A stock split is a decision by a company to break single stocks into multiple stocks. A company does this by giving each shareholder multiple shares for each single share he owns. The opposite of a stock split is a reverse stock split. A reverse stock split is a decision by a company to transfer multiple shares into a single share. For instance, in a 3-to-1 reverse stock split, a company offers each shareholder a single share for every three shares he owns.
Benefits of Reverse Stock Splits
Companies use reverse stock splits to increase their stock prices without making any major shifts in the company. By combining multiple shares into a single share, the share price increases by the multiple of the reverse stock split. A company might use a reverse stock split when it is in danger of breaking stock exchange rules that require each stock to maintain a certain minimum price. For example, the New York Stock Exchange requires that stocks have a price of at least $1. A 3-to-1 reverse stock split would triple the stock price and could prevent the stock from being delisted for falling below the $1 threshold.
Reverse stock splits provide many benefits to companies in need of a quick stock price bump. However, there are certain disadvantages. Reverse stock splits require extensive securities filings, and the cost of preparing those filings can be quite high. Additionally, the attorneys required to monitor the preparation and completion of the reverse stock split can be especially expensive.
Frequency of Reverse Stock Splits
Some investors might wonder how often a company can complete a reverse stock split. There is no official limit. However, just as a company must maintain a minimum share price to remain listed, it also must maintain a minimum number of shares. This limits how many times a company can make a reverse stock split. If the number of shares falls below 500,000, the company runs the risk of being delisted.
Depending on the industry, there can be special concerns associated with a reverse stock split. Your company will need to file with the SEC, but it also might need to file notifications with industry regulators. For example, banks are required to submit special applications to the Office of the Comptroller before such action will be approved. These industry-specific regulations are typically used to protect consumers and investors from misleading actions by the company. This concern is especially apparent with reverse stock splits, because they artificially increase stock prices.
Erika Waters is a business lawyer licensed to practice in California. She has experience working with nonprofits including Teach for America, as well as entrepreneurs and startups. Waters has contributed to several blogs, including the Business & Media Institute and other online publications and has worked as an editor for an academic publication.