The unfairness of dual class shares

Today Deliveroo has delivered, for some at least. The tech business linking hungry people to immediate gratification literally on the backs of gig economy workers has listed at a slightly reduced, though still steep price for a heavily loss-making business that offers no prospect of a dividend “in the foreseeable future”. However, the share price tumbled steeply on its first day of trading on the London market and at the time of writing is down more than 20% from its 390p launch price (still valuing the company at approaching £6 billion).

Stuttering though its reception may be, Deliveroo could be a harbinger of more to come. For its dual class share structure, with a share class with 20 votes each retained by the founder and CEO, Will Shu (who will enjoy 57.5% of the voting rights and so retain entire control), looks like a model that many are urging as part of the brave new future for the London market.

For the debate about dual class shares has been revived. Following the Hill UK Listing Review, London is the latest market apparently determined to further undermine shareholder rights in order to encourage the listing of technology companies, on the strange understanding that this is the only way that tech founders can keep control and so be willing to bring their companies to the market. 

The Review proposes allowing the inclusion of dual class share structures on the premium segment of the London market, as well as just the standard level – this would mean they would be included in the main market indices, which means many investors would invest in them automatically. Yet the whole point of public markets is surely that business leaders do cede some control, and invite other owners in to participate in business success, but also to have influence on it. If they are unwilling to cede control, founders do not need to sell – or they could retain a majority of the shares and not resort to a gerrymander of the votes.

Minority shareholder rights enable investors to protect their own interests and protect their investment; they represent the common law heritage of the rule of law and certainty of ownership. They have been built up over many years and provide a basis of certainty and security of ownership, enabling confidence that it is safe for investors to trust their money to the market. They are the very foundations of market confidence. There seems a risk that this is being forgotten in a rush of blood about a rush of money. 

Investors call shares equities precisely because they are supposed to give their owners equal rights – their fungibility is fundamental to liquid markets. And yet dual class share structures deliberately create unfair shares: these are inequitable equities. Indeed, it seems that investment bankers and others appear to be arguing for foisting inequities on the investing public.

Instead, we need the regulators and markets to protect investors. Caveat emptor is a fine expectation. But it doesn’t work in a world that requires employees to save for their pensions, facing individual risk, and with charge caps that (rightly) oblige providers to invest mainly through passive index funds. Forced buyers cannot beware. While such retail investors simply cannot, institutional investors ought to be able to protect themselves, yet the way that most institutions currently invest means that they too would find themselves buying whatever is included in the index.

Forced buying of these inequitable equities seems to be the point. The proponents of including dual class stocks in the indices are keen to ensure that there is a ready market for the shares from index investors, that there is an automatic demand. This mindset is built into the Hill Review. Indeed, the Review rather oddly suggests that investors need to have a discussion about what standards they wish to require for inclusion in the index, rather than automatically linking index inclusion to premium listing on the London market. This ignores the fact that this exact linkage between index inclusion and the premium listing standards has been hard fought by investors on a number of occasions over the last several years: it is deliberate, not an accident, something that institutions have sought so that they continue to enjoy the minority shareholder rights that they so value. The Hill Review also argues for dismantling the terms ‘premium’ and ‘standard’ so that standard listing does not seem a lesser expectation – again in apparent ignorance that this quality distinction was entirely deliberate.

The debate on dual class shares specifically was last had back in 2017, in the US in particular, when the IPO of Snap forced it onto the agenda. Snap listed non-voting shares, with essentially all voting rights left in the hands of its two founders. In fact, because the company said that investors should not expect dividend payments, the instruments it issued were not really shares at all but in effect warrants – simply a right to hoped-for capital appreciation.

At that time, I and other investors tried to persuade the index providers to limit the inclusion of stocks in indices according to their voting power at the company, avoiding the inclusion of non-voters altogether and cutting the weighting of lower voting shares also. Some will argue that index investors would thereby have missed out on great recent performance by various tech businesses – but who knows what the share price performance of these companies would have been but for their full inclusion in indices and the heavy fund flows in recent years into passive investment strategies? I know that a number of investors are exploring ways to tailor indices so that they are not forced buyers of unfair shares, should the rules be changed as proposed.

Deliveroo’s, and Snap’s, lack of any prospect of a dividend is not unusual among the soaring technology stocks, even those with more mature businesses and huge market shares. There is no dividend from Alphabet (Google), Amazon or Facebook, let alone Spotify or Twitter. These companies’ cashflows, when not reinvested, are used for share buybacks – much of which is needed to neutralise the impact from the dilutive effect of heavy share issuance to employees as part of their compensation. That dilution, of course, does not affect the class of shares enjoyed by the founders, only that to which outside investors are exposed.

Investors in these companies thus do not expect dividends, and are not buying shares on the expectation of cash returns from the businesses themselves. Rather, they are willing to buy these shares on the expectation that someone else will later pay them more on the market. This is usually called the greater fool theory. Though sometimes it seems hard to believe, the world does always eventually run out of fools.

Perhaps the greatest risk with the dual share class approach is that the leaders of these businesses are insulated from influence. They literally do not need to listen to anyone, at least as long as they can fend off regulation. That ability to remain cloth-eared to outside influence is seen by them as a strength – they can ignore the supposed short-termism of the markets – but it can easily be a weakness, as shown by how slow many of the tech giants have been to respond to concerns about their role in fostering hatred and anger and in damaging democracy. Some tech leaders show an unwillingness even to consider rational questioning from within their own organisations

The Deliveroo prospectus was blunt about this: 

“The Founder’s ability, while he and any Permitted Transferees hold sufficient Class B Shares, to block any resolution to remove him as a Director will mean that his position on the Board, and his influence over the decision-making of the Company through decisions made by the Board, will effectively be entrenched for so long as the Founder wishes to remain on the Board.”

One hopes that Mr Shu at least will learn to listen. The remarkable efforts of the wonderful Bureau of Investigative Journalism show that, as is true of so many gig economy workers, Deliveroo riders can earn well below the minimum wage. Concerns about this, and about the unfair dual class share structure, were enough for some institutional investors to avoid investing in the company. For the time-being, they can choose, because the company is only making a standard listing; if the Hill Review proposals are adopted, not all of them will be able to avoid making an investment. At that point, absent regulatory intervention, Mr Shu alone will have been able to choose the ongoing business model for the company, and its treatment of its riders. 

Let’s hope he chooses greater fairness in relation to the workforce than he has in relation to investors.

Deliveroo Prospectus, March 2021 [not available in some geographies]

UK Listing Review, Lord (Jonathan) Hill, March 2021

Deliveroo riders can earn as little as £2 an hour during shifts, as boss stands to make £500m, Bureau of Investigative Journalism, March 25 2021