All Shares Are Not Created Equal

 

A corporation can have even more fun with dual common before it goes public, by writing it into the charter document. One ploy newly public companies have been adopting is to stipulate that votes be reduced in any block of stock representing more than a small percentage of the total shares outstanding. Thus a party accumulating a large position -- over 20%, say -- ipso facto suffers severe voting dilution. (Of course, the charter document exempts present big-block shareholders.) Each situation is different, and emerging corporations can devise just about any deal they want, declares Thomas F. McKee of Calfee, Halter & Griswold, a Cleveland law firm with a specialty in multi-class entities. Indeed, a few angst-ridden entrepreneurs have started from scratch with fail-safe voting ratios as low as one to 100 -- or even, as in the case of The Washington Post Co. in 1971, zero to one. But, the lawyers caution, underwriters don't like to see terms that are too ridiculous.

So far, underwriters are going along with the trend -- if trend it can be called. More than 50 initial public offerings have come out with multiple classes of common in the past three years, and of those, some did it more out of necessity than conceit. A broadcasting license, for example, can be removed by the Federal Communications Commission if business control of the station changes hands; pocketbooks loosen up when they can be assured the investment won't inadvertently become worthless by outside interests taking over. Even so, with the NYSE hopefuls and the cachet of sch names as Dow Jones & Co. and Hershey Foods Corp. already in the recapitalizing camp, dual-class popularity is bound to pick up.

Indeed, there's no reason why all private corporations planning to go public shouldn't capitalize with two classes of common -- one retained by the owners, the other marketed to investors. In 1985, OshKosh B'Gosh Inc., a clothing manufactuer in Wisconsin, eased nicely into the public arena by first recapitalizing one share of common into 15 Class A nonvoting shares and 5 voting Class B. A group of major stockholders then sold blocks of their Class A holdings through an underwriter, and -- voila -- the company was public. Even though they sold a lot of stock, insiders' votes remained undiluted. The Class A buyers (b'golly, OshKosh assigned "A" to the public stock "because it sounded better") were rewarded with a 15% bonus in cash dividends and the opportunity to elect one-quarter of the board. The IPO came out at $25 and by the end of the first day had been bid up to $30. "What that shows," concludes corporate secretary Steven Duback, "is that the lack of meaningful voting rights doesn't mean much." Perhaps not at the moment, among the genre's slim IPO pickings. But in the rush that is sure to come if the SEC grants the NYSE request, multi-class new issues may find the going nettlesome.

One current bramble is the hodgepodge of provisions -- called blue-sky laws -- by which individual states judge and regulate the fairness of securities offerings made to the general public. Even if the SEC passes on the new issue, an individual state can prevent it from being bought or sold there. A good number of states, including such financial hot spots as Texas and Massachusetts, ban unequal voting on IPOs outright. Others require minimum board representation, a ceiling on the voting ratio, or prominent statements in the prospectus notifying retail buyers that they'll be receiving irregular goods. In the aggregate, blue-sky laws can take away a considerable number of would-be customers.

Unequal-voting IPOs also may find they will have to forfeit the customary premiums associated with bull markets in new issues. To float inferior securities successfully, a concession in price might have to be granted, since savvy investors will be unwilling to sign up for voting impotence. Or to miss the chance of a quick killing when takeover rumors send the stock soaring higher than sedentary executives could. While it may be tempting to write a clause in a company's charter document allowing an inferior-vote class of common at a future date when it's needed, don't: underwriters want to know exactly what they are buying; they wouldn't like it if the second class came out down the road. "Either do it up front," say Calfee, Halter & Griswold, "or leave it out of the charter document altogether and get a vote of all the shareholders later."

For today's light offerings, underwriters steer around irritating blue-sky laws and recalcitrant investors. But Paul H. Carleton, senior vice-president of corporate finance of NYSE member McDonald & Company Securities Inc., predicts that indiscriminate adoption of multi-class capitalization by emerging corporations could eventually be self-defeating. "When too many think they can get away with it," Carleton frets, "the market will exact its penalty." And it could be severe, as under any regime where the only recourse left to disenfranchised citizens is revolt.

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