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Back to the future: Expected resurrection of multiple-vote share structures in Germany

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Daniel von Bülow
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Daniel von Bülow
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When founders prepare to take their company public, the prospect of losing control over their business can be daunting. In the United States, dual-class structures can help alleviate these concerns as they provide certain shareholders with voting power that is disproportionate to the economic interest they own in the company. German corporate law banned these structures in the late 1990s – but they are about to become permissible again and the recently published draft of the “German Future Financing Act” (Zukunftsfinanzierungsgesetz) sheds light on the potential legal framework. But a crucial question is whether it would enable German companies to implement structures in a way that lives up to the most prevalent features of the US market. This post provides an overview of the key characteristics of the proposed German multiple-vote share structure and provides a comparison to the most common features of dual-class structures in the US market.

In anticipation of this change in legislation, much can be learned from the US experience when identifying how German companies can implement comparable structures and how these features can be marketed effectively in an IPO.

The past and the present: Dual-class structures in the United States and Germany

Currently, approximately 90% of US public companies have a single-class share structure in place. However, over the last several years, the popularity of dual-class structures among US companies going public has increased, particularly among technology companies. US companies are not the only ones to find these structures to be attractive – specifically, among German companies, a few of them have successfully gone public with a structure that functionally provides disparate voting power among shareholders, even though dual-class structures themselves have been prohibited. For example, under German corporate law a company can issue non-voting preferred shares (Vorzugsaktien). Alternatively, founders may choose a German partnership limited by shares (Kommanditgesellschaft auf Aktien, KGaA) as their IPO vehicle, which allows certain shareholders to exert greater influence on the company’s decision-making bodies irrespective of their economic interest in the company. However, the corporate governance of these structures is atypical and may not be as widely understood by international investors. As a result, founders of German companies oftentimes consider opting for non-German corporate entities that do permit dual-class structures (such as the Dutch N.V.).

Breaking down dual-class structures in the United States and under the proposed German draft Act

In April 2023 the first draft of the German Future Financing Act was published, and a revised draft is expected to be published over the summer. The full legislative process is expected to be completed by the end of 2023 so that the provision could enter into force early 2024. Unlike the US approach, the German draft Act aims to tightly regulate these shares structures to ensure a certain level of shareholder protection, instead of leaving the design of dual-class structures to market forces and key stakeholders to freely determine acceptable structures.

The chart below compares the key features of dual-class structures in the US market and pursuant to the German draft Act:

Feature

US market practice

German draft Future Financing Act

Eligible companies

  • Delaware incorporated entities are eligible to have dual-class stock structures, although stock exchange requirements limit the ability of already public companies to adopt dual class structures.
  • Multiple-vote share structures are available for all entities regardless of whether they are listed.
  • In contrast to the European Commission's proposal, the German draft act allows companies to implement multiple-vote share structures irrespective of whether they seek a listing on a registered market for small and medium-sized enterprises (e.g., the “Scale” segment of the Frankfurt Stock Exchange), or a more regulated market.

Implementation

  • Implementing a dual-class structure requires a recapitalization by way of share-for-share exchange or by way of conversion of all outstanding stock.
  • Approval by the board and requisite shareholders is required for such a recapitalization, as determined pursuant to the company’s organizational documents or applicable state law.
  • No legal restrictions as to who is eligible to receive high-vote stock as part of recapitalization.
  • The structure can be established at any time in a company’s lifecycle either by designating existing shares as multiple-vote shares or through the issuance of new shares.
  • Introducing this structure requires consent by all shareholders. Hence, for practical purposes they may only be introduced during the pre-IPO stage when there are fewer shareholders and obtaining their consent is feasible.
  • No legal restrictions as to who is eligible to hold high-vote stock.

Voting ratio

  • The number of votes for each high-vote share can be set in the company’s discretion. Most companies have implemented a ten-times or a twenty-times voting right for high-vote shares, but there are also examples of lower or higher ratios .
  • Shares may carry up to ten times the ordinary voting right; a higher ratio is not permissible.

Conversion upon transfer

  • High-vote shares generally convert to low-vote shares upon a transfer to a third party other than any permitted transfers provided for in the company’s charter.
  • These permitted transfers often include transfers for estate-planning or charitable purposes and sometimes transfers among co-founders or among the founder’s family members are also permitted without triggering a conversion.
  • Multiple voting rights fall away upon any share transfer. There are no permitted transfers.

Sunset mechanism

  • A time-based mechanism pursuant to which all high-vote shares convert into low-vote shares (so-called “sunset clause”) is not legally required but is often (but not always) a key feature of dual-class structures. Proxy advisory firms and institutional investors advocate for these clauses with a preferred sunset of less than seven years.
  • Typically, the time-based sunset period is seven or ten years after the IPO date (although there are examples with longer or shorter periods).
  • In addition, event- or dilution-triggered sunset mechanisms may be included: for example, conversion is often triggered once the number of high-vote shares falls below a certain level, by the death or disability of the founder, or the founder’s departure from the company.
  • Mandatory time-based sunset with a period of a maximum of ten years after the IPO date.
  • This sunset period may be extended for a period of up to ten years. This extension requires a 75% majority of the share capital (not just the votes) represented at the shareholders’ meeting, meaning that holders of multiple-vote shares may not be able to push through an extension by themselves. Any such extension can only be implemented one year before the expiration of the original time-based sunset.
  • Other sunset mechanisms may be implemented.

Proxy advisors

  • Proxy advisory firms recommend voting against directors of dual-class companies until the structure is removed or revised to a reasonable sunset (generally seven years or less) or the company provides sufficient protections for minority shareholders (e.g., allowing for a shareholder vote on whether the capital structure should be maintained).
  • Most relevant European proxy advisory firms are critical about these structures.
  • However, European proxy advisors tend to adopt a more relaxed approach for newly-public companies that feature a sunset of no more than seven years. They also acknowledge that these structures are generally accepted by investors in Europe if they do not impede effective governance or undermine minority shareholders’ rights.

Index inclusion

  • Until recently, other than for grandfathered companies, S&P Dow Jones did not include companies with dual-class structures in its indices but it reversed this decision in April 2023.
  • For FTSE Russell, companies with a free float of less than 5 percent of total voting power will be excluded for its indices.
  • Companies with multiple-vote share structures would be eligible for inclusion in the DAX indices.

Can the German proposal close the gap?

While the German draft Act is a step in the right direction, German companies seeking to adopt the US structures would continue to face limitations under the German draft Act, including s the following:

  • Voting ratio: While the 1:10 ratio aligns with the most prevalent ratio in the US, it does not reflect that the US practice allows for flexibility in determining the appropriate ratio. German companies will have to adhere to the maximum voting ratio of 1:10. Even though this ratio might not account for the specific composition of their cap table or might otherwise not be suitable for the company’s individual circumstances.
  • Conversion of multiple-vote shares: The German draft Act provides that the high-vote shares convert to low-vote shares upon transfer, without any exceptions. The currently proposed strict approach does not leave room to account for the circumstances of a transfer. This means that if a founder intends to implement a multiple-vote share structure it could potentially impede effective estate planning and intra-group reorganizations.
  • Mandatory time-based sunset mechanism: Prescribing a maximum sunset date ensures a return to “normal” corporate governance after a certain period. However, it prevents companies from designing a structure fit for their needs, for example one that is tailored to the unique business model of the company, the involvement of the founder or other legitimate business needs.

In light of the historical skepticism towards multiple-vote share structures in Germany, there will nonetheless continue to be challenges ahead to making these structures a success in the German market. However, experience with dual-class structures in the United States can here, too, serve as a helpful blueprint for promoting their success in Germany.

German companies wishing to adopt multiple-vote share structures should consider the following:

  • Disclosure is key: Founders should clearly present their long-term vision for the company and demonstrate how a multiple-vote share structure could support this vision. By doing so, a founder can help investors see the value this structure can bring to the company and all of its shareholders. In this way, the multiple-vote share structure will help promote the mission of the company and protect it against short termism or other stakeholder interests that risk diverting management attention from its long-term goal.
  • Design an effective governance structure: The capital structure of the company is just one element of its governance structure. Founders should focus on designing a holistic governance structure with features that counterbalance any perceived risks resulting from a multiple-vote share structure. For example, does the company have an appropriate number of independent supervisory board members in compliance with the German Corporate Governance Code requirement, composed of strong experienced members who are able to provide a check on management and adequately oversee the company?

In conclusion: A preliminary verdict on the German draft Act compared to the US practice

If the German draft Act comes into force with its currently proposed regulations, German companies would be once again permitted to adopt multiple-vote share structures that come close to mirroring the most prevalent features of the US market. However, because of the restrictions imposed by the German draft Act, founders of German companies would not enjoy the same level of flexibility available to them as their US counterparties. Therefore, founders of German companies may not see much value in opting for the proposed German structure and may instead continue to opt for using a non-German corporate form (such as the Dutch N.V.).

Nonetheless, we expect that the eventual adoption of the German draft Act will contribute to reducing the differences between the German and US market practices and generally help in strengthening the German capital markets.

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Tags

future financing act, ecm, corporate governance, financing and capital markets

Get in touch

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Daniel von Bülow
Principal Associate

Get in touch

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Daniel von Bülow
Principal Associate

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