Reverse Stock Split Agreement
A company may enter into a reverse stock split (RSS) agreement with its own stockholders, or with another entity -- especially pursuant to an impending merger that will involve a stock exchange. An RSS is a lowering of the numbers of outstanding shares of stock without any loss in market capitalization.
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RSS Functions
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There are at least three common reasons for an RSS: It may aid a company in going private, assist two companies in merging, or keep a company's stock price above an exchange's minimum listing requirement.
An RSS can aid a company in going private by reducing some of the holdings to fractional amounts. Someone who has only 15 shares of a company's stock could in principle hold out against a going-private agreement shared by all other shareholders. In such a case, the company could execute a 1-for-20 RSS so that the 15 shares would become a fractional amount, which would be paid off in cash. The holdout is thereby removed.
Expert Insight
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In their book "Takeovers and Freezeouts," Martin Lipton and Erica Steinberger caution that "states may impose statutory restrictions on reverse stock splits, in addition to the fairness requirement implicit in most going-private transactions."
Wisconsin, for example, requires registration of reverse stock splits. Connecticut and Maryland each require that shareholders approve, by a two-third vote, of any measure that reduces the number of shares outstanding.
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Considerations
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Separately, in the context of a merger, the parties may agree that the number of shares outstanding of one of the issuers must be reduced. This was the case in 2006 in a transaction involving Cirracor Inc., a Nevada company with only 10 shareholders and a negative shareholders' equity. Cirracor's shareholders naturally looked for an opportunity to sell their shares for a positive sum.
At the same time, Panda Ethanol, the owner of ethanol plants in Texas, was looking for a convenient way to go public because the market was putting a high valuation on ethanol plants.
Reverse Merger
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Panda decided on a reverse merger with Cirracor. Cirracor shareholders would end up with 4 percent of the equity in the combined company, and Panda shareholders would receive the rest. However, 3.5 million Cirracor shares remained outstanding, which was an inconveniently high number. As part of the deal, Cirracor agreed to a roughly 1-for-3 RSS. Nevada law required a special meeting of Cirracor shareholders to approve this agreement, but it did not require a supermajority. Under Cirracor's articles of incorporation, the deal -- including the RSS -- was approved by simple majority vote.
Listing
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Exchanges routinely impose minimum prices for their listings, such as $1 a share in the case of NASDAQ. As Carl Warren noted in "Survey of Accounting," a company with a price hovering dangerously near $1 could boost that price to $5 simply by decreeing a 1-for-5 RSS.
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