If anything, I'm more confused after that. You're comparing the case of a $20 share price without a reverse split to the same share price with the split. That's absurd, since changing the number of shares changes the price (market cap = number of shares * price of a share -- and the market cap is to a first approximation fixed).
The proper comparison would be a share price of 20 -> 60 with the reverse split, or a share price of 2.5 -> 7.5 without. And with those numbers you'll see that the split had no effect at all.
Maybe there's a scenario in which a reverse split screws up the employees. But I don't think it's the one you're describing.
Sorry if it confused you. You are right I am comparing the pricing of $20 using both with and without the split. Let me try again.
Let's say you have 32,000,000 shares and you want to raise $8,000,000. You would need to price the stock at $0.25 per share to guarantee that raise (32,000,000 * 0.25 = $8,000,000). Now let's say an employee has 8000 shares. At IPO their 8000 shares are worth $2000 if the stock opens at $0.25. Let's say the price goes up 4x, or to $1.00, that day. The gain is $6000 ($8000 - $2000).
To rectify the issue of the $0.25 opening price (major stock exchanges will not allow a stock to open that low and have minimum prices), the company decides to do a reverse split to reduce the outstanding shares and in turn raise the price of the stock. The company still wants to raise $8,000,000 so to adjust the number of shares outstanding (go from 32,000,000 to 400,000) they must do an 1 for 8 reverse split. If an employee had been granted 8000 shares when they started, they would, after the reverse split, only have 1000 shares.
After the reverse split and on IPO day the company now opens at $20 (8,000,000 / 400,000). Now let's say the price still goes up 4x, or to $80. The gain is still 4x, and the employee walks away with a $60,000 gain instead.
Where I think this confuses everyone is comparing the gain pre-split and post-split. You are right in that the gain is the same and in theory the employee neither lost or gained anything through the split. However, from an employee morale perspective the employee still views it as a loss. In the back of the employee's head they took the job under the premise of having 8000 shares and when the company IPOs they begin comparing what they should have had to what they really have after the split (8000 vs 1000 or $480,000 vs. $60,000).
The other part that I have left out is that with the reverse split your strike price goes up. So if you were originally brought on with 8000 shares and a $1 strike, you now have 1000 shares and a $8 strike. I didn't factor this in the math above in an attempt to make it easier to follow.
Hopefully that clarifies, sorry if I made that more confusing. You are 100% right the percentages and the gains are still the same in theory. It is a perspective that causes the loss of morale. That is why I was using my original comparison numbers. I am by no means an accountant or attorney so probably not the best person to explain the accounting aspect of a reverse split. :)
All those numbers are really muddying the waters, but I suppose that's par for the course with stock splits.
The bottom line is much simpler: before and after a forward or reverse split, everyone has exactly the same share of the company as before. The rest is just an accounting fiction.
Granted, the exchanges enforce some of that fiction with their minimum share prices, and of course in the old days when shares were often traded in blocks of 100 it made a difference in how small a trade you could make.
But aside from that, it's still a fiction.
A reverse split is like saying "So you want to buy some pie? I was going to sell you 16 huge slices, a full quarter-pie each! But I changed my mind. Now I will only sell you four pies."
In other words, it's a psychological/educational problem, not a financial one. The only people truly affected by the splits you described are those who don't understand splits work.
Granted, this problem can be a real one. I had a friend who celebrated with joy any time a company whose shares he owned did a 2 for 1 split. He was certain that the shares would almost immediately climb back up to their previous price, because that was the natural share price for the company.
I tried to explain to him that he had exactly the same share of the company as before and the split didn't affect the company's financials in any meaningful way, but it just never sank in. He bought companies that had a habit of splitting their stock, and avoided companies that just let their share price rise.
The stock reports on the radio certainly don't help with this: "X co is up $6.51 at $327.90, and Z co is up 55 cents at $14.23."
An analogy that might help morale about the reverse split: "Instead of each getting eight pizza slices (opening price $0.25, strike price $1), you each get one pie (opening price $2, strike price $8)."
The real danger in a split or reverse with a private company is they can pretty freely change your ratio of unvested: vested stock, trapping you into 4 more years of servitude.
Had that happen to me once and saw others go through it at another company since then that I joined afterwards.
Want to discuss morale killers ? This is a pretty good one
The proper comparison would be a share price of 20 -> 60 with the reverse split, or a share price of 2.5 -> 7.5 without. And with those numbers you'll see that the split had no effect at all.
Maybe there's a scenario in which a reverse split screws up the employees. But I don't think it's the one you're describing.