On Monday, Aurora Cannabis, one of the Canadian licensed producers, announced a reverse split of its publicly-traded stock. (link) I thought this might be a good opportunity to explain what this means, since the reasons are both regulatory and practical.

Typically, a public company’s stock is traded on an exchange, such as the New York Stock Exchange, the Nasdaq, or the Canadian Securities Exchange. To get very basic, an exchange is merely a facility for the purchase and sale of securities. You can buy and sell securities outside of an exchange (such as stocks that are traded “over-the-counter”), but the exchange is there to make trading more efficient by providing, among other things, price transparency (stock quotes) and volume (access to many buyers and sellers).

Stock exchanges require listed stocks to trade over a certain price threshold in order to remain listed on the exchange (meaning the stock may continue to be traded through that exchange). For example, the Nasdaq may delist the stock of a company that does not maintain a minimum $1.00 bid price (the price at which a buyer is willing to buy) for 30 consecutive days. A solution to the problem is to reduce the number of shares outstanding (at its simplest, market value/number of shares = stock price). This is done through a reverse stock split, where a fixed number of shares of stock are reclassified into a smaller, fixed number of shares (say, three shares are reclassified into one). As you probably noticed, this is the opposite of what happens in a stock split, where the stock price is reduced by issuing new shares to each shareholder. Fractional shares are either paid out in cash, or just rounded up/down. The reserve split does not change any shareholder’s proportional ownership of the company (except for those fractional shares), so the only practical effect is adjusting the trading price.

In addition to solving a stock exchange listing problem, there are practical benefits to the reverse split. Whether economically rational or not, investors and traders tend to be more interested in stocks trading over $1.00, likely on the theory that companies trading below that price are too risky and speculative. Ultimately, that optic of the share price is key, potentially making it easier to raise capital and gain interest from key institutional investors and analysts.

As we have seen, cannabis stock prices have been depressed not only by general market sentiment on the sector, but then also by the broader market declines in the past few weeks. The reverse split is one of those powerful tools that listed companies can potentially use in response to such trends.