Creating different classes of shares

What are alphabet shares?

While many companies manage well with only one class of share – ordinary shares – others find it advantageous to create different classes of shares, allocating different rights to each class – so called ‘A’, ‘B’, ‘C’ or ‘alphabet shares’.

The rights of each class of shares will be set out in the Shareholder Agreement. Any class of share, regardless of its label, can be bestowed with the key rights. Or all shares could all be created equal. It is up to the shareholders to decide at the outset.

The lettering system doesn’t in itself create a hierarchy of rights. This is not a measure of celebrity status. A shares are not automatically more glamorous than B shares. D shares could be just as desirable as C shares. There is no need to take offence or feel shame if you are being offered Z shares. The shares could even be distinguished by colour code: red shares, yellow shares, blue shares. Labels are just labels.

Different classes of shares are commonly used to create a means of allocating dividends to shareholders in a more tax efficient way, allowing different rates of dividends to be paid to different classes of shareholder.

What are share class rights?

Different classes of shares can also carry different rights, such as the right to vote at shareholder meetings, the right to receive dividends, or the right to receive a share of the sale proceeds when the company is sold. Creating different share classes can also be used for a founding shareholder to retain greater control over the company – he may create non-voting ‘B’ shares for the other shareholders which only enjoy dividend rights, while retaining all ‘A’ shares, which could be bestowed with the voting rights, for himself.

Mark Zuckerberg exercises almost total control over Facebook, whilst owning approximately only 25% of its shares.

Where shares are offered as an employee incentive the availability of different classes of shares can be a particular boon, granting an employee the right to receive a small share of the sale proceeds if the company is sold in future, without inviting them to have a say in board meetings or even paying them annual dividends.

Once created, it is fair to the shareholders to spell out that the share classes cannot be changed without the consent of those holding the relevant class of shares (for example, by converting full voting ‘A’ shares into non-voting ‘B’ shares). The Shareholder Agreement can provide a detailed summary of each share class, to avoid confusion.