Reverse Merger

What is Reverse Merger?

Reverse merger refers to a type of 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)

Forms of the Reverse Merger

  • A public company may go on to 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 as being public.
  • A public company may sometimes merge with a private company, usually through means of a stock swap, wherein the privately held company shall go on to keep significant control over the public company.

Example of Reverse Merger

Example #1 – Diginex Reverse Merger

Reverse Merger Example

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 – Ted Turner-Rice broadcasting

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

Example #3 – Rodman & Renshaw and Roth Capital

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.

Advantages

  • 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 a period of weeks. This saves a lot of time and effort for the management of the company
  • Risk minimization: Though several months are put into planning out the IPO, it is conventionally never guaranteed if the company would actually go in for the IPO. At times the stock market may seem really unfavourable, and the deal may get cancelled, and all of the efforts sometimes do go into waste
  • Less dependence on the market: All the laborious tasks of undertaking roadshows to gauge the market sentiment and convince the potential investors to undertake subscriptions of the upcoming issue is not a matter of concern when a company adopts the route of reverse mergers. It even need not be even concerned when it comes to subscription and market acceptance of the offer. Since the process of this mergers 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
  • Less costly: Since there are no hefty fees to be paid 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 preparation of prospectus.
  • 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.

Reverse Merger

Disadvantages

Of course, the process comes with certain drawbacks, as listed

  • 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 so with the private company. They will have themselves audited with the franchise of famous audit companies, by some dubious financial statements as 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, it often happens that 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 result in affecting the performance of the company if managers tend to focus more on all of the administrative concerns than having to run the business

Limitations

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

Conclusion

Reverse merger stands as an excellent opportunity for private companies to bypass all of the procedure, which is 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 the scope of misuse of such routes owing to limited transparency and information asymmetry, it has enabled many in the financial sector sphere to take advantage of such loopholes. It becomes imperative that ethical frameworks be well imbibed in them 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 also the essential nitty-gritty involved in managing the regulatory requirements demanded from that of a public company.

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