There is a dearth of British tech-companies listing on the London Stock Exchange (LSE), and the LSE lacks a large, innovative tech-company such as Google. The UK Government has pinpointed attracting tech-firms to the LSE as a policy priority. However, the search for a ‘British Google’ has proved elusive. In my Article (Cambridge Law Journal, forthcoming), I extoll the potential for the use of dual-class stock in the publicly-listed company sphere to encourage the listing of high-growth tech-firms.
Dual-class stock is a share capital structure pursuant to which voting rights attached to shares vary between different classes of stock. Such a capital structure can enable a founder to retain a majority of the voting rights in a company while holding a disproportionately lower level of the cash-flow rights. In the US, the founders of companies such as Alphabet (the parent company of Google), Facebook and Snap have retained control of their companies while only holding a minority of the cash-flow rights. In the UK, on the premium-tier, the most prestigious tier of the LSE, dual-class stock structures are, effectively, proscribed.
For the founder of a British tech-company, listing on the premium-tier brings with it various compromises. Since the concept of one share, one vote must be respected, the founder will either cede control to a disparate group of public shareholders, or retain a majority of the shares and, therefore, cash-flow rights in the company. The former strategy exposes the founder to being indirectly removed from the management of the company at the will of the public shareholders, and the latter strategy restricts the ability of the founder to diversify its wealth and the level of future equity funding for growth. Accordingly, founders currently face a ‘catch-22’, which may explain the reluctance of founders of tech-companies to list in the UK. Although the UK is home to several private tech ‘unicorns’, the opportunity for public investors to participate in their growth and success is curtailed by a scarcity of such firms on the UK public markets. UK tech-firms are disproportionately the subject of M&A activity, with numerous such firms being acquired by foreign predators. Dual-class stock, by enabling a founder to retain control while substantially divesting of its investment in the company and generating significant equity finance, could solve the catch-22 scenario facing founders, and encourage British tech to remain British.
In the paper, I outline the benefits that dual-class stock can bring to high-growth tech-companies. For example, the investments often required by such firms in R&D and long product-cycles can be achieved without fear that the management of the company will be removed if short-term profits decline. A founder with a disproportionately small equity holding can sustain fluctuations in share price in favour of long-term profits, without being punished by the public shareholders. The same rationale can lead to greater risk-taking by dual-class companies which is an essential element of innovation. Dual-class stock can also benefit public shareholders by bonding a visionary founder to the firm, and such long-term commitment and bonding can, in turn, engender the development of long-term relationships of trust with suppliers and customers, and the investment of firm-specific human capital by employees that is much needed in the tech-industry.
The benefits of dual-class stock must be balanced, though, against the potential detriments which have driven institutional investors to view such structures with distrust. The key concern is that a controller will cause the company to take actions that are personally beneficial to the controller—the extraction of private benefits of control—but detrimental to the company and public shareholders. If the controller only holds a low level of the equity, it will only suffer a small degree of pain from the extraction of those private benefits. The incentivisation of such behaviour through the adoption of dual-class stock can manifest itself in the tunnelling of assets and profits out of the firm to the controller, the taking of actions that prioritise the reputation and fame of the controller over the profits of the company, and the entrenchment of an underperforming management team.
My paper describes how, in the context of UK high-growth tech-companies, it is more likely that the potential benefits will outweigh the detriments. The UK embraces strong investor protection mechanisms, related-party transaction regulations, and anti-fraud laws. Furthermore, high-growth firms may need to keep open the option of tapping the equity markets for further funding, deterring founders from egregiously expropriating public shareholders which would cause a corresponding increase in the cost of capital. It is accepted that certain types of private benefit extraction could still prejudice the interests of outside shareholders, but with the implementation of further limited investor protections and the strengthening of related-party transaction regulations, dual-class stock could be introduced to the premium-tier in a pragmatic manner.
With the economy facing some dark days, any tools which can encourage the UK’s entrepreneurs to innovate and create success should be considered. With the implementation of judicious regulatory restraints, the use of dual-class stock on the premium-tier could kick-start the UK’s tech-sector and a British Google may not be as elusive as some think.
Bobby V. Reddy is a Lecturer in Corporate Law at the Faculty of Law, University of Cambridge.