Overview


In a reverse merger, shareholders of the private company purchase control of the public shell company and then merge it with the private company. The publicly traded corporation is called a "shell" since all that exists of the original company is its organizational structure with little to no assets. The private company shareholders receive a substantial majority of the shares of the public company and control of its board of directors. The transaction can be accomplished within weeks.

If the shell is an SEC-registered company, the private company does not go through an expensive and time-consuming review with state and federal regulators because this process was completed beforehand with the public company. The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing, the shell company issues a substantial majority of its shares and board control to the shareholders of the private company. The private company's shareholders pay for the shell company by contributing their shares in the private company to the shell company that they now control. This share exchange and change of control completes the reverse takeover, transforming the formerly privately held company into a publicly held company. When the private company and public shell merge together, the combined entity thereafter trades under the previously private company’s name rather than the shell company’s name as it did before.


Advantages


The advantages of public trading status are too numberous to list here but the following are some advantages of going public with a reverse merger instead of a traditional IPO:

  • Lower Cost - Going public through a reverse merger allows a privately held company to become publicly held at a lesser cost.

  • Less Dilution - Generally less stock dilution than through an initial public offering (IPO).


  • Simplicity - While the process of going public and raising capital is combined in an IPO, in a reverse merger, these two functions are separate. A company can go public without raising additional capital. Separating these two functions greatly simplifies the process.


  • Market Conditions - A reverse merger is less susceptible to market conditions. Conventional IPOs are risky for companies to undertake because the deal relies on market conditions, over which senior management has little control. If the market is off, the underwriter may pull the offering. If a company in registration participates in an industry that's making unfavorable headlines, investors may shy away from the deal. In a reverse takeover, since the deal rests solely between those controlling the public and private companies, market conditions have little bearing on the situation.


  • Less Time - The process for a conventional IPO can last for a year or more versus 30-60 days for a reverse merger. When a company transitions from an entrepreneurial venture to a public company fit for outside ownership, how time is spent by strategic managers can be beneficial or detrimental. 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.