By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C.
Worried about losing control of your company by offering shares to investors as it grows? Super voting stock for founders can help.
These days, founders struggle with the issue of share dilution on their ownership. They are concerned that as their business grows, and the more capital they raise from investors, and the more options they grant employees and advisors, that their ability to drive the company’s success, control the direction and ultimate voting power will dissipate. So, they want to protect themselves and their company from losing control. In some circumstances, super voting stock can offer a great alternative.
Super voting stock is a class of stock that is typically reserved for founders and offers greater proportional voting rights compared to other series or classes of stock issued by the company – allowing only a limited number of shareholders to control a company. The primary purpose of super voting shares is to offer the primary members more control over the company’s voting rights. Also, the members can have greater control over the composition of management, of the board of directors and certain corporate actions like a sale of the company.
The basic structure is for the common stockholders to receive a separate class of shares with multiple votes per share. Typically, the ratio for super voting stock is 10 votes per share, although the number of votes can vary to enable founders to maintain control over the company efficiently no matter the economic stake they hold or the dilution they suffer. To be most effective, owners must ensure that their ownership percentage provides more voting rights than the shareholders who have greater percentage rights. For instance, if a founder has 10% ownership in the company and a venture capital firm has 25%, the VC will have greater voting rights than the founder. But with super voting stock, the founder can provide that her shares have 10 to 1 voting allocations, meaning that the founder can outvote the VC by four to one. Therefore, the founder maintains control.
This structure allows the founders to maintain control while still raising significant amounts of capital and generously granting equity to employees, consultants and advisors. However, investors may frown up this construct in a fundraise, and demand that the super voting stock be converted into normal common stock. If things are going well, investors may be open to a robust valuation and founder-friendly terms. If you are a prerevenue startup with an unproven, non-seasoned management team, this might cause a venture firm to pass on a deal. Or, the VC may require that the dual-class common stock structure be unwound.
Dual-class common stock structures are more commonly introduced just before an initial public offering when venture firms are not concerned about maintaining control, and want to incentivize the founder to get them a public exit. In this scenario, the super voting shares are given to all pre-IPO holders, and the single vote shares are sold to the public in the IPO. When pre-IPO holders start selling shares to the public, those shares convert from Class B (super vote) shares to Class A (single vote) shares. The result is, as shares convert from high-vote to low-vote stock, the largest pre-IPO holders who do not sell shares after the IPO will have voting power increase – potentially controlling any stockholder vote.
Implementing a dual-class structure with super voting rights can offer significant benefits for investors who might otherwise not achieve an IPO due to the founders’ fear of losing control over their company. When it comes to implementing any multi-class structure, the board should consider the fiduciary duties and justification before making a final decision.
These structures have advantages but have also been the subject of significant investor scrutiny and stockholder litigation.
Before implementing a dual-class capital structure, whether at formation or in anticipation of an exit, be sure to consult widely to confirm feasibility, both from a legal, fundraising and capital markets perspective. Super voting stock is not for the faint of heart.
Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley, San Francisco and Los Angeles offices, where he is a member of the Private Equity & Venture Capital, M&A and Transactions Practices and the Technology, Health Care, and Energy Industry Teams. Louis focuses his practice on advising entrepreneurs and their management teams, investors and financial advisors at all stages of growth, from garage to global. Louis especially enjoys being able to help his clients achieve hyper-growth, go public and to successfully obtain optimal liquidity events.