Share Classes

• The Bottom Line: Share classes are different types of a company's stock, often with unequal voting rights, which can dramatically impact your influence, your risk, and your potential returns as a part-owner of the business.
• Key Takeaways:
• What it is: A way for a company to issue stock with different characteristics, most commonly giving one group (like founders) more voting power than another group (like the public).
• Why it matters: It determines your power as a shareholder. With inferior shares, you might have a claim on the profits but little to no say in how the company is run, which is a major risk factor in corporate_governance.
• How to use it: Always check a company's regulatory filings (like the annual 10-K report) before investing to understand its share structure and whether you are being treated as a partner or just a passenger.

Imagine you and your friends decide to buy a pizzeria together. You all chip in money to buy shares, or “slices,” of the business. In the simplest scenario, every slice is equal. If you own 10% of the slices, you get 10% of the profits and 10% of the votes on big decisions, like whether to add pineapple to the menu. This is a single-class share structure. Now, imagine the original chef who founded the pizzeria, Chef Giovanni, wants to sell some of his slices to the public to raise money for a new wood-fired oven. However, he's terrified that the new investors will vote to replace his authentic Neapolitan recipe with a cheap, frozen-dough alternative. To solve this, he creates two types of pizza slices:

• Class A Slices: He sells these to the public. Each slice gets a fair share of the profits but only gets one vote on menu decisions.
• Class B Slices: He keeps these for himself and his family. Each of these slices also gets a fair share of the profits, but they come with ten votes.

This is the essence of share classes. It's a way to separate economic rights (your claim on profits) from voting rights (your say in running the company). While Chef Giovanni now only owns 20% of the pizzeria's total equity, his special Class B slices give him over 70% of the voting power. He can raise money without losing control. Companies do this for the same reason. The most common structure you'll encounter is a dual-class system:

• Class A Shares: Typically sold to the public with 1 vote per share.
• Class B Shares: Typically held by founders, early investors, and executives, with multiple votes per share (10-to-1 is common) or sometimes exclusive voting rights on certain matters.

There are also Preferred Shares, which are a different beast entirely. Think of them as a hybrid between a stock and a bond. They usually have no voting rights but get paid their dividends before any common shareholders. If the company goes bankrupt, they also get their money back before common shareholders. They have preference, hence the name. For the value investor, however, the primary focus is on the different classes of common stock, because this is where the critical issues of control and ownership truly lie.

“In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don't have the first, the other two will kill you.” - Warren Buffett ¹⁾

To a speculator, share classes are irrelevant. They only care if the stock ticker goes up or down. But for a value investor, who views buying a stock as buying a piece of an actual business, the share structure is a fundamental aspect of the investment's quality and risk. It goes to the very heart of the principal_agent_problem. Here’s why it's so critical: 1. Alignment of Interests: As Benjamin Graham taught, you are buying a business, not a lottery ticket. You want the people running the company—the management and board of directors—to have their interests perfectly aligned with yours. In a company with a single class of stock, a founder who owns 20% of the shares has 20% of the voting power. Their financial success is directly tied to the success of all other shareholders. In a dual-class company, that same founder might own only 5% of the economic interest but control 51% of the votes. This creates a dangerous disconnect. They can make decisions that benefit themselves (like awarding themselves a massive salary) without bearing the full financial consequences, which are spread among all the other shareholders. 2. Management Accountability: What happens if a brilliant, visionary founder starts making terrible decisions? In a normal company, shareholders can vote to oust underperforming management or reject a bad strategy. This accountability is a crucial safety net. In a company with super-voting shares, the founder and their inner circle can be effectively immune to shareholder discipline. They become entrenched. A value investor needs to ask: Am I buying a stake in a well-governed business, or am I handing my capital to an untouchable monarch? 3. The Erosion of Margin of Safety: Your margin of safety isn't just about buying a company for less than its intrinsic_value. It's also about the quality and predictability of the business. A poor governance structure, like one that disenfranchises public shareholders, is a significant, unquantifiable risk. It's a “governance discount” that should be applied. If you can't trust that management will act in your best interest, the intrinsic value of your shares is inherently lower and more fragile. 4. Long-Term Vision vs. Dictatorship: Proponents of dual-class shares argue they protect visionary leaders from the short-term whims of Wall Street, allowing them to focus on long-term value creation. There's some truth to this. Companies like Google (Alphabet) and Berkshire Hathaway have used these structures, and it's hard to argue with their success. However, for every Warren Buffett or Larry Page, there are countless other founders who use this power to run the company into the ground, safe from any challenge. As a value investor, you must make a judgment call on management_quality. Is the person holding the super-voting shares a generational genius you're willing to trust unconditionally, or just an average executive who has insulated themselves from accountability? The former is rare; the latter is common.

Analyzing a company's share structure isn't about complex math; it's about investigative work. You're acting like a detective, looking for clues about power and control.

You can find all the information you need in a public company's official filings with its country's securities regulator (e.g., the SEC in the United States). The key documents are the IPO Prospectus (Form S-1), the Annual Report (Form 10-K), and the Proxy Statement (DEF 14A).

1. Step 1: Locate the “Description of Capital Stock” Section

Use the search function (Ctrl+F) in the annual report (10-K) and look for phrases like “Capital Stock,” “Common Stock,” or “Description of Securities.” This section legally defines the rights associated with each share class.

1. Step 2: Identify the Different Classes and Their Voting Power

The document will explicitly state the classes of stock the company is authorized to issue (e.g., Class A Common Stock, Class B Common Stock, Preferred Stock). Look for the sentence that describes the voting rights. It will sound something like this:

  > //"Each holder of Class A common stock shall be entitled to one vote for each share... Each holder of Class B common stock shall be entitled to ten votes for each share."//
- **Step 3: Ask the Critical Value Investing Questions**
  Once you know the structure, analyze its implications:
  *   **Who holds the power?** The Proxy Statement will list the major shareholders and how many shares of each class they own. Calculate the total voting power held by insiders. Is it over 50%? If so, they have absolute control.
  *   **Is there a "sunset" clause?** Some modern dual-class structures include provisions where the super-voting shares automatically convert to regular shares after a certain amount of time (e.g., 7-10 years post-IPO) or if the founder leaves the company. This is a huge plus, as it prevents the power from being inherited by less-capable descendants.
  *   **Are the economic rights equal?** Usually, different classes of common stock share equally in dividends and liquidation proceeds. Verify this. If the super-voting shares also get preferential economic treatment, it's a massive red flag.
  *   **How trustworthy is the controlling party?** This is the most subjective but important question. Has the founder/family demonstrated a history of prudent capital allocation and respect for minority shareholders? Or do they have a track record of self-dealing? Read their past shareholder letters and watch interviews to assess their character and philosophy.

Let's compare two hypothetical tech companies, both looking to go public. “OpenBook Inc.” This company has a modern, shareholder-friendly approach. It decides to issue a single class of common stock.

• Structure: One class of stock. 1 share = 1 vote.
• Insider Ownership: The founder, Sarah, owns 30 million shares. The company sells 70 million shares to the public.
• Control: Sarah owns 30% of the company and thus controls 30% of the votes. To make major decisions, she needs to persuade other shareholders to vote with her. Her financial success is directly tied to theirs.

“FortressTech Corp.” This company is led by a founder, Tom, who wants to retain absolute control. He opts for a dual-class structure.

• Structure:
  • Class A shares (for the public): 1 vote per share.
  • Class B shares (for Tom): 10 votes per share.
• Insider Ownership: Tom keeps 10 million Class B shares. The company sells 90 million Class A shares to the public. Tom only owns 10% of the total equity.
• Control: Let's do the math.
  • Public Votes: 90,000,000 shares * 1 vote/share = 90,000,000 votes.
  • Tom's Votes: 10,000,000 shares * 10 votes/share = 100,000,000 votes.
  • Total Votes: 190,000,000.
  • Tom controls 100M / 190M = ~53% of the voting power with only 10% of the economic stake.

^ Comparison ^ OpenBook Inc. (Single Class) ^ FortressTech Corp. (Dual Class) ^

As a value investor, the structure of OpenBook Inc. is far superior. It represents a partnership with aligned interests. Investing in FortressTech Corp. is a bet not on the business, but solely on the unending brilliance and integrity of its founder, Tom. That's a much riskier proposition and demands a much larger margin_of_safety.

Dual-class share structures are not inherently evil, but they are inherently more risky for outside investors. It's crucial to understand both sides of the argument.

• Long-Term Vision: In an industry that requires massive, long-term R&D and investment (like biotech or technology), this structure can shield a visionary founder from Wall Street's pressure for quarterly profits, allowing them to build a more durable moat.
• Takeover Defense: A company with a controlling shareholder is nearly immune to hostile takeovers. This can provide stability and prevent a forced sale at an inopportune time.
• Preservation of Culture: For some companies, the founder's unique vision and culture are their biggest assets. Super-voting shares ensure this culture can be preserved and not diluted by outside influences. This was part of the argument for The New York Times and Ford Motor Company.

• Management Entrenchment: This is the biggest risk. Poor leadership, bad capital allocation, and value-destroying acquisitions can go unchecked because management is accountable to no one but themselves.
• Weakened corporate_governance: It creates a system of “haves” and “have-nots” among shareholders. This can lead to insiders approving excessive pay packages, related-party transactions, or other decisions that benefit them at the expense of public investors.
• Succession Risk: The magic often resides with the founder. When that founder retires or passes away, the super-voting shares are often passed to heirs who may lack the same business acumen. You could be stuck with entrenched, incompetent management for generations.
• Lower Long-Term Returns: Numerous academic studies have shown that, over the long run, companies with dual-class structures tend to underperform those with single-class structures. The initial benefits of a visionary founder often fade, while the costs of poor governance grow over time.

• corporate_governance: The system of rules, practices, and processes by which a company is directed and controlled. Share classes are a cornerstone of this.
• voting_rights: The specific power granted to shareholders to vote on corporate matters.
• management_quality: A key qualitative factor in investing; a dual-class structure requires you to have near-absolute faith in it.
• principal_agent_problem: The inherent conflict of interest between management (the agent) and shareholders (the principal). Dual-class shares can exacerbate this problem significantly.
• margin_of_safety: A governance structure that disenfranchises you is a risk that must be factored into your margin of safety.
• owner_earnings: Understanding who controls the company is essential to knowing how these earnings will be deployed in the future.
• dividends: The distribution of profits, which may be equal across share classes, but the decisions on whether to pay them are controlled by the super-voters.