16 Feb Math of a Reverse Stock Split
Prior to an a reverse merger a company may find itself with too many issued and outstanding shares and not enough authorized shares to be able to do an alternative offering. According to a every company’s corporate charter there is only a set number of authorized shares allowed for the company. There are two ways of solving this in order to perform a reverse merger. One, the company could simply increase the number of authorized shares allowed for trading or (and this is the more common solution) the company could opt for a reverse stock split to true up the number o shares authorized. In most cases, this also requires shareholder approval through a proxy statement.
To put it simply a reverse stock split reduces the overall number of outstanding shares without changing the value of the underlying total securities. The math is quite simple, but can sometimes end in fraction shares. The typical math in a reverse stock split is performed by a company’s brokerage firm. Let’s do a quick example. But first let’s provide the simple formula:
Shares after the split=shares * A/B
Stock price after the split=stock price * B/A
Let’s say for instance a company were to execute a 1 to 5 reverse stock split. Then the shareholders would receive 1 share for every 5 previously held shares they had prior to the split. Concurrently, the price/value o shares will increase by the same ratio. For the purposes of simple math so we don’t have to do Cash in Lieu (CIL) in the case of fractional shares. If the total number of shares authorized and outstanding were 10 million, and the stock price were say $0.10, then a 1 to 5 reverse stock split would require we multiply the number of shares by 0.20 and increase the value of each share by 5x. Hence our total share number after the split would be 2 million and the value of each new share would be $0.50.
If fractional shares are included in the math, the company may simply provide some cash for the stock. In this case, the shareholder may be required to account for a typical gain or loss on the sale of the security, depending on his/her basis in it. If you’re dealing with a previously-operated shell, you’ll often hear in the industry, “this shell needs a reverse”–meaning a reverse stock split to true up the stock to match what’s stated in the company charter as well as provide a more reasonable stock price and reduce the amount of float for the new initial offering.
We typically like to create most of our public shells from scratch. It typically costs less if you do it right (but it does take more time to market), but you avoid some of the issues that may already exist in the previous shell company. Not every example of a reverse stock split involves a reverse merger. Some think that reverses are bad because they increase the value of individual securities in cases where the stock’s value may have dropped. Here’s one such example. Regardless of the motivation for a reverse, the math is still the same. The difference in doing a reverse for a reverse merger is that it’s typically not done to attempt to stay on an exchange or paint a more rosy picture. It’s just a necessary process to get something new into a currently non-operating shell corporation.
If you decide to play the shell game, manufacture your own or perform a self-filing with Super 8-K, our team of experts are here to assist.