Companies With Dual-Class Equity Face Governance Challenges

The Trump administration is already ushering in a number of regulatory changes, and mergers and acquisitions activity is forecasted to increase this year. Rising M&A activity may result in companies with dual-class equity structures being among those targeted to be acquired.

Dual-class companies raise unique governance challenges and possible benefits in the M&A context. Such companies typically have one class of common stock held by the investing public (one vote per share) and one class that isn’t publicly traded that has super-voting rights (multiple votes per share) held by founders, pre-IPO investors or a combination thereof.

Dual-class structures tend to be popular with founder-led companies that can raise money by leveraging public interest in the business, while continuing to maintain voting control by the founders. Given this rationale behind issuing privately held, super-voting stock to businesses’ visionaries/leaders, a common feature of super-voting stock is that upon their transfer, the shares automatically convert into shares of the same class of common stock held by public investors.

These super-voting rights come into play in the M&A context when potential acquirors seek deal protection through support from significant stockholders in the form of voting agreements, support agreements, tender agreements, and so on, that contractually obligate the stockholders party to such agreements to support the proposed transaction.

These support arrangements generally terminate if the proposed transaction isn’t approved and consummated. Depending on the specific language describing the conversion mechanics of the super-voting stock set forth in the target’s charter, the conversion mechanism could be triggered (or alleged to have been triggered by stockholders who aren’t in favor of the proposed transaction) upon execution of the support agreement.

Without an exception from the automatic conversion feature of super-voting stock for entering into a support arrangement in connection with a proposed exit or liquidity transaction, the value of obtaining such an agreement from a holder of super-voting stock may be significantly diminished.

Mindful consideration of a dual-class structure is also warranted during the negotiation of a proposed M&A transaction. A suitor may be tempted to woo the holders of super-voting stock by proposing different or additional consideration compared to what the holders of single-vote common stock may receive. However, if the holder of super-voting stock is considered a controlling stockholder, the standard of review of the proposed transaction, if challenged through litigation, may be heightened.

By law in Delaware, the leading jurisdiction of formation of US-formed public companies, proposed M&A transactions that involve conflicted controlling stockholders are subject to an “entire fairness” standard—the highest level of scrutiny.

To meet the “entire fairness” standard, a court must determine that the transaction was objectively fair to stockholders and find that there was “fair dealing” (how a transaction was timed, initiated, structured, negotiated, and disclosed by the target’s management to its directors, and how board and stockholder approval were obtained). In addition, the court must determine whether a “fair price” was paid (after reviewing all relevant factors: assets, market value, earnings, future prospects, and any other element that affects the intrinsic value of a target’s stock).

A controlling stockholder that’s offered different or additional consideration that isn’t shared by and is to the detriment of other stockholders, whether as part of the transaction or in a side arrangement, could become conflicted.

Under Delaware law, a stockholder is deemed a “controlling stockholder” if they either own 50% or more of the voting power of or exercise control over the business and affairs of the target. However, the burden of proving a lack of entire fairness can be shifted to a plaintiff objecting to the transaction by either using a “well-functioning” special committee of independent directors to negotiate the proposed transaction, or obtaining the informed, uncoerced approval of a majority of the unaffiliated minority stockholders. If a special committee were used, it would need to stay active through the entire course of the transaction from negotiation through closing.

Public companies with dual-class structures aren’t the majority, nor are they outliers. The pending merger between Skydance Media and Paramount Global and the merger of World Wrestling Entertainment and Endeavor Group Holdings are examples of recent transactions involving dual-class structures.

Careful consideration of the special characteristics of a dual-class structure, the consideration that may be offered, and how a transaction is negotiated is recommended for a suitor to be in the best position to reel in a target successfully.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Honghui Yu and Kenneth Silverman are corporate partners at Olshan Frome Wolosky.

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