Stock Split

What is a stock split?

Stock split (German: Aktiensplit, Aktienteilung) refers to a measure by which a company increases the number of its shares without new capital flowing in and without any change in shareholding percentages. The notional value per share falls in the same proportion in which the number of shares rises; the value of the company remains unaffected. It is like a cake cut into more pieces: each piece becomes smaller, the cake stays the same size. The English term share split means the same.

The term comes from the stock market; in the German stock corporation (Aktiengesellschaft, AG), it corresponds to the re-division of the share capital. In the GmbH (German limited liability company), the equivalents are the division of company shares (Geschäftsanteile) and the re-division into smaller units, that is, the division into more shares, by a capital increase from company reserves. In the latter, reserves are converted into share capital without money flowing. Both are typically carried out before financing rounds, to reach a manageable price per share, and before an IPO, to adjust the number of shares.

Formula: value per share after the split = value per share before the split ÷ number of shares into which one existing share is turned

Stock split in a stock corporation

For no-par-value shares, the split increases the number of shares with unchanged share capital. Each share must account for a proportionate amount of at least EUR 1 (Section 8(3), sentence 3, of the German Stock Corporation Act, Aktiengesetz, AktG). For par-value shares, the par value falls, likewise not below EUR 1. Because the articles of association fix the division of the share capital (Section 23(3) No. 4 AktG), the general meeting resolves it. In principle, three quarters of the share capital represented are required (Section 179(2) AktG); the amendment takes effect on registration.

The reverse measure is the consolidation of shares (reverse split), which occurs above all in capital reductions. In the US market, splits often serve to make high share prices more accessible to retail investors, and reverse splits serve, among other things, to comply with minimum price requirements of exchanges. Split ratios are written inconsistently; a spelled-out statement is clearer, for example “ten new shares for one existing share”.

Stock split in a GmbH: division and re-division

Division of company shares

The division of a company share requires a shareholders' resolution (Section 46 No. 4 of the German Limited Liability Companies Act, GmbHG) and the consent of the shareholder concerned, but no amendment of the articles of association. The share capital remains the same; each new share must be denominated in full euros and be at least EUR 1 (Section 5(2), sentence 1, GmbHG). A new shareholder list must then be filed (Section 40 GmbHG). The limit is therefore predetermined: a GmbH with share capital of EUR 25,000 can have at most 25,000 company shares.

Re-division through a capital increase from company reserves

More company shares than the share capital amounts to in euros arise only by an increase of the share capital, without a capital inflow by a capital increase from company reserves (Sections 57c et seq. GmbHG). In this, reserves are converted into share capital, and the new shares accrue to the shareholders in proportion to their existing ones (Section 57j GmbHG). The amendment of the articles of association requires three quarters of the votes cast and notarial certification. The basis is an audited balance sheet whose reference date is no more than eight months before the filing; small GmbHs whose annual financial statements are otherwise not audited must have the balance sheet specially audited for this purpose. Reserves can be converted only to the extent that they exceed a reported loss or loss carry-forward (Section 57d(2) GmbHG), often the narrowest condition for growth companies with start-up losses.

Stock split before a financing round

Technology companies often start with the minimum share capital. In financing rounds, investors then pay a high premium, that is, a price far above the nominal amount, on few new shares. The price per company share thus quickly reaches several hundred euros. Small stakes, exact percentages, the conversion of convertible loans and compensating shares can then be reflected only in rounded form. A re-division before the round lowers the price per share to a manageable level.

The value does not change, but a number of documents do. Participation programmes adjust the number and base price of virtual shares, convertible loans the conversion price, and anti-dilution clauses must take splits into account in such a way that they do not count as an issue at a lower price. The cap table shows the prices of earlier rounds on a split-adjusted basis. The maintenance of capital must also be considered: assets in the amount of the now higher share capital may not be paid out to shareholders under Section 30 GmbHG. New shares also may not be issued below their nominal amount. Because the capital increase lowers the value per euro of share capital, this lower limit is reached sooner in a later down round (see recapitalization). A mere division changes nothing in this respect, because the share capital stays the same.

Tax treatment of a stock split

A stock split and a division are not a disposal. The acquisition costs are spread across the new shares, and the shareholding percentage remains the same. A capital increase from company reserves is tax-neutral for the shareholders under the German Capital Increase Tax Act (Kapitalerhöhungssteuergesetz); the acquisition costs are allocated to old and new shares in proportion to the nominal amounts. If retained earnings are converted, a later repayment of this capital can be taxed like a profit distribution.

Worked example: re-division before a financing round

A GmbH has 25,000 company shares of EUR 1 each. A pre-money valuation of EUR 20 million has been agreed, that is EUR 800 per share. A lead investor wants to invest EUR 3 million, a business angel EUR 50,000. The capital reserve exceeds the loss carry-forward by more than EUR 225,000.

• Without re-division: 3,000,000 / 800 = 3,750 shares for the lead investor, 50,000 / 800 = 62.5 shares for the business angel. Half company shares do not exist, and a division does not help because all shares already amount to EUR 1.
• Capital increase from company reserves by EUR 225,000: For each existing share, nine new ones arise, so 250,000 shares in total.
• New price: 20,000,000 / 250,000 = EUR 80. The lead investor receives 37,500 shares, the business angel 625.
• Preservation of value: A founder with 10,000 shares then holds 100,000 shares. At EUR 800 before and EUR 80 after, both holdings are worth EUR 8 million.
• Participation programme: 1,000 virtual shares with a base price of EUR 500 become 10,000 with a base price of EUR 50. The intrinsic value remains (800 minus 500) × 1,000 = (80 minus 50) × 10,000 = EUR 300,000.

The re-division changes neither the valuation nor the percentages. It does, however, make the business angel's entry possible without rounding and allows finer percentages in future rounds. In return, the tied-up share capital rises from EUR 25,000 to EUR 250,000.

Distinctions: stock split, capital increase and reverse split

• Capital increase against contributions: New shares arise against payment, and the percentages of the existing shareholders fall. In a split, no capital flows in, and the percentages stay the same.
• Dilution: A split does not dilute, because all shareholders receive more shares in the same proportion.
• Reverse split: the consolidation of shares, which reduces their number and raises the notional value per share.

Common mistakes

• Adjustment clauses forgotten. Without adjusting the participation programme, convertible loans and anti-dilution protection, the number and price of shares no longer match the contracts.
• Loss carry-forward overlooked. Reserves tied up by a reported loss cannot be converted into share capital.
• Balance sheet deadline missed. If the reference date of the audited balance sheet is more than eight months old at filing, a new balance sheet must be drawn up and audited.
• Division below EUR 1 planned. Company shares below EUR 1 or with cent amounts are not permitted.
• Share capital raised sharply without need. A far-reaching re-division extends the maintenance of capital and narrows the room for manoeuvre in a later down round.

Frequently asked questions

Does a stock split change the value of the company?

No. The number and notional value of the shares change in opposite directions; company value and shareholding percentages stay the same.

What happens to the share price in a stock split?

It is adjusted at the reference date of the changeover in the split ratio. If shareholders receive ten new shares for one existing share, the price falls arithmetically to a tenth, and there are ten times as many shares in the securities account. The value of the position stays the same; later price movements have other causes.

Can company shares of a GmbH be divided at will?

No. Each company share must be denominated in full euros and be at least EUR 1; more shares require a capital increase.

Is a split taxable?

As a rule not. Nothing is sold and nothing is paid out, and a capital increase from company reserves also remains without tax consequences for the shareholders.

Does the re-division need a notary?

For the capital increase from company reserves yes, because it amends the articles of association. The division of a company share requires only a shareholders' resolution and a new shareholder list.

The Roemer Capital view

Whether the division of company shares suits the planned round is something we clarify early in the preparation. A re-division needs an audited balance sheet that is at most eight months old at filing and must therefore be coordinated with the annual financial statements and the timetable of the round.

In the financial model and the cap table, we keep the prices of earlier rounds on a split-adjusted basis so that investors can follow the price development per share in due diligence without conversion. The resolution, the balance sheet audit and the filing are with the company's notary, law firm and tax advisers.