Why a Private Company’s Board Decides to Split Its Shares

Medical Patents Broker Inc.
By Kenneth Pearce, President

For publicly traded companies, a stock split generally causes many investors to swoop up shares while the price is cheaper. In theory, this can work well, but most of the time, be ready for a long-term play rather than to hold for a year and sell.

Private companies' Boards usually have a specific purpose for the split, but the split may not meet the desired goal. The purpose is to accelerate growth. Since the split does not change the company's valuation or add a single dime to the balance sheet, why do it?

👥 1. Lowering the Ticket Price for New Talent (Employee Equity)

A growing private company rarely competes for top-tier executive or scientific talent on salary alone; they use equity (stock options) as the ultimate lure.

Let's say the company’s internal valuation is $5,000 per share. The board votes to give equity share bonuses or lures for new talent instead of cash bonuses or increased salaries. By executing a 100-for-1 split, that $5,000 share suddenly becomes 100 shares worth $50 each.

This provides incentives for both current and future employees. There is something about ownership that seems to be part of human nature.

💰 2. Setting the Stage for the Next Funding Round

Many private companies may need sequential rounds of venture capital or private equity to keep moving toward the patient. A $50 per share price sounds more tempting than a $5,000 per share price.

It’s mathematics and an acceptable part of today’s sourcing of capital. The trick is it feels better and makes it easier for the next round of investors to buy in.

🏛️ 3. Rehearsing for the Grand Finale (The IPO or Acquisition)

If a private board has its sights set on eventually taking the company public via an Initial Public Offering (IPO) or possibly an acquisition, before jumping into the major league, they better first practice in the minor league.

How do things go smoothly? Well, athletes, musicians, and private boards need to practice, practice, practice, before going full speed ahead into the next level.

If the Board cannot manage a private company shares split, the IPO or acquisition can quickly turn into a disaster. Of course, there will be the officers, the lawyers, the bankers, the buyers, and the Securities and Exchange Commission—all of whom have very expensive fees.

Have you ever read a public company's prospectus? It seems like if anything goes wrong—that is anything—it’s the Board’s and management’s liability. Unhappy shareholders can join together and cause major problems.

The President’s Viewpoint

For most companies depending on equity capital to keep moving forward, it is wise to have a Board of Directors that are not just “yes men” to an officer's “got to have it now” mentality. Good boards have steered many young companies in the long-term profit direction.

When possible, I prefer the less-stress alternative. I have experienced SEC laws and both side's lawyers, and I always felt on the defensive. So for me, if the Board can eventually steer MPB toward an acquisition, that is my preference.