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Reverse Takeover

Updated on May 29, 2024
Article byWallstreetmojo Team
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Reverse Takeover?

A reverse takeover, also called reverse IPO, is a strategy to list a private company by acquiring an already listed public company. Therefore, as a result, it avoids the costly and lengthy process of getting listed on a stock exchange through an Initial Public Offer (IPO).

What Is A Reverse Takeover

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These transactions can also occur with other motives, just from the acquirer’s strategic point of view to expand inorganically or improve business functions if they see value in a public company. It is an alternative model for private companies to go public and get the benefits of trading like a public company. This gives an easy and faster access to the capital market.

Key Takeaways

  • A reverse takeover is also called a reverse IPO. It is a tactic to list a private company by gaining an already listed public company. Hence, as a result, it averts the costly and lengthy method of getting listed on a stock exchange via an Initial Public Offer (IPO). 
  • These transactions occur with other objectives, just from the acquirer’s strategic perspective, to widen inorganically or enhance business functions when they view value in the public company.
  • New York Stock Exchange, Berkshire Hathaway – Warren Buffet, Ted Turner – Rice Broadcasting, and Burger King are examples of the reverse takeover.

How Does A Reverse Takeover Work?

The process of reverse takeover (RTO) is also called reverse merger. It is a method often used by private companies to go public with a short period of time without bearing much of a hassle of issuing Initial Public Offer (IPO) to the public, which is not only time consuming but also expensive.

In the reverse takeover process, there is a company which is publicly traded but has very less assets and limited scope of operations, which is also called a shell company. These shell companies, even though listed in the stock exchange, do not perform operations in an active manner. Such companies are sought after by the private ones who want to go public.

These private companies have strong balance sheet, high growth prospects in future and a good business model. They try to negotiate with the shell companies to convince them and get control over their operations. Since the private company has strong prospects and ood future opportunity, it is usually not very hard to acquire the shell company. In the process, there may be exchange of stocks or issuing new ones.

In this way the private company successfully gets the control of the operations and management of the shell company. This change in control results in reverse takeover. Very often the name and logo of the public company is changed to something that shows that from now onwards, its operations will be controlled by the private one.

Thus, in a reverse takeover transaction, since the private company now has total control of the public one, it can enlist itself in the stock exchange too and trade like a public company.

Different Forms

  • A public company can acquire a significant stake in a private company through an exchange of 50% ownership (most of the time) of a public company. In such a case, a private company becomes a subsidiary of a public company and can also be considered public.
  • The public company sometimes merges with a privately held company through a stock swap. Eventually, the private company takes on significant control over the public company.

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Examples

Let us look at some suitable examples and cases where such reverse takeover process happened. This will help to gain a better understanding of the concept.

#1 – New York Stock Exchange

In 2006, the New York Stock Exchange acquired Archipelago Holdings and created the ‘NYSE Arca Exchange’ to go public. Later on, it renamed itself NYSE and started trading publicly.

#2 – Berkshire Hathaway – Warren Buffet

The company owned by one of the wealthiest men in the world ‘Warren Buffet,’ Berkshire Hathaway, also used this route to go public. Though Berkshire was engaged in the textile business, it merged with the private insurance company owned by Warren Buffet.

#3 – Ted Turner – Rice Broadcasting

Ted Turner inherited a small billboard company from his father, which was not doing well financially. So, in 1970, with the limited cash availability, he acquired another U.S.-based listed company called Rice Broadcasting, which later became part of the media giant, The Time Warner Group.

#4 – Burger King

In 2012, Burger King Worldwide Holdings Inc., a hospitality services chain that serves burgers in its restaurants, executed a reverse takeover transaction. A publicly listed shell corporation called ‘Justice Holdings’ was co-founded by the famous hedge-fund veteran Bill Ackman, who acquired Burger King.

Advantages

Here are some important advantages of the concept of reverse takeover transaction.

#1 – Swift Process

Due to various regulatory requirements, the usual way of getting listed through an Initial Public Offering takes months to years due to various regulatory requirements. Getting listed through reverse takeover can be done within weeks only. It helps the company’s management in saving time as well as effort.

#2 – Minimal Risk

Many times depend upon the microeconomicmacroeconomic, or political situation and the company’s recent performance. For example, management may decide to go back to the public because getting listed may not fetch a good response from investors, which can deteriorate its valuation.

#3 – Reduced Dependability on the Markets

Before going public, there are several other tasks that the company needs to undertake to create a positive sentiment in the market for its IPO, which include roadshows, meetings, and conferences. These tasks require effective management and cost efforts because the company hires investment banks as advisors for these tasks.

In the case of a reverse takeover, the dependence on the market reduces significantly. The company does not need to care about the response from investors from the first listing. A reverse takeover converts the private company into a public company, and market conditions do not impact its valuation.

#4 – Less Expensive

As described in the last part, the company saves the fees paid to investment banks. In addition, the costs involved with regulatory filings and prospectus preparation also get exempted.

#5 – Benefits of Getting Listed

Once the company is public, it becomes easier for the shareholders to exit their investment to sell their shares in the market. In addition, access to the capital becomes easier since the company can go for a secondary listing whenever it needs more money.

Reverse Takeover - Adv-disadv

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Disadvantages

Some disadvantages of the process as given below as follows:

#1 – Asymmetrical Information

In M&As, the process of due diligence of the financial statements often gets overlooked or does not involve much scrutiny because the company focuses on its business needs only now. At times, the management of the companies manipulates their financial statements too to get good value for their company.

#2 – Possibilities of Fraud

At times shell companies can misuse this opportunity. They do not have any operations whatsoever or are troubled companies. They provide a safe route to private companies in going public by acquiring them.

#3 – Burden of Regulations

There are a lot of compliance issues in case of reverse takeover accounting when a company goes public. Taking care of these compliances requires significant efforts, and thus management gets busier in sorting out administrative issues first, which hinders the company’s growth.

  • IPOs are more profitable. Often, it says that IPOs are overpriced, increasing their valuation. That is not the case with reverse takeovers.
  • The positive sentiment created by the investment bank acting as an advisor for the concerned company helps the company get good support in the market, which does not happen with reverse takeovers.

Reverse Takeover Vs Special Purpose Acquisition Company(SPAC)

Both RTO and SPAC are procedures that private companies follow in order to become public company without undergoing the detailed procedure of issuing IPO. But there are some differences between them, as follows:

  • The former is the process of acquiring a public company by a private one and in the process, the private company becomes public. But in case of the latter, there is a shell company called SPAC, whose only purpose is to acquire a private organization and make it public through issue of IPO.
  • The reverse takeover accounting involves acquiring the public company directly and issuing or exchanging shares to the shareholders of the public company. But the latter does not perform any business activity but only raises capital through IPO and takes the private company public.
  • The former is less time consuming and less expensive than the IPO process and can be done with proper negotiation and regulatory approvals. It can be executed quickly. But the latter is more time consuming since it needs to issue IPO , look for a suitable shell company and then initiate the process of merger to complete the process.
  • The funds raised after acquisition of the public company and getting listed in stock exchange is used for funding the operations of the new entity, whereas the funds that the shell company raises through IPO is used to finance the merger or acquisition of the target company. If this cannot be done within a certain timeframe, the SPAC has to return the funds to the investors.
  • The stock dilution of existing shareholder is less for RTO, compared to  SPAC because in the case of former, there is usually an exchange of shares with the shareholders of the public company. But for the former, the existing shareholders ownership in the target company gets diluted.

However, even though the above are some important differences between the two, it depends on factors like goals, market situation etc, whether an organization will adopt the former or the latter method for going public.

Reverse takeovers provide an excellent opportunity for private companies by bypassing all the complex procedures involved in getting listed through IPOs. They are a cost-effective alternative for such companies to go public. However, considering the limitations of reverse takeovers and possibilities of misuse due to constraints related to transparency in the transaction and lack of information, it provides an option to misuse the loopholes in this route to financial sector-focused companies.

Thus, regulatory authorities must have proper frameworks in place to check that it does not lead to the loss of capital of investors. Once such externalities are taken care of, the only thing management of the companies needs to take care of are the additional responsibilities that come up as a public company, which, if handled properly, can lead to good output in the future.

Frequently Asked Questions (FAQs)

How does a reverse takeover work?

A Reverse Takeover (RTO), known as a reverse IPO, is the approach in which a small private company goes public by gaining a more prominent and already publicly listed company. It is contrary to the normal process because the smaller company takes over the larger company. Therefore, the merger occurs in a “reverse” order.

Is a reverse takeover good for shareholders?

A successful reverse merger can increase the company’s stock value and liquidity. For example, when a private company gains a publicly traded company, its share prices usually rise to the takeover price. In addition, existing shareholders receive cash in return for their stock when the deal is closed.

What happens to shares in a reverse takeover?

Initially, a private company purchases sufficient shares to regulate a publicly-traded company. Then, the private company’s shareholder exchanges its shares in the private company for shares in the public company. In this way, the private company has efficiently become a publicly-traded company.

This article is a guide to what is Reverse Takeover. We explain it with examples, differences with SPAC, its different forms, advantages & disadvantages. You can learn more about M&A from the following articles: –

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