Understanding Dual-Class Share Structure: What It Is and How It Works for Startups

By Lior_Ronen | Founder, Finro Financial Consulting

While raising capital is essential for growth and success, it often means losing decision-making power to outside investors. Giving up control of their company can be daunting for many startup founders. However, there is a potential solution that allows founders to maintain control over their companies while still accessing much-needed funding: a dual-class share structure.

Dual-class share structure is a system that allows companies to issue different classes of shares, each with other voting rights. This structure grants the founders and early investors of the company a higher proportion of voting rights relative to their ownership percentage, which can help to maintain control over the company's strategic direction and decision-making.

In recent years, dual-class share structure has gained popularity among startups, particularly those in the tech industry. Companies like Facebook, Google, and Snap have used this structure to control their businesses while raising capital from outside investors. 

This article explores the dual-class share structure, how it works, and why it can benefit startups. We'll also examine some potential risks and criticisms of this structure and case studies of startups that have successfully implemented it. By the end of this article, you'll better understand whether a dual-class share structure might be the right choice for your startup.

What is Dual-Class Share Structure?

Dual-class share structure is a system that allows companies to issue two or more classes of shares, each with different voting rights. In this structure, one class of shares (typically Class A) is generally granted more voting power per share than another class (typically Class B).

For example, in a company with a dual-class share structure, Class A shares might have ten votes per share, while Class B shares have only one vote per share. This means that the holders of Class A shares have significantly more voting power and control over the company's decision-making than holders of Class B shares.

The company's founders, early investors, or other insiders usually hold Class A shares. In contrast, Class B shares are typically issued to outside investors through an initial public offering (IPO) or subsequent offerings. This structure allows founders and early investors to maintain control over the company's direction and decision-making even as outside investors come on board and the company grows.

Dual-class share structure has become popular among tech companies, as they often rely on visionary founders and innovative ideas to drive growth and success. By maintaining control over the company's strategic direction, these founders can pursue long-term goals and maintain the company's focus on innovation, even as outside investors seek short-term profits and returns.

While a dual-class share structure can benefit startup founders significantly, it also has drawbacks. In the following sections, we'll explore some of this structure's key benefits and potential risks for startups.

Dual-Class Share Structure: Benefits and Risks for Startups

Dual-class share structure can benefit startup founders, particularly those in the tech industry. Some of the key benefits of this structure include:

1. Control: Dual-class share structure allows founders and early investors to maintain control over the company's strategic direction and decision-making, even as outside investors come on board. This can be particularly important for companies in the tech industry, where founders often have a strong vision for the company's future and want to pursue long-term goals without interference from short-term-focused investors.

2. Stability: By maintaining control over the company's strategic direction, founders can provide a sense of stability and continuity that can be reassuring to employees, customers, and other stakeholders.

3. Long-term focus: Dual-class share structure can help to encourage a long-term focus among company leaders, as they are not as beholden to short-term shareholder demands.

However, dual-class share structure also has its risks and drawbacks, including:

1. Limited shareholder rights: Dual-class share structure can limit the power and influence of outside investors, as they may not have the same voting rights as insiders. This can make it difficult for outside investors to hold company leadership accountable or have a say in significant decisions.

2. Risk of abuse: Dual-class share structure can give founders and insiders significant power and influence over the company, which can be abused if not held accountable. This can create a risk for the company and its stakeholders if insiders prioritize their interests over those of the company.

3. Potential for lower valuation: Some investors may hesitate to invest in companies with dual-class share structures, which can be considered a potential risk factor. This can lead to a lower valuation for the company and less access to capital.

In the next section, we'll explore some case studies of startups that have successfully implemented dual-class share structures and potential alternatives to this structure.

Case Studies of Dual-Class Share Structure in Action

While dual-class share structure has risks and drawbacks, there have been several high-profile cases where it has been used successfully by startups. Here are a few examples:

1. Google (now Alphabet Inc.): As mentioned earlier, Google went public with a dual-class share structure in 2004, giving its founders and then-CEO control over its strategic direction. This structure allowed Google to prioritize long-term goals, such as investment in artificial intelligence and other emerging technologies, without the pressure of short-term shareholder demands. Over time, Google's dual-class share structure has enabled the company to become one of the most successful and innovative tech companies in the world.

2. Facebook: Facebook's dual-class share structure has also been credited with helping the company maintain a long-term focus on innovation and growth, even as it has faced challenges such as privacy concerns and competition from other social media platforms. By giving Mark Zuckerberg control over the company's decision-making, Facebook has been able to pursue new products and acquisitions that align with its long-term goals.

3. Snap: Snap's dual-class share structure has been seen as a way for its co-founders, Evan Spiegel and Bobby Murphy, to maintain control over the company's strategic direction and decision-making, even as it faces intense competition from other social media and messaging apps. However, Snap's stock has also been volatile since going public, partly due to concerns over the company's ability to generate consistent revenue and user growth.

While these case studies illustrate some of the benefits of a dual-class share structure, it's worth noting that there are also potential alternatives to this structure. For example, some startups have implemented "loyalty shares," which give long-term shareholders greater voting power over time, regardless of their initial share class. Others have opted for a single-class share structure, making it easier for outside investors to hold company leadership accountable and have a say in significant decisions. Ultimately, the choice of share structure will depend on a startup's specific goals, values, and needs.

Summary

Dual-class share structure can be a valuable tool for startup founders looking to maintain control over their company's strategic direction and decision-making, even as outside investors come on board. This structure can help startups achieve sustained growth and success in the competitive tech industry by prioritizing long-term goals and stability.

However, a dual-class share structure has risks and drawbacks, including limited shareholder rights and the potential for abuse by insiders. Ultimately, the choice of share structure will depend on a startup's specific goals, values, and needs.

As startups continue to innovate and disrupt industries, it will be interesting to see how dual-class share structures and other governance structures evolve to meet the changing needs of the tech industry.