What Is a Reverse Merger?

What Is a Reverse Merger?

A reverse merger is an acquisition in which a private company buys a public company. Reverse takeovers are a quick and easy way for a private company to become a publicly traded company, but they come with the risk of lowering stock value and inheriting significant liability. Learn more about reverse mergers and their benefits and drawbacks.

 

Reverse Merger Definition

A reverse merger, also known as a reverse IPO or a reverse takeover, is a type of acquisition in which a private company acquires a publicly traded company. Reverse mergers are a popular strategy for private companies that want to go public but don't want to deal with the typical costs and procedures associated with becoming publicly traded. Because the private company is frequently smaller than the public company, it is the inverse of a traditional merger in which larger companies acquire smaller companies. A reverse merger is one of several types of mergers and acquisitions, which also include horizontal and vertical mergers.

 

Process of a Reverse Merger

A reverse merger transaction is a simple process that, when done strategically, can help increase the value of a company's stock. A reverse merge entails the following steps:

1. Bargaining and due diligence: M&A transactions typically begin with a letter of intent from the acquiring company summarizing the transaction details. The letter is not a legally binding agreement, but it may include a confidentiality and exclusivity agreement between the two parties, allowing lawyers, tax advisors, and other professionals to begin the due diligence process. Following the completion of due diligence, the legal team will draft a merger agreement outlining the merger or acquisition conditions as well as any regulatory filings requiring shareholder approval.

2. Purchase of majority shares: Following the signing of the share exchange agreement, the shareholders of the private company purchase the majority of the shares of the public shell company (the number of shares owned by the private company exceeds 51 percent). This completes the transfer of ownership and gives the private company's stakeholders power as members of the public company's board of directors. The new company is a publicly traded company that can trade on the stock exchange without being registered with the SEC.

3. Restructuring: With new ownership, the new company typically undergoes significant restructuring. The new reverse merger company must consider how to organize its leadership and management in order to meet the reporting and regulatory requirements of a publicly traded IPO.

 

Pros of a Reverse Merger

The advantages of a reverse IPO deal include:

Fast turnaround times: Unlike a traditional IPO, which can take months or years to complete, a reverse merger can be completed in just weeks. Reverse mergers do not necessitate the same time-consuming steps as a traditional IPO, such as raising capital or going through the lengthy registration process.

Lower risk: Because a reverse merger involves only a public and private company, it is less vulnerable to fluctuations in the New York Stock Exchange. A traditional merger, on the other hand, necessitates an underwriter from an investment bank, who may withdraw their offering if the market is weak.

Simple process for going public: A reverse merger enables a private company to enter the public market without the need for a lengthy registration process. Becoming a publicly traded company can result in increased valuations, improved liquidity, and access to public capital markets. Registration with the Securities and Exchange Commission to become a publicly traded company on the stock market can be costly and, in some cases, impossible due to market conditions.

 

Cons of a Reverse Merger

The disadvantages of a reverse merger include:

Increased responsibility and baggage: The new company formed by a reverse merger will inherit both companies' histories and will have to learn how to operate as a publicly traded company. If they are unable to successfully organize and adapt, the company's stock price may fall and the business may fail.

Risk of low share demand: When a small company merges with a larger company, investors may lose interest in the company's stock. A reverse merger process may not garner enough attention, or the new company may lack adequate funding or planning to entice investors.

Significant due diligence: While reverse mergers are a quick way to become an IPO, the process can still require extensive due diligence upfront. Both businesses must consider potential liabilities or the threat of legal action. The shareholders of the private company will want to examine the target company's financial statements and legal obligations to ensure they are not inheriting high-risk issues.

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