Capitalizing any new company can be a complicated matter. If too much equity is given away, founders can lose control of their own ideas and innovations. On the other hand, if not enough capital is raised, the business could be more likely to fail due to a lack of critical resources. Consult with an experienced California startup lawyer before structuring the capitalization of any new business.
What Is Dual Class of Share Structure?
One popular method of selling equity in the early phases of a business is to create two separate classes of shares of equity. A dual-class structure gives disproportionate voting control to one class of shareholders (usually “Class A” shareholders). Thus, founders can retain control of their companies by selling stock to a concentrated voting block of owners whose judgment is trusted. Other shares can be sold to Class B shareholders, who still provide the capital that is critical to a company’s success, but whose voting rights are limited. This allows founders to retain control over the management and overall direction of the company.
Of course, like everything in life, there are potential downsides to using a dual-class shareholder structure. Some critics argue that Class A shareholders can become so powerful that their bad decisions are allowed to hurt the business – without any restrictions on the future decisions making authority, which is significant. Founders also run the risk of having disputes with these Class A shareholders. If the founders begin to disagree with Class A shareholders or have a different vision for where the company should be headed, the Class A shareholders can often win these disputes with their powerful voting rights. In some cases, the Class A shareholders may even be able to vote to remove the founders from their management positions.
When To Use It
So when should founders create a dual-class shareholder structure? Be very careful when you consider who, exactly, should have more voting rights. Some family businesses retain extra voting rights for relatives to ensure that control of the business remains with the family. Ford Motor Co. is a classic example: the Ford family has retained forty percent of the voting rights in the company while holding just four percent of the equity.
Some proponents also argue that founders will have a better vision for the long-term success of a company. Shareholders are often more concerned with their quarterly dividends than plans for the company’s continued success. When founders and trusted managers retain a higher proportion of voting rights, this can help shift the company’s focus from the short-term gains of Wall Street to the continued success of the business for years to come.
Experienced California Business Equity Lawyers
It is important to have a strategic plan for the effective capitalization of any new business. The experienced California corporate lawyers at Structure Law Group can help develop a capitalization plan that also protects founders from losing too much control over their own business ideas. Call (408) 441-7500 to schedule a consultation or contact us online.