Stock Split 101 for Startups
When incorporating a company, we typically start with a small base of paid-up share capital, since there is no minimum threshold for the same. However, a low paid-up share capital results in a smaller pool of shares, and when investors invest in the company, their shareholding is calculated based on the number of shares in the current paid-up share capital.
For example, let’s say you start the company with a minimum capital of INR 10,000/-. This could mean that you have 1000 shares in the company worth INR 10/- each. Some time down the line, you have an investor who wants to subscribe to 10% of the company’s shares. This effectively means that the investor shall be subscribing to 100 shares (10% of 1000). The two of you have come to an agreement for the transaction of 100 shares for, let’s assume, $1 million or approximately INR 7,49,30,000/-. This exponentially raises the value of each share to a whopping INR 7,49,300/- From an investors perspective, this may not matter, you will begin feeling the pain when you create and start granting ESOPs.
When creating and granting Employee Stock Ownership Plans (ESOPs), 1 ESOP converts to 1 share. Therefore, in the aforementioned example, if 1 share is worth approximately INR 7,49,300/-, then it becomes impossible to grant ESOPs to junior employees. So what do you now? Do you wish you could turn back time and increase the paid-up share capital of your company? Yes! Will that solve the issue at hand? No. This is where one considers the splitting of shares or a ‘stock split’ or ‘stock divide’.
Splitting shares is much like splitting a pizza; no matter how many slices you cut, you would still have only one pizza. By splitting shares, you increase the number of shares in the company without causing a change in the total market capitalization of the company. So with a 2-for-1 stock split, each stockholder receives an additional share for each share held, but the value of each share is reduced by half. It would mean two shares now equal the original value of one share before the split. Common stock splits are 2-for-1, 3-for-2 and 3-for-1.
In the example given above, you could split 1 share into 10 shares which will reduce the value of each share to INR 74,930/- and this would now allow you to grant ESOPs to your employees.
Above is a cheat sheet to help you through the process of splitting shares!
*AoA = Articles of Association
RoC = Registrar of Companies
MoA = Memorandum of Association