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

A reverse merger separates these two functions, making it an attractive strategic option for corporate managers and investors. With a reverse merger, investors in the public company are effectively being asked to conduct due diligence into the acquirer – a private company. As such, a private company’s management team may lack the experience it needs to meet the demands of regulators, including financial reporting and meeting compliance standards. Significantly increased liquidity means that both the general public and institutional investors (and large operational companies) have access to the company’s stock, which can drive its price up.

Reverse Mergers and Shell Corporations

Investors of the public shell should also conduct reasonable diligence on the private company, including its management, investors, operations, financials, and possible pending liabilities (i.e., litigation, environmental problems, safety hazards, and labor issues). Reverse mergers typically occur through a simpler, shorter, and less expensive process than a conventional IPO. With an IPO, private companies hire an investment bank to underwrite and issue shares of the new, soon-to-be public entity. If you learn that a company may be engaged in a reverse merger, avoid any temptation to act right away. Take time to allow the merger to complete, and then watch the company’s performance.

Some companies and individuals use shell corporations for various illegitimate purposes. This includes everything from tax evasion, money laundering, and attempts to avoid law enforcement. Before finalizing a reverse merger, the management of a private company must conduct a thorough investigation of the shell corporation to determine if the merger brings with it the possibility of future liabilities or legal entanglements. Going public through a reverse merger is like an IPO as it means the company’s owners must dilute ownership and give up a stake in the company to public investors. This means that they also give up a great degree of control over the future of the company and how it’s managed. Are there pending liabilities (such as those stemming from litigation) or other “deal warts” hounding the public shell?

Ownership of a public company

While this can be a time-consuming process, the rewards can be tremendous—especially if you find the diamond in the rough that becomes a large, successful publicly traded company. A private company may elect to do a reverse takeover in order to simplify the process of becoming a public company. Reverse takeovers allow companies to go public without the requirement to raise capital. After a private company executes a reverse merger, will its investors really obtain sufficient liquidity? After the reverse merger is consummated, the original investors may find little demand for their shares.

Once this happens, the company’s securities are traded on an exchange, and their shares enjoy greater liquidity. The original investors gain the ability to liquidate their holdings, providing a convenient exit alternative (versus having the company buy back their shares). The company has greater access to capital markets because management now has the option of issuing additional stock through secondary offerings. If stockholders possess warrants—the right to purchase additional stock at a pre-determined price—the exercise of these options provides an additional capital infusion into the company. It’s important to understand that, unlike in an initial public offering (IPO), there is no capital being raised immediately during a reverse merger.

A Simplified Process

When the transaction takes place, all of B’s shares are merged with A’s, the company keeps its publicly owned name, and the new owners control the company’s direction. In a reverse merger, the private company purchases the public company using either cash or equity, but the overall transaction may be less expensive than an IPO, assuming the what is reverse merger private company does not employ investment bankers to market new securities. The private company may need to hire outside service providers like lawyers and accountants to facilitate the reverse merger. But if no additional securities are being offered at the same time as the merger, the amount of work (and therefore the cost) may be reduced. At the start, the acquirer conducting a reverse takeover commissions the mass-buying of the publicly listed company’s shares.

A reverse merger also has the possibility of affecting a company’s status as an emerging growth company (EGC) under the JOBS act. Emerging growth companies have fewer requirements when going public as outlined in our article The JOBS Act. However, to qualify as an EGC you must meet certain criteria, most notably having revenues less than $1 billion in the last fiscal year. A company also cannot be considered an EGC if it completed an IPO prior to December 8, 2011. Choosing to go public through the issue of an Initial Public Offering is not an easy task for a small private company.

1. The private company may need to hire outside service providers like lawyers and accountants to facilitate the reverse merger.
2. Public markets provide liquidity to private company shareholders, increase the private company’s investor base, and make it easier to obtain future equity and debt funding.
3. It is a little known fact that the inflection point for Ted Turner’s empire came when his billboard advertising company, Turner Advertising, raised the cash to acquire a relatively cheap and under traded television company, the RiceBroadcasting Company in 1970.
4. 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.
5. Given the limited time to conduct diligence and the reduced amount of information available, the lack of transparency (and unanswered questions) causes share price volatility, especially right after the transaction closes.
6. While a reverse merger can be an excellent opportunity for investors, they also have certain disadvantages.
7. Over time, you’ll learn whether the company is on a solid financial footing or not.

The merger allowed Nikola, a private company established in 2015, to raise more than $700 million. Nikola said the capital would allow it to increase production of its electric batter and hydrogen fuel-cell vehicles. Shares began trading on the Nasdaq under the ticker symbol NKLA on June 4, 2020.

Financial Accounting and Reporting for SPACs: Tips from the Experts

1. Companies that are looking to raise funds as they go public are better off taking the traditional route of pursuing an IPO.
2. SPACs are initially formed by a group of investors who contribute cash or other assets.
3. At the start, the acquirer conducting a reverse takeover commissions the mass-buying of the publicly listed company’s shares.
4. There is no immediate capital raised during this time, which helps speed up the process of being publicly listed.
5. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path.
6. Under the first scenario, a private company acquires enough shares of a public company to gain control of the company and its board.

If the public shell’s investors sell significant portions of their shares right after the merger, this can materially and negatively affect the stock price. To reduce or eliminate the risk that the stock will be dumped, clauses can be incorporated into a merger agreement, designating required holding periods. As stewards of the acquiring company, the management can use company stock as the currency with which to acquire target companies. Finally, because public shares are more liquid, management can use stock incentive plans to attract and retain employees. As for China, these companies registered on the US exchanges and not on the Chinese exchanges gives little incentive for Chinese regulators to oversee these firms’ actions due to the exchange location. For these companies, their audits are a source of controversy between the United States and Chinese governments.

While a reverse merger still requires preparation and due diligence, the process can be quicker than going through an IPO. The IPO process involves creating financial statements, having the financial statements audited, drafting an S-1, getting the S-1 approved by the SEC, pitching to potential investors, and many other tasks. A reverse merger may avoid some of these formalities because the public company is already registered with the SEC. With reverse mergers on the other hand, the private company is acquiring a dormant listed company – i.e. a publicly listed company that has almost no assets to speak of, is thinly traded, and still files annual reports that for the most part, go unread by almost anybody.