Reverse Merger: What Is a Reverse Merger?

A reverse merger, also known as a reverse initial public offering or a reverse takeover, describes a type of acquisition in which a private company purchases a public company. Reverse mergers are a common strategy for private companies that want to go public but don’t want to deal with the typical costs and procedures of becoming registered to publicly trade. Often the private company is smaller than the public company, which is why it is the reverse of a traditional merger in which larger companies purchase smaller companies. A reverse merger is just one of many types of mergers and acquisitions, including horizontal mergers and vertical mergers.

A reverse merger transaction is a simple process that can help improve the value of a company’s stock if done strategically. The process of a reverse merge includes:

1. 1. Negotiations and due diligence: Mergers and acquisitions (M&A) deals usually begin with a letter of intent from the acquiring company, summarizing the transaction details. The letter is not a binding agreement, but it may contain a confidentiality exclusivity agreement between the two parties that allows lawyers, tax advisors, and other professionals to begin the due diligence process. Once due diligence is complete, the legal team will draw up a merger agreement outlining the merger or acquisition conditions and any regulatory filings regarding shareholder approval.
2. 2. Purchase of majority shares: Once the companies have signed the share exchange agreement, the shareholders of the private company purchase the majority 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 stakeholders of the private company power as board of directors of the public company. The new company is a publicly listed company that can trade on the stock exchange without needing to register as an SEC company.
3. 3. Restructuring: The new company typically undergoes significant restructuring with new ownership. The new reverse merger company will need to consider how to organize its leadership and management to meet the reporting requirements and regulations as a publicly traded IPO.

Advantages of a reverse IPO deal include:

• Fast turnaround times: While a traditional initial public offering can take many months or years to finalize, companies can finalize a reverse merger in just weeks. Reverse mergers don’t require the same time-consuming steps as a conventional IPO like raising capital or going through the lengthy registration process themselves.
• Lower risk: A reverse merger is a deal exclusively between the public and private company, which means it won’t be as susceptible to fluctuations in the New York Stock Exchange. Conversely, a traditional merger requires an underwriter from an investment bank who could pull their offering if the market is poor.
• Simple process for going public: A reverse merger allows a private company to enter the public market without having to go through a lengthy registration process. Becoming a publicly operating company can lead to higher valuations, improved liquidity, and access to public capital markets. Registering with the Securities and Exchange Commission to become a publicly traded company on the stock market can require significant capital and can sometimes be impossible due to adverse market conditions.

Disadvantages of a reverse merger include:

• Increased responsibility and baggage: The new company created in a reverse merger will inherit the history of both companies and will have to learn to run as a publicly traded company. If they can’t successfully organize and adapt, the company’s stock price could drop and the business could fail.
• Risk of causing low demand for shares: After a small company merges with a larger company, investors may lose interest in the company’s shares. A reverse merger process may not attract enough attention or the new company may lack sufficient funding or planning to appeal to investors.
• Significant due diligence: While reverse mergers are a simple way to become an IPO, the process can still involve significant due diligence up front. Both companies have to consider potential liabilities or the threat of litigation. The private company’s shareholders will want to examine the target company's financial statements and legal obligations to make sure they aren’t inheriting high-risk problems.

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