San Diego Corporations: What are Fractional Shares?
As the name would imply, a “fractional” share of stock means a fraction, part, or portion of a whole share. Thus, a one-half share is considered a “fractional” share. See Cal. Corp. Code § 407. Here is a quick primer on how fractional shares can come into existence and why they can be problematic.
San Diego Corporate Law: How Fractional Shares are Created
A corporation can actually decide to issue fractional shares. However, that is unusual. Most often, fractional shares come into existence as a result of stock splits. A “stock split” is where the board of directors of a corporation votes to divide the existing shares into multiples. Thus, if the company has 100,000 shares, and decides to initiate a two-for-one split, then 200,000 shares will come into existence. The number of shares owned by each shareholder will double. The price of each share will also be halved.
Fractional shares can come about when a company splits the shares three-to-two, meaning, two shares will be increased to three. If you own an even number of shares, no fractional share will result. For example, if you own two shares, you will have three, four will be six, etc. However, if you have only three shares, then you end up owning four and one-half shares. The one-half share is a fractional share.
Another common reason for fractional shares is a byproduct of corporate mergers and acquisitions and other corporate reorganizations. The previously owned shares are “traded in” for new shares usually based on a formula established in the Sales/Merger Agreement or the reorganization plan. The formula can often result in fractional shares for the new entity or newly reorganized corporation.
San Diego Corporate Law: Problems With Fractional Shares
The largest problem with fractional shares is that they are difficult to sell. Normally, only a full share can be bought or sold. If you have a fractional share, you have to “match it up” with other fractional shares to create a full share. If the shares are publicly traded, this is often not a problem. A broker can often “find” other fractional shares, but costs may be higher. As an aside, a new app — Stockpile App — is available which purports to allow investors to find and purchase fractional shares. See news article here.
A second problem is that California corporations are not REQUIRED to allow fractional shares. If the corporation does not want to allow the existence of fractional shares — let’s say, as a result of a merger between two corporations — then the corporation has three options under § 407:
(1) arrange for the disposition of fractional interests by those entitled thereto — such special arrangements CAN put a reasonable time limit on shareholders to combine fractional shares into whole share
(2) pay in cash the fair value of fractions — note that, in paying cash, these fractions are removed from the existing pool of shares — § 407 limits the quantity of shares that can be removed in this manner
(3) issue “scrips” entitling the holder of the scrips to receive a certificate for a full share upon the surrender of the scrips aggregating a full share — again, reasonable time limits can be imposed and, if the time expires, the scrips can be deemed expired
Finally, if the fractional share is less than one-half of 1% of the total shares, a corporation can disregard such de minimis fractional shares. As an example, see here, for a news report about the announcement by Heat Biologics, Inc. of a reverse stock split. As noted in the article, “[n]o fractional shares will be issued in connection with the reverse stock split. Shareholders of record will receive a cash payment in lieu of fractional shares …”
Contact San Diego Corporate Law Today
If you need legal advice relating to fractional shares, issuing stock certificates, filing a LOEN, setting up your San Diego corporation, or with respect to any of the other aspect of incorporation and corporation maintenance, call corporate attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has been named a “Rising Star” for 2015, 2016 and 2017 by SuperLawyers.com. Contact Mr. Leonard by email or by calling (858) 483-9200.