There are two kinds of stock splits. A forward stock split is normally done to lower the trading price of a stock and attract investor attention. A reverse split is done to decrease the number of shares trading and raise the stock price, often to qualify the stock to trade on an exchange.
When a company incorporates it authorizes a certain number of common stock shares and has the option to authorize a certain number of preferred stock shares. The company issues stock out of the authorized shares by vote of the board of directors. Some of this stock goes to founders, employees and board members. The rest of the issued stock remains in the company treasury until sold to investors, thereby providing capital to fund company needs. Whether a company is private or public, the number of authorized shares cannot change without amendments to the company's articles of incorporation or charter.
A company may not issue more stock than authorized. If the company wants to issue more stock, it must petition the state in which it is incorporated for an increase in the number of authorized shares. A forward split or a stock dividend may require such a petition if the split or dividend will add more shares to the number of outstanding shares than are in the total number of authorized shares. Authorized shares do not trade. They have no voting rights until issued by the board of directors and until issued they do not exist as anything but potential shares.
Stock Forward Split
A forward split increases the total number of outstanding shares. For example: if there is a 2-for-1 forward split, each shareholder will receive extra shares in the same amount as he already holds. He will now own twice as many shares, but each share will be worth half the amount it was worth before the split. A forward split does not affect the percentage ownership held by each shareholder, just the number of shares. It also doesn't affect the number of authorized shares unless the forward split will require more shares than are already authorized. That means the company must petition to raise the number of authorized shares.
A reverse split lowers the number of shares outstanding. For example: if a company reverse splits its stock 1-for-2, it means the shareholders must turn in their certificates and receive new certificates evidencing ownership of half the previous number of shares. A shareholder who owns 1,000 shares pre-split will own 500 shares of the post-split stock. The total number of outstanding shares decreases but the total number of authorized shares doesn't change. If the company had 100 million authorized shares and 50 million shares issued and outstanding pre-split, it will have 25 million issued and outstanding shares post-split and 100 million shares authorized. Post-split, the company will have 75 million shares that can be issued in the future if needed to raise capital. Prior to the reverse split, this available number of authorized shares had been 50 million out of the total 100 million authorized.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.