Reverse Merger

Reverse merger refers to a merger in which private companies acquire a public company by exchanging the majority of its shares with a public company, thereby effectively becoming a subsidiary of a publicly-traded company. It is also known as reverse IPO, or Reverse Take Over (RTO). This process allows the owners to have more ownership and authority over the newly acquired company.

For a public company to go public it can take a year or longer. However, the reverse merger process can finish the same process in less than 30 days. It is also a less tedious and reasonable process for private companies in comparison to the traditional Initial Public Offering (IPO) route.

A Reverse merger is the process where a private company acquires a majority stake in a publicly listed company. Through this acquisition, the private company can save time and money which the traditional IPO route might take.

Reverse merger stocks stand as an excellent opportunity for private companies to bypass all of the procedures generally involved as a part of the IPO process. It tends to be a cost-effective route for companies to get themselves listed on any stock exchange and thereby become public.

However, given the limitations and scope of misuse of such routes due to limited transparency and information asymmetry, many in the financial sector sphere have taken advantage of such loopholes. It becomes imperative that ethical frameworks be well imbibed to avoid such occurrences.

Once such issues are taken care of, the only factor the private companies need to consider becomes the limited scope of such routes as a contrast to that of the IPO route and the essential nitty-gritty involved in managing the regulatory requirements demanded from that of a public company.

It is often noticed that the IPO process raises more money, contrary to a reverse merger process. It lacks market support for the stock, which is usually prevalent in the case of an IPO.

Let us understand the reverse merger process better by understanding its different forms that can be found in the market. Different companies have different nature of business and their style of operation. Therefore, their acquisitions can be different as well. Let us discuss their forms through the explanation below.

• A public company may acquire a significant proportion of the privately held company, thereby giving in exchange a majority of usually more than 50% of the public company. The private company now becomes a subsidiary of the public company and can now be considered public.
• A public company may sometimes merge with a private company, usually through a stock swap, wherein the privately held company shall keep significant control over the public company.

Let us understand the intricate details about reverse merger stocks with the help of a few of examples.

Example #1

source: cfo.com

Diginex is a Hong Kong-based cryptocurrency firm that became a public company by closing a reverse merger deal. It exchanges shares with 8i Enterprises Acquisitions Corp, a publicly listed company.

Example #2

A prominent example of a reverse merger is Ted Turner merging his company with Rice Broadcasting. Ted had inherited his father's billboard company, but the operations were bad. However, with his bold vision for the future, he managed to get a little investment cash in 1970 and purchased Rice Broadcasting, which is today a part of The Times Warner group.

Example #3

Small boutique firms like Rodman & Renshaw and Roth Capital went on to bring more than 40 Chinese companies to the American investors and stock exchanges by undertaking reverse mergers with ‘shell’ American public companies that were defunct or had little or no business with deals worth 32 million USD.

Reverse merger stocks have a significant number of advantages and it is understandable why private companies invest their efforts and resources to go public through these means. Let us understand the various benefits through the points below.

• Simplified process: The conventional method of offering a public issue through IPO usually takes months or years to materialize, whereas a reverse merger is done swiftly within weeks. It saves a lot of time and effort for the company's management.
• Risk minimization: Though several months are put into planning the IPO, it is conventionally never guaranteed if the company would go in for the IPO. At times the stock market may seem unfavorable, the deal may get canceled, and all of the efforts sometimes go to waste.
• Less dependence on the market: All the laborious tasks of undertaking roadshows to gauge the market sentiment and convince potential investors to undertake subscriptions to the upcoming issue is not a matter of concern when a company adopts the route of reverse mergers. Since this merger is merely a mechanism to convert a private company into a public one, the market conditions have little or no bearing on the company that wants to go public. It even need not be concerned about subscription and market acceptance of the offer.
• Less costly: Since there are no hefty fees for investment bankers, unlike in the case of public issuances, this adopted measure of reverse merger becomes cost-efficient to the company. Further, it may also exempt itself from all of the lengthy procedures involved in regulatory filings and prospectus preparation.
• Gains the benefits of a public company: Once a private company goes public, it provides an excellent exit opportunity for original promoters. The companies’ shares will now be traded on a public stock exchange and thus would help it gain the advantage of additional liquidity. The company now will have further access to capital markets to issue further shares through even secondary offerings.

Despite the series of benefits mentioned above, there are factors from the other end of the spectrum that prove to be hassles or hurdles in the whole process. Let us discuss the disadvantages of the reverse merger process to understand the topic in depth.

• Information asymmetry: Since the process of due diligence is often overlooked, the letters and bank statements may often be forged by dishonest management as there is little transparency, thereby causing information asymmetry
• Scope for fraud: There is scope for huge fraud as there are times when the shell or defunct company may have little or no underlying business along with the private company. They will have themselves audited with the franchise of famous audit companies by some dubious financial statements provided by the management. However, there shall be little or no operations underneath. Boutique firms, too, misuse this opportunity to make bucks out of taking such companies public through the scope of reverse mergers
• New burden of compliance: When a private company goes public, managers are often sometimes inexperienced when it comes to all of the requirements that come along in being a public company. These burdens may often affect the company's performance if managers tend to focus more on all of the administrative concerns than having to run the business.

This article has been a guide to what is a Reverse Merger. Here we explain its examples along with forms, benefits, and disadvantages in detail. You can learn more about accounting from the following articles –

• Examples of Vertical Merger
• Horizontal Merger Definition
• Statutory Merger Definition