Reverse MergerDefinition, How to Spot One & Examples

Written By:
Adiste Mae

There are several different types of acquisitions and today we are going to talk about one that is different than many traditional acquisition methods – the reverse merger.

This type of merger is used to acquire another company but also bring a private company public.

Let’s dive-in to learn all about reverse mergers, their advantages and disadvantages, and what makes them unique.

 

What is a Reverse Merger?

A reverse merger, also known as a reverse takeover or reverse IPO, is when a private company acquires a public company.

The acquisition makes the private company public without having to go through the lengthy and complex process of “going public.”

Rather than having to raise capital in the public market, the private company may go public by acquiring a controlling stake in a public company.

This type of merger requires a lot of planning and some reorganization of capitalization of the acquiring company.

The shareholders of the private company usually obtain ownership of the public company and they gain control of its board of directors.

In other words, the private company merges with the public company to form one public company.

Process of a Reverse Merger

When a reverse merger happens, the shareholders of the private company purchase a majority of the shares of the public company, which gives them control of its board of directors.

The public company is called a “shell” company because all that is left of the original company is the actual organizational structure itself.

The private company and shell company exchange information, agree on the terms of the merger, and sign the share exchange agreement.

The exchange of shares and exchange of control is where the name “reverse merger” comes from and what completes the acquisition.

The private company’s shareholders pay for the shell company by contributing their shares in the private company to the shell company they now control.

Although a reverse merger skips the process of taking the private company public through the IPO, they must still submit audited financial statements, legal disclosures, and a comprehensive disclosure statement to the SEC (Security and Exchange Commission).

Once the reverse merger is completed, Form 8-K must be filed with the SEC.

Advantages of Reverse Mergers

Avoid IPO

When a reverse takeover happens, the privately held company is taken public at a much lesser cost, with less stock dilution, and without all of the necessary preparation that comes with an initial public offering (IPO).

Going public requires raising capital but a reverse takeover means that a company can go public without actually raising any capital.

Less Risk to Market Conditions

When a company does its IPO, it is susceptible to current market conditions which can be either favorable or unfavorable.

In a reverse takeover, market condition have little to no bearing on the deal because the acquisition is solely between the private and the public companies involved.

Faster Turnaround

Preparing for an IPO can take 6 months to a year or more while a reverse merger can be completed in a matter of weeks.

Disadvantages of Reverse Mergers

Risk of Fraud

There is an increased risk of fraud with reverse mergers if the proper due diligence is not done.

In 2017, the documentary titled The China Hustle covered a series of reverse mergers between China and US publicly traded companies that resulted in fraudulent activity.

Acquiring companies were created as a front with non-existing business activity and used to perform reverse mortgages, resulting in a number of US companies being defrauded out of millions of dollars.

Shareholder baggage

In a reverse takeover, the shareholders often stay on with the public company. This could come with some baggage in the forms of pending lawsuits, sloppy or unorganized records, or other unforseen potential liabilities.

Merger vs Reverse Merger – What are the differences?

In a traditional merger, also known as a forward merger, the target company merges with the acquiring company and its shareholders recieve the stock of the acquring company.

A reverse merger is actually the opposite where the acquirer mergers with the target company but keeps the target companies stock.

SPAC vs Reverse Merger – What are the differences?

SPAC stands for Special Purpose Acquisition Company.

A SPAC is a company that has not actual commercial operations but is rather formed with the purpose of raising capital through an initial public offering.

This is done with the goal of acquiring or merging with another existing company.

For this reason, SPAC’s have also been called “blank check companies” they are not actually operational.

Investors or sponsors usually form SPAC’s to pursue a specific acquisition target.

The SPAC raises funds from underwriters and investors and the funds are placed in an interest-bearing account until an acquisition is completed.

If an acquisition is not completed within two years time, it could face liquidation.

SPAC’s are advantageous for companies that are private but want to go public without going through the IPO process.

A SPAC is like a “shell” company in a way and a private company can use a SPAC to go public by performing a reverse merger.

Once the SPAC becomes a public company, it then merges with the private company and takes it public – this process is called a reverse merger.

The SPAC is a company used to bring a private company public and the reverse merger is the method used for the acquisition.

Examples of Reverse Mergers in the Real World

reverse merger

Here are a few examples of reverse mergers that happened in real life: