Classes of Stock: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Each class of stock comes with its own list of features (voting rights, price, payout priority, etc.), with a number of advantages and disadvantages for each. 5 min read
Before you purchase stock or issue stock as part of a new company, you need to have an understanding of the basic classes of stock. Each class of stock comes with its own package of features (voting rights, price, payout priority, etc.), resulting in a number of advantages and disadvantages associated with each. Here’s a look.
What Are Classes of Stock?
In the most general terms, there are two main types of stock: common and preferred. However, each type of stock may be further distinguished by class.
Note: “Classes of stock” should not be confused with “classes of shares.” Although the two terms may be interchangeable when referring to company stock, the term “classes of shares” may also refer to different classes of mutual fund shares.
Why are Classes of Stock Important?
The different classes of stock are handled differently, particularly when it comes to voting rights, and priority for paying out assets and dividends. If you are a stockholder, therefore, the types and classes of stocks that you own will have an affect on your portfolio’s overall value. If you are a start-up business, the types and classes of stock you issue may affect how much stock you sell and the overall valuation of your business.
Common stock is aptly named since it is the most common type of stock issued by a company. In most cases, if you purchase stock in a company on a major exchange, you will be buying common shares of stock. Common stock shareholders have voting rights that allow them to select members of the board of directors and provide a voice in company policies. They also possess an ownership stake in the company and a claim to a share of company profits. If the company has also issued preferred stock, common stockholders are placed in a secondary position when sharing in the company’s assets (i.e., after debt holders and preferred shareholders) in the event of liquidation or bankruptcy. Common stock ownership may come with other vested rights, such as preemptive rights (the right to maintain proportional ownership in the company in the event more stock shares are issued.)
Classes of Common Stock
For most companies issuing commons stock, there will only be one class of that common stock, with each share providing equal valuation and rights to every other share. There are companies, however, that issue two or more classes of common stock. These different classes are commonly designated by letter (Class A, Class B, Class C, etc.).
The biggest reason for issuing multiple classes of common stock is to allow for the assignment of greater voting rights (known as “super-voting” rights) for one class over another. For example, a company may create one class of stock (Class A), to be owned by the company founders and senior executives only, that assigns a greater per-share voting “multiple” than another class of common stock (Class B). In some cases, that multiple may be as high as 10 times that of the company’s Class B common stock, meaning that each share of Class A stock comes with 10 votes, compared to one vote for each Class B share. The purpose of doing this is to ensure that the founders and executives maintain control over the company’s board of directors and major corporate decisions. In this particular example, Class A shares would not be publically traded, their availability limited instead to company founders and senior executives.
Here’s another example of how a company may structure different classes of common stock:
Class A - Class A shares are similar to the shares issued by a company with only one common stock class. That is, Class A shares are available to individual investors and publicly traded. Each share comes with one vote.
Class B - Class B shares are similar to those described in the first example as Class A shares. That is, they are not available for trade to individual investors and are limited to ownership by company founders and top executives. Per-share voting power may be a multiple of those of Class A shares.
Class C - Class C shares are similar to Class A shares in all aspects, except that the Class C shares lack voting rights.
As can be seen from the two examples presented here, there are no terms or provisions specific to particular class designations. The rules and features of different stock classes depend on how each specific company defines them. For example, some companies designate less voting power for their Class A stock, when compared to Class B stock, in an attempt to disguise this disadvantage to the public. Therefore, it is important to always carefully check the details regarding a company’s stock classes to determine exactly what is being offered with each class.
Class F Stock - Class F stock is a common stock designation that has recently been used by a number of companies for shares available only to company founders. Class F shares typically come with features such as super-voting rights and restrictions on public trading.
Preferred Stock - Preferred stock is the other major type of stock issued by companies. As with common stock, preferred stock shareholders possess an ownership stake in the company and a claim to a share of company profits. They also typically receive dividends in a fixed amount on their preferred shares and enjoy a priority position (over common shareholders) to company assets in the event of the company’s liquidation or bankruptcy. On the other hand, ownership of preferred stock does not include voting rights. Preferred stock is sometimes characterized as providing features of both bonds and common stock shares. Preferred stock can be classified by the following four types:
Cumulative stock allows shareholders to carry over missed dividend payments if the company stops paying those dividends and then starts paying them again.
Non-Cumulative stock does not allow owners to collect dividends that may have been skipped.
Participating stock could have higher dividend payments, as long as the company has larger-than-expected profits.
Convertible stock may be converted to a certain number of common stock shares.
Classes of Preferred Stock
Separate classes is typically a feature of common stock. However, companies can issue different classes of preferred stock. The different classes are normally distinguished from one another by priority in payment of dividends and distribution of assets upon company liquidation or bankruptcy.
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