A reverse stock split is a process in which a company cancels a shareholder’s original shares and replaces them with a smaller number of shares. Each new share has a greater value in order to mitigate the reduction in quantity. For example, a shareholder with 50 shares each worth $1 may get five new shares after a reverse stock split that are worth $10 dollars. The number of shares changes, but the overall value stays the same. This is done for each shareholder. Although many companies have had success with it, a reverse stock split is generally considered an indication that the company isn’t doing well financially. For this reason, companies only initiate reverse stock splits in very specific instances.

Preventing Delisting

Delisting is a process in which a company’s stock is removed from a stock exchange. When this happens, investors are no longer able to trade that company’s stocks on that particular exchange. If a company’s share price is extremely low, it can be delisted. By doing a reverse stock split, the company increases the value of each individual share, which may prevent it from being delisted.

Reducing the Number of Shareholders

A company can use a reverse stock split as a way of reducing the number of shareholders. If the company decides that one share will be issued for every 50 original shares, any shareholder with less than 50 shares will be paid off and will no longer hold any stock in the company. This is sometimes done when a company wishes to be placed in a different regulatory category, usually due to differences in certain laws.

Attracting Investors

Some companies do a reverse stock split to try and attract retail investors and mutual funds. Many investors and mutual funds will not purchase a stock whose value is less than a certain amount. Since a reverse stock split increases the price of each individual share, it can push the value over the investor’s minimum requirement. Many companies also believe that having a higher absolute stock price is more attractive to investors.