A reverse stock split is a decrease in the number of shares of stock outstanding without any change in shareholder’s equity or market value for the company at the time of the split. As outstanding shares decrease, each share’s value increases proportionately, so there is no effect on the company’s total net value with a reverse stock split.
For example, a one-for-ten reverse stock split would reduce the number of shares outstanding and give every shareholder one share for every ten shares owned, while increasing the value of each share by a multiple of ten.
Consider a shareholder with 10 shares of XYZ stock at $5 per share for a total market value of $50. If company XYZ announces a one-for-ten reverse stock split, the shareholder would now have 1 share of XYZ stock worth $50.
If a company announces a reverse stock split and a shareholder does not have a round number of shares to convert, the shareholder will receive the greatest number of whole shares that can be converted and the remainder in cash.
For example, if a company announces a one-for-three reverse stock split and the investor holds 17 shares, they would receive five shares of the underlying and the equivalent of .66 shares in cash. With the rise of fractional shares, some companies may just give investors the full amount in stock (5.66 shares in this example).
Reverse splits can be one-for-two, one-for-four, one-for-ten, or any proportion the board of directors chooses. Companies often use a reverse stock split after a significant decline in stock price because the reverse split increases the price per share of the company’s stock, making the stock appear more attractive to potential investors.