Founders of successful startups create brilliant concepts and devote considerable effort to see their business take off. But often this is not sufficient. Fresh capital is needed to implement marketing plans and hire personnel that provide relief to the founders’ day-to-day operations.
Attracting new capital is arguably one of the primary goals of the founders. Conversely, this could cost them a significant ownership diminution. In these cases, the multi-class stock becomes a very attractive option.
Each class of stock has their own unique features. Founders typically offer shares with limited or no voting rights to angel investors and venture capitalists, who, in exchange, may demand preferences on distributions and liquidation. The desired result is to secure additional funds without giving up power, or limiting this undesired side effect.
The multi-class stock provides the founders an opportunity to devise their strategies with a long-term view and to disable the possibility of being forced to follow requests of new investors who might have nearsighted plans to accrue a quick but short-lived profit. Therefore, this scenario would clearly benefit all the stakeholders of the company.
Additionally, the multi-class stock is a system that allows founders to award shares without voting rights to certain key employees essential to the sustained growth of the company, thus aligning their economic interests without giving away power.
On the other hand, the multi-class stock system exposes stakeholders to the risk of poor corporate governance. Founders could circumvent the checks and balances of the very people that invested in their projects. The recent hardships experienced by the co-working startup WeWork and its former CEO Adam Neumann is a classic example. A brilliant founder attracts substantial investments with game-changing visions. The multi-class stock system gave him outsize power. His controversial and unfettered actions then hurt the shareholders. To minimize this risk, venture capitalists and angel investors should condition their financial contribution to obtaining voting rights on certain most significant decisions, such as appointing and removing directors and capital calls, to name a few.
Although these are some of the most common features of multi-class stock systems, there are other considerations that must be taken into account on a case-by-case basis. Reply to this blog post to schedule a consultation with one of our Attorneys to discuss how a multi-class stock system may benefit your company.
Michele Cea is a founding member of the firm. Mr. Cea graduated from Catholic University School of Law in Milan, Italy (J.D., 2009, with honors), and Fordham University School of Law in New York (LL.M., 2011, Cum Laude).