Silicon Valley Legal Bible（14）Same Share Different Rights

Silicon Valley Treasure Trove Forty-Two Chapter Sutra, a legal encyclopaedia tailored for founders. I am Liu Xiaoxiao, a U.S. attorney.

In the process of development of startups, equity will be gradually diluted, and many entrepreneurs will say that they want to use the "same share different rights" structure, saying that this kind of structure can allow the founder to still control the company after the development of the company. But is "equal shares with different rights" really as magical as people think? Can every company do the same shares with different rights? Today we will learn more about the concept of "Equalisation and Diversification".

1. Three misconceptions about different rights on the same shares

1.1 Misconception 1: Equal shares with different rights can prevent the investor from taking power

We may often see media reports that say, what which which company through the different rights of the same shares, so that the founder's shares are not subject to investor dilution. Many founders say, "Oh, I'll give those VC investors different shares, so they can't dilute my shares.

People don't believe too much in these news media eye-catching reports. They are actually confusing the concepts of "private investors" and "public investors". Some people still don't know who a public investor is, right? They are the people who buy shares with a click on a mobile phone app, the common people like you and me.

Shares are broadly categorised into ordinary shares and preference shares, and "same shares, different rights" means the same type of shares, but with different rights. Let's first figure out what kind of shares are held by these different people:

- Founders get ordinary shares.

- Publicly traded investors get ordinary shares.

- Private investors get preferred shares.

So for founders who haven't gone public yet, who are still in the early stages of private investment, what you have to worry about is your relationship with the private investors. And the preferred shares of the private investors and the common shares of the founders, they're not the same shares, so naturally they don't have the same rights, and the difference is that they're not the same shares with different rights, they're not the same rights with the same shares.

The natural question is whether the different shares have different rights, and whether the founders can be given more rights than the private investors. Come on, don't think too beautiful, why is the founder's called "common stock", private investors called "preferred stock", is because people's private investors' equity naturally has higher priority than the founder's equity, otherwise who would want to invest in a few shares of your company when it's still unknown? Who else would want to invest a few million when your company is still unknown?

1.2 Misconception 2: Same share different rights is a check and balance between founders?

We will share some cases later, you can find that the same share different rights in are in the company is about to go public when the structure will be taken into account, rather than the company just set up when the structure between the founders, for the founders, the size of the power between you is based on the proportion of shareholding division.

1.3 Same share different rights is a veto power for certain important matters?

A lot of entrepreneurs say they want to do same share different rights, but talking to them, they find that what they want is actually a veto on some major matters. In our next example, you will find that the differentiated stock option is actually "one share for ten shares", not a veto power.

2. The case of different shares in the United States

Let's look at some examples.

2.1 Google

Nowadays, almost everyone knows about different shares and all companies want to do different shares. But in fact, before Google's IPO in 2004 which reintroduced the same share differentiation, the last one that adopted the same share differentiation was Ford Motor more than half a century ago.

Google's equal shares are divided into Class A and Class B. Class A shares are offered to stockholders who buy shares on the open market, and these shares have one vote per share, while Class B shares are for founders Page, Brin, and the company's core members, and have 10 votes per share.

So that means that as long as Class B shares make up more than 9.1 percent of the stock, they can have more voting power than all the Class A shares combined.

But even so, as more and more shareholders are buying shares publicly on Nasdaq. When Class A stock exceeded Google's 90.9% in absolute numbers, there was still the possibility that Google's founders and core members would prevail in the vote.

So in 2014, Google proudly introduced Class C stock.

Class C stock is a type of stock that is treated even worse than Class A stock, and while it is also sold to stockholders who buy it through public channels at NASDAQ, these Class C shares don't have any voting rights at all.

So to summarise, it's

- One share of Class A stock counts as 1 share

- Class B shares count as 10 shares

- One share of Class C stock counts as zero.

2.2 Facebook

Facebook is also divided into A shares and B shares, where A shares are held by the general public and one share counts as 1 share, and B shares are held by the founding team and one share counts as 10 shares. So even if Zuckerberg only owns 13.8 per cent of the shares, he holds 59.9 per cent of the voting power.

2.3 Snapchat.

In 2017, Snapchat, the after-reading social tool, went public on the New York Stock Exchange.Snapchat was even more ruthless by launching three classes of stock right off the bat: class A, class B, and class C. Class A was for publicly traded shareholders on the New York Stock Exchange, class B was for the company's outside executives as well as early investors, and class C was simply for the company's two founders, Evan Spiegel, and Bobby Murphy.

3 Same-share different rights for Chinese companies

3.1 Jingdong.

After Jingdong was listed on the Hong Kong stock market, it adopted Class A and Class B shares, where Class A shares are the shares that are publicly traded on the Hong Kong stock market to the shareholders. And Class B shareholders are those of company insiders. The difference in voting rights between the two tiers of Jingdong's stock is even more dramatic, with one share of Class A stock counting as one share, while one share of Class B stock counts as 20 shares. That's what leads to Liu having nearly 80% of the voting power, even though he only owns 15.5% of the stock.

A lot of the news media like to say something about how Liu alone has more or less voting rights than others, but in fact it should be said that it's the insiders of the company, represented by Liu, which is trying to show that the same shares with different rights is not used to differentiate the shares between different founders. So it's still the news media to blame for the exaggeration.

3.2 Xiaomi.

At Xiaomi, two of the founders, Lei Jun and Lin Bin, own Class A shares, while others own Class B shares. Lei Jun owns 31.41% of the shares and has more than 55.7% of the voting rights. While Lin Bin owns 13.33 per cent of the shares and has 30 per cent of the voting rights.

3.3 The Demise and Rebirth of Same-Share Different Rights in Hong Kong Stocks

You will notice that both Jingdong and Xiaomi are actually listed on Hong Kong stocks. Why? Because the law in mainland China has always disallowed different rights on the same shares until 2019, when the Shanghai Science and Technology Innovation Board began to allow it, but it is only the Shanghai Science and Technology Innovation Board, and all other boards are still disallowed. That's why companies that wanted to do same-share-different-rights before went to Hong Kong stocks for listing.

But some people are going to say, I heard that Alibaba didn't go to Hong Kong to list at that time, but listed on NASDAQ, just because there is no same-share different rights in Hong Kong stocks? Yes, once the same shares with different rights is a very common shareholding structure of Hong Kong listed companies, but I do not know why, after 1989, the Hong Kong stock abolished the same shares with different rights, until 2014, Ali plans to use the same shares with different rights to impact the Hong Kong stock failed, turned to list on NASDAQ, so that the Hong Kong stock missed the $25 billion of the largest IPO in history.Hong Kong Stock Exchange learnt from the bitter experience, and finally in 2018 moved back to same-share different rights again.

Seeing this, you should also know that the same shares with different rights, whether AB shares or ABC shares, in which the voting rights of the worse conditions, are those who are the majority of public investment in the shareholders. The same shares with different rights is not discrimination against private investors, nor unfair treatment between different founders, nor a veto on certain important matters. In the unlisted stage of the startup, don't be delusional to think that through the same share different rights of what magic to achieve equity subversion, or down to earth to build a healthy equity structure.

The Silicon Valley Treasure Book of Forty-Two Chapters, a legal encyclopaedia tailored for founders. I'm Xiaoxiao Liu, a U.S. attorney.