturally, share classes with more votes should trade at a premium compared to their less counterparts. This is evident once again in Alphabet’s example:

This price differential is something to be aware of and can potentially create minor arbitrage opportunities.

If its so bad, why is SGX allowing it?

One word – Competition. SGX’s main competitor, the Hong Kong Stock Exchange allowed dual class shares structures in April this year. If they were to remain firm and continue to disallow it, prospective tech companies might simply choose to list in Hong Kong instead. Interestingly, Xiaomi announced their intention to list in Hong Kong soon after the rule relaxation.

The pain of missing out on the Manchester United IPO in 2012 and the continued lack of Tech IPOs in Singapore is also another push factor.

What does this mean for investors?

For now, nothing. There are currently no companies listed in Singapore under the dual class structure. You should only to be aware of this when such companies start listing or if you wish to buy the Tech stocks in the US or for now Xiaomi in Hong Kong. Just know that investing in companies with dual class share structures are like putting your money with a fund manager. You are effectively surrendering control of your funds to the founders, with the only decision you can make is whether to stay invested or not.

Happy Hunting,
KK

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