We recently represented Klaviyo, Inc. (NYSE: KVYO), in its $576 million initial public offering on the New York Stock Exchange. As has been extensively reported in the media, Klaviyo’s very successful offering represented the first IPO by a traditional venture-backed technology company in more than 18 months. Astute readers of the Form S-1 registration statement for the Klaviyo offering will have seen that Klaviyo implemented a high vote/low vote capitalization structure, wherein all pre-IPO stockholders now hold Series B common stock, which carries 10 votes per share, and the shares issued to the public in the IPO are shares of Series A common stock, which carry one vote per share. This high vote/low vote structure is certainly not uncommon in venture-backed technology IPOs completed during the last 10 years, and in fact, most of the details of Klaviyo’s structure were squarely in line with ample historical market precedent.
What was unique about Klaviyo’s structure was that the certificate of incorporation included several provisions designed to make it clear that the high vote and low vote common stock were separate series of stock rather than separate classes of stock (including by naming them “Series” A common stock and “Series” B common stock instead of the more traditional “Class” A common stock and “Class” B common stock). Why does this matter? This seemingly innocuous change actually has meaningful implications under Section 242(b)(2) of the Delaware General Corporation Law (DGCL), which is the relevant corporate law of the jurisdiction of incorporation of most venture-backed corporations throughout the country (Delaware).
Under the DGCL, a corporation is permitted to divide its capital stock into both classes and series of stock in its certificate of incorporation. The most common example of this structure is the distinction between preferred stock and common stock. However, particularly in the technology company space, a “dual class” high vote/low vote common stock structure often is utilized to protect the company from the short-term pressures of the market and to allow management to focus on growth, long-term strategy, and founder vision. In most IPOs that have been consummated in the last 10 years and that chose to implement a high vote/low vote structure post-IPO, the companies and their counsel (ourselves included) traditionally referred to the high vote and low vote common stock as “Class A” common stock and “Class B” common stock, even when they were intended to be series. This, in turn, created the potential for ambiguity about the rights granted to the high vote and low vote stock by virtue of Section 242(b)(2), which gives different voting protections depending on whether stock is a class or a series.
Under DGCL Section 242(b)(2), post-adoption amendments to a company’s certificate of incorporation may require different threshold votes of its stockholders depending on whether the amendment affects multiple classes of stock or multiple series of stock. Under Section 242(b)(2), an amendment that changes the “powers, preferences or special rights” of a class of stock requires a vote of the affected class (voting separately) if that amendment is “adverse” to the class. In contrast, an amendment that changes the powers, preferences, or special rights of a series within a class of stock requires a separate vote of the affected series only if that amendment is adverse AND the affected series is treated differently than other series. Said differently, if an amendment adversely affects two series of stock but affects both series in the same manner, the stockholder vote required to approve the amendment is a vote of the two series voting together on a combined basis. Compare this to the treatment of classes. In the case of classes, if an amendment adversely affects two classes of stock, then each class is entitled to a separate class vote on the proposed amendment, even if the classes are affected in the same manner. Thus two separate votes are required rather than one combined vote.
Why does this matter? The net effect of a dual class common stock structure is that under Section 242(b)(2), the company’s low vote stockholders have a separate class vote (and resulting veto power) over a proposed charter amendment that adversely affects the low vote and high vote classes of common stock in the same manner. If the intent is to implement a dual series common stock structure, naming the high vote and low vote stock “Series A” and “Series B” will make it clear that the low vote stock does not have a veto right by virtue of Section 242(b)(2) on amendments that treat the low vote and high vote stock the same.
Evidence of the importance of this issue can be found in recent litigation in the Delaware courts involving Fox Corp. and Snap, Inc., both of which have multiple class common stock structures and sought to amend their respective certificates of incorporation to provide for officer exculpation to the extent permitted under the DGCL. The plaintiffs in those cases argued that the proposed amendment adding officer exculpation adversely affected the powers, preferences, or special rights of the common stock by limiting certain causes of action against officers. As such, the plaintiffs argued that both the high vote and low vote (as well as the no vote) classes of common stock were each entitled to a separate class vote on the amendment, rather than a combined vote, even though the amendment adversely affected each class in an identical way. Although the plaintiffs in these two cases have not been successful (to date) on the particular facts of those cases, capital markets practitioners have been following this litigation very closely because of the potential impact on high vote/low vote structures and the stockholder voting standards that may be required in the future for proposed charter amendments by Delaware companies having this structure.
The legal ambiguity at issue in the Fox and Snap cases could have been avoided if the high vote/low vote stock at issue were more clearly structured as “series” rather than “classes.” As such, we have rewritten our model Delaware certificate of incorporation to reflect this change for our IPOs going forward. While there may still be some circumstances in which IPO companies opt to maintain the traditional dual “class” structure rather than a dual “series” structure, that decision should be made after full consideration of the relative costs and benefits of the two structures.
There are many factors in a company’s consideration of whether to adopt a high vote/low vote structure in connection with its IPO. Examples include sunset provisions, transfer restrictions, voting multiples, founder service conditions, and many other factors. And of course, the views and opinions of public market institutional investors and prominent shareholder advisory and industry groups such as ISS and Glass Lewis and the Council of Institutional Investors should be considered in every decision to pursue (or not pursue) a high vote/low vote structure and how best to implement it, particularly in today’s uncertain capital markets.
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Many thanks to our good friends Mark Gentile, Nathaniel Stuhlmiller, and Jennifer Barrett at Richards Layton & Finger, P.A., who served as Delaware counsel to Klaviyo in connection with its IPO.
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