Reverse Mergers: Advantages and Disadvantages

Once the private company effectively controls the public company, it can begin merging operations. A reverse merger is a process by which a smaller, private company goes public by acquiring an already-public company. Some public shell companies present themselves as possible vehicles that private companies can use to gain a public listing.

Downsides of a reverse takeover

A reverse merger strategy involves a smaller company acquiring a company that’s already publicly traded—usually a relatively small public company with relatively few operations. While the public company “survives” the merger, the private company owners become the controlling shareholders. They reorganize the merged entities in their vision, which usually includes replacing the board of directors and altering assets and business operations.

The disclosure is filed on Form 8-K and is filed immediately upon completion of the reverse merger transaction. These transactions allow owners of private companies to retain greater ownership and control over the new company, which could be seen as a huge benefit to owners looking to raise capital without diluting their ownership. For managers or investors of private companies, the option of a reverse merger could be seen as an attractive strategic option. You should also learn how the merger works and in what ways the reverse merger would benefit shareholders for the private and public company.

Private companies don’t have to follow the same rules and regulations as public companies. This means that investors can’t do their due diligence or research about the financial history of the company initiating the merger. This can be very risky for investors as there is no way to make an educated guess about the future of the company. The vast majority of public companies were created through the IPO process before reverse mergers became popular.

Management also has more strategic options to pursue growth, including mergers and acquisitions. The shell company can be registered with the Securities and Exchange Commission (SEC) on the front end (before the deal), making the registration process relatively straightforward and less expensive. To consummate the deal, the private company trades shares with the public shell company in exchange for the shell’s stock, transforming the acquirer into a public company. In a reverse merger, a private company buys an existing, smaller company, generally by purchasing more than 50% of the public company’s stock.

1. The purpose of a reverse merger is to help a private company gain access to a public market in a way that is more efficient than going through an IPO.
2. To reduce or eliminate the risk that the stock will be dumped, clauses can be incorporated into a merger agreement, designating required holding periods.
3. ‍Burger King – In 2012, Burger King was absorbed by Justice Holdings, a public shell company.
4. Time spent in meetings and drafting sessions related to an IPO can have a disastrous effect on the growth upon which the offering is predicated, and may even nullify it.
5. That means the controlling interest in a company changes hands, because the private company is acquiring the public one.
6. A reverse merger is a less time-consuming and less costly alternative to the conventional initial public offerings (IPOs).
7. The merger allowed Nikola, a private company established in 2015, to raise more than $700 million.

To bypass the expensive and laborious process, a private company can go public more simply by acquiring a public company. SPACs are a less administratively cumbersome method of accessing the stock market than an IPO. In a SPAC deal, a listed shell company led by a management team looking for an acquisition raises funds to acquire a private firm and bring it public. It is common for the process to involve acquiring a small-scale public company with a relatively low level of operations. Although the public company remains intact after being acquired, the owners of the (formerly) private company transition to being the controlling shareholders. This is generally followed by a reorganization of the company’s assets and operations and a new board of directors.

Ownership of a public company

The goal is to gain control of the target company by acquiring 50%+ of the outstanding voting shares. A Reverse Takeover (RTO), often known as a reverse IPO, is the process in which a small private company goes public by acquiring a larger, already publicly listed company. The practice is contrary to the norm because the smaller company is taking over the larger company – thus, the merger is in “reverse” order. There is no immediate capital raised during this time, which helps speed up the process of being publicly listed.

1. On the other hand, reverse mergers have various risks, namely the lack of transparency.
2. The goal is to gain control of the target company by acquiring 50%+ of the outstanding voting shares.
3. Dell soon confirmed its intention to merge with VMware Inc, its publicly-held subsidiary.
4. If you’re interested in effective M&A strategies, take some time to listen to the M&A Science podcast, where transactions experts cast a critical eye over reverse mergers and every other corner of M&A transactions.
5. The second scenario almost always involves a special purpose acquisition company (“SPAC”), which is a public “shell” company that does not actively generate revenue.
6. As an alternative to the traditional IPO route, a reverse merger can be perceived as a more convenient, cost-efficient method to obtain access to the capital markets, i.e. public equity and debt investors.

This is the opposite of a traditional IPO, making reverse mergers suitable only for companies that are not in need of cash in the short term. One of the main drawbacks of going through a reverse merger is that it may not provide instant access to capital. There is never any guarantee that a company will be able to access liquidity through the stock market through a reverse merger (or even an IPO)—especially when a company has never traded before.

The Reverse Merger Alternative to an IPO: Technique Gaining Traction in Life Sciences Sector

A reverse takeover allows a private company to go public without the costs and delays of an IPO. In many cases, the combined company will seek to raise additional capital (either privately, concurrently with the completion of the merger, or publicly, following the merger) to extend its cash runway. For Dell, the reverse merger – a complicated ordeal with several major setbacks – enabled the company to return to the public markets without undergoing an IPO.

If you are hoping to take your company public without going through the IPO process, you may want to consider a reverse merger. Since the private company will acquire the public listed company through the mass buying of shares in the shell companies, the company will not need any registration, unlike in the case of IPO. Although reverse mergers have taken a back seat to SPACs over the last half decade, they still offer an effective means of publicly listing a company if the right acquisition target can be found. An IPO involves the company directly listing on the stock market index, going through the month process of SEC oversight, investor roadshows and corporate governance preparation. In contrast, the reverse merger process is not only significantly more cost-effective but can also be completed in a matter of weeks since the public shell company is already registered with the U.S.

Reverse takeover

To alleviate this risk, managers of the private company can partner with investors of the public shell who have experience in being officers and directors of a public company. The CEO can additionally hire employees (and outside consultants) with relevant compliance experience. Managers should ensure that the company has the administrative infrastructure, resources, road map, and cultural discipline to meet these new requirements after a reverse merger. As mentioned earlier, the traditional IPO combines both the process of going public and the capital-raising functions. Because the reverse merger is solely a what is reverse merger mechanism to convert a private company into a public entity, the process is less dependent on market conditions (because the company is not proposing to raise capital). Since a reverse merger functions solely as a conversion mechanism, market conditions have little bearing on the offering.

Risk of overvaluation

Time spent in meetings and drafting sessions related to an IPO can have a disastrous effect on the growth upon which the offering is predicated, and may even nullify it. In addition, during the many months it takes to put an IPO together, market conditions can deteriorate, making the completion of an IPO unfavorable. In a reverse merger, an active private company takes control and merges with a dormant public company.