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What Happens In A Consolidation of Shares?

consolidation of shares

A consolidation of shares, or a reverse split, is a strategic move that a company makes to reduce its outstanding shares. This is done by exchanging existing shares for a proportionally smaller number of new shares. For example, in a 1-for-5 reverse split, every 5 existing shares would be exchanged for 1 new share. 

The outcome of this is that the number of outstanding shares is reduced, the market price per share increases proportionally, but the company’s overall market capitalisation remains unchanged. 

What drives a company to consolidate shares? Reducing the costs per share trading price to meet exchange listing requirements, improving the image of the company to attract investors, and simplifying the shareholder structure are some advantages of the move.

How are these consolidated shares identified? What advantages and disadvantages do they bring to companies and shareholders? If you are planning to consolidate shares, read this step-by-step guide to know how this can be achieved.

What is a Share?

A share is a unit of ownership at a company. These units represent the distribution of the capital, where each unit represents a portion of the business. Owners of shares can be individuals or corporate bodies. They have rights as shareholders, such as voting rights, receiving dividends, and attending shareholder meetings.

What is an Outstanding Share?

Outstanding shares are the number of shares issued by a company, omitting any shares that company sold and then bought back. The current number of shares owned by shareholders represents the outstanding shares. These shares are indicators of certain important business calculations such as earnings per share (EPS). For instance, a company that has 10 million outstanding shares, and earns £100 million, would yield £10 per share, therefore having an EPS of £10.

What is Consolidation of Shares?

When a company decides to reduce its outstanding shares, it resorts to combining or consolidating its shares. Thus the market value of these combined shares increases too.

To make the idea more practical, let’s say that the company decided to consolidate its shares by 5:1. In this case, a shareholder’s 5 shares will be reduced to one share. Decreasing the number of shares leads to an increase in the price. This protects the investments from loss, without touching the percentage ownership of the shareholder.

Advantages of Share Consolidation

Consolidating shares can be beneficial in some cases, since potential investors will be likely attracted to companies with consolidated shares. Low share prices can send an idea to the investors that the business is struggling and not doing well. When shares are consolidated and the prices of shares rise, it makes the company more appealing to investors, even though the value of the company stays the same.

Another potential benefit of consolidating shares is avoiding delisting from a stock exchange. If a company falls beyond the minimum price per share for a while, it gets delisted. For example, in the New York Stock Exchange (NYSE), companies that fall below the $0.50 price per share for 30 consecutive days get delisted. Consolidating shares raises the price of shares, so companies get saved from delisting.

Simplifying shareholder structure is a third advantage of consolidation. Through consolidating shares, a company can reduce the number of small shareholders, allowing the company to keep track of them and communicate better with them. When small shareholders sell their shares as a result of consolidation, things will be more streamlined for the company.

Finally, consolidation of shares reduces costs. Issuing a large number of share certificates can be costly. By reducing the number of shares and consolidating them, fewer share certificates will be issued, and business owners will save a good deal of money.

Disadvantages of Share Consolidation

Despite its advantages, share consolidation can be risky, and has some disadvantages that should be considered. Consolidating shares to attract investors can backfire on the company since it can signal financial distress, putting off some investors. It gives the investors the impression that the company is augmenting prices to disguise its financial struggles.

Another drawback of consolidating shares is that it is a time-consuming process. If a company has a large number of shareholders, every one of them should be contacted and informed of the changes that will occur. Things get more complicated if the shareholders live in other countries, since it adds a bureaucracy load for the company to deal with.

While the company aims to save its position by consolidating shares, the process itself may fail. Even when shares are consolidated, the rise in prices per share might not happen. The results then will be frustrating for shareholders who will lose faith in the company. The value of the company does not change. The change occurs in the number of outstanding shares and their individual prices.

So do not rush to consolidate shares before weighing up the advantages against disadvantages.

How are Shareholders Impacted When Shares are Consolidated?

When shares are consolidated, shareholders will have fewer shares with increased value. But does this impact shareholders?

Shareholders are not impacted by share consolidation. It is true that the shareholder will hold fewer shares, but the shares he holds will have more value. If a company decides to reduce the shares by 5:1, and the share’s price is worth £1, then every five shares will be merged into one share and will be worth £5.

If your company is consolidating shares, you as a shareholder do not need to take any action, and even your taxes will not be affected.

Is Share Consolidation a Good or Bad Thing?

Share consolidation is not a positive indicator in business. It rather indicates financial distress or a company at risk. Investors understand that the sharp decline in the share price value forces a company to consolidate shares in an attempt to save itself from failure.. Investors may head to sell their shares which will lead to additional losses in the share price.

Share consolidation leads to a boost in share value and may improve the company’s prospects. New investors would like to buy these shares with reduced costs. It is important to know that there is no one fixed approach for share consolidation. The decision to consolidate shares should be wisely made after studying the circumstances of each company on an individual basis.

Before you head to share consolidation, it is important to contact a financial advisor whose role is to give you tailored advice for your situation. They can highlight the pros and cons for you which helps you to make a more informed decision.

Do You Lose Money When Shares Are Consolidated?

Shareholders often worry about losing money when shares are consolidated. But is that true?

You do not lose money if shares are consolidated. On the contrary, your investment’s value will improve after consolidation. But there is still a chance that the value of your shares will not change or even decrease in the short term.

Is Trading Liquidity Affected When Shares Are Consolidated?

As fewer shares will be outstanding, there is worry that share consolidation reduces liquidity in the market. This is not always true, especially if the company’s stock is popular.

If buyers and sellers are few, liquidity may be reduced. But if there are lots of buyers and sellers, the trading liquidity will not drop after share consolidation, and the trade of shares will not be affected.

How is Market Trading Affected by Consolidating Shares?

When the value of shares increases and their number decreases, it may be more difficult to buy and sell large blocks of shares, which negatively affects market trading.

Buying consolidated shares means that shares will cost more for investors to buy. If you buy 100,000 shares before consolidation, with £1 per share, you will pay £100,000. Buying consolidated shares by 5:1 will cost you £500,000.

The price increase may lead large institutional investors to think twice before buying and selling large blocks of shares, since they may lack the necessary capital. Investors will be hesitant to sell other investments to have enough cash. But for small investors, buying a few consolidated shares will not have a major impact on their ability to buy and sell large share blocks.

How Can I Tell if Shares Are Being Consolidated?

If you want to make sure if a company is going under share consolidation, take a look at its stock chart. The chart can signal share consolidation if it looks like it has been squeezed together in a narrow trading range. If you see low trading volume with no big spikes on the chart, then the company has likely consolidated shares.

The notices on a company’s website or financial press can also exhibit consolidation of shares. In this case, shareholders will be contacted and informed of all the details of the process.

What is a Consolidation Breakout?

A consolidation breakout happens when the price of a share finally moves from a period of horizontal trading. It occurs after long consolidation phases when the stock coils up before getting ready to make a move.

Breakouts can either be bullish or bearish. A bullish breakout happens when the price of a share breaks out to the upside from a period of consolidation. This is considered bullish since it indicates that buyers are in control, and that prices will keep the rising trend.

A bearish breakout is the opposite of a bullish breakout. It indicates a break out of prices on the downside from a period of consolidation. It is seen as bearish since it signals that the downward trend of prices will go on.

Step-by-Step Guide on Consolidating Shares

Before consolidating your shares, you need to take some steps to make sure you have made the right decision.

  • First, you need to check with your broker or the company itself to see if your shares are eligible for consolidation. It is mentioned in the company’s Articles of Association if consolidation is allowed, restricted, or excluded.
  • There is also the shareholder’s agreement, that includes whether you need to give notice before consolidating shares.
  • You checked whether the company’s Articles of Association and the shareholder’s agreement allow you to consolidate your shares. Now, you need to decide the number of shares you want to consolidate on a ratio basis, such as two-for-one or three-for-one.
  • After consolidation of shares, you need to submit the SH02 form to Companies House. This updates your company’s records, and reflects the number of new shares for each shareholder in addition to the value of each share.
  • To finalise the process, you should send a notice to your shareholders, informing them that their shares have been consolidated, and sending them new share certificates that include the amount and value.

Final Thoughts

In Summary, a consolidation of shares is a financial move that reduces a company’s outstanding share count whilst increasing the share price proportionally. This tactic doesn’t change the company’s market value, but it can influence trading activity, investor perception and costs associated with having a large shareholder base.

Business owners should weigh up to the pros and cons of reverse stock splits and take advice from finance experts. Whilst shareholders don’t lose ownership value, they may face short-term liquidity changes.

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