Why Your Corporation Should Have Different Classes of Shares

It's All About Cash & Control

Equity means Ownership.

It’s entitlement to make decisions and receive the business’ profits. In that sense, it’s everything. Cash and control are why people go into business in the first place. Even if you see yourself as having a selfless mission outside of the twin aims of cash & control, the truth is that mission needs a functioning business around it so that it can sustain itself.

Voting vs. Non-Voting Shares & Preferred Shares vs. Common Shares

How equity is structured is equally important. You can split these twin aims into separate parts. You commonly see this as voting and non-voting shares of a corporation, in which one class is entitled to make decisions, while the other is not. Meanwhile the cash entitlement aspect of equity is separated by what are called preferred shares, which are entitled to receive profits before other classes of shares, typically called common shares.

Typically the trade for one is the other. Meaning its very common to find that preferred shares are nonvoting shares, putting cash before control; and that voting shares are common shares, putting control before cash.

How To Authorize Shares of a Corporation

In a corporation, equity is managed through shares. When the corporation is being formed, its formation documents authorize a certain number of shares. When the corporation begins operating, the corporation issues some or all the shares authorized by the formation documents. The founder(s) divvy up those issued shares how they see fit and become the shareholders of the corporation (i.e. the corporation’s owner(s).)

This makes bringing in new shareholders easy. Simply have the new shareholder acquire any unowned issued shares, or issue new shares from the amount authorized and have the new shareholder acquire those new shares, or amend the corporation’s formation documents to authorize more shares, then issue those new authorized shares, which the new shareholder acquires.

Different Strokes for Different Folks

 There are reasons you want different classes of shares. For example, your early investors, likely your friends and family, may lack the business acumen needed to make important decisions, but should still be rewarded for their early belief in your success. So giving them non-voting preferred shares is likely appropriate.

You could want to attract outside investors,. Those investors, especially if from a private equity firm, are also going to want control. They know that any investment they make will payout over a term of years, so getting their initial investment back is not top of mind. So on top of the board seat they’ll inevitably ask for, prepare to give them voting shares.

Or perhaps, you want to attract small investors who would be turned off by a large share price. If so, creating classes of shares, with different voting and preference rights, similar to Berkshire Hathaway’s Class A and Class B stock, would be advantageous.

There are almost unlimited ways to structure your corporation’s equity. This flexibility allows for a ownership structure that works for you.

How To Structure Equity in an LLC

It is possible to structure an LLC’s equity like that of a corporation. However, there are some technicalities. An LLC’s equity is typically described in percentages. The solution is to describe ownership in terms of “units,” which would be the equivalent of shares in a corporation. Then you would structure the different classes of units the way you’d describe different classes of shares.

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