A corporation can decrease the number of its publicly held shares through a reverse split. The board of directors does not need to get stockholder approval to authorize a reverse split. The board selects the reverse split ratio, such as issuing one share for every 10 shares owned, and announces the date the split takes effect. Whether this helps or hurts your stock portfolio depends on the company’s reason behind the split.
A reverse stock split may result in a loss of shares for minority shareholders. Unfortunately, these individuals have little legal recourse if such an act occurs.
Understanding How it Works
A reverse stock split reduces the number of issued shares but without changing the total value of all shares issued. With a reverse stock split, you end up owning fewer shares but each share is worth more that the original. For example, if you own 1,000 shares of a stock priced at $50 a share, your position is worth $50,000.
If the board of directors institutes a 1-for-5 reverse split, you will receive one share of stock for every five shares you own. You end up owning 200 shares (1,000 divided by five) worth $250 each ($50 multiplied by five.) Your position value of $50,000 is unchanged.
Reverse Splits and Minority Stockholders
If you are a minority stockholder, a reverse split could extinguish your position and force you out. Unfortunately, there is not much you can do as long as the reverse split follows legal procedures and you receive the correct number of new shares.
Your chance of prevailing in a lawsuit brought against the board of directors is slim. The courts have held that, absent fraud, misrepresentation or misconduct, a corporation has the right to eliminate minority stockholders through a reverse split.
Reverse Split Advantages
Reverse splits can signal good news for investors or bad news. A reverse split can signal that a company is financially strong enough to be listed on an exchange. The stock price will increase enough to meet the exchange’s minimum price requirement. If you own stock in a small company that has seen increased sales and profits, the stock price should continue to rise after the reverse split.
Stocks newly listed on an exchange can attract new buyers, especially institutional investors who avoid over-the-counter and pink sheets stocks. Although you will end up owning fewer shares, they will be worth more as the price continues to rise.
Reverse Split Disadvantages
If your stock is listed on an exchange, a reverse split could herald a potential delisting as a consequence of its fallen price. If the stock remains below the exchange’s minimum price, the company’s stock is delisted and relegated to the over-the-counter market or the pink sheets.
The reverse split may boost the stock’s price for a while, but if sales have stalled or the company posts consecutive losses, the stock price will continue falling. Left unchecked, the stock will eventually be delisted off the exchange.