Reverse Merger, why some companies prefer it to an IPO?

IPO is the best-known way for a company to go public. But this isn’t always the best one

Companies go public in a number of ways. The most common method is that of having an initial public offering, also known as an IPO.

In an IPO, the company talks with advisors and investment bankers, conducts a roadshow, and then sells shares to investors. This process is usually long and expensive.

Some of the recent common IPO was that of Uber, Peloton, and Shopify.

Another way of going public is that of direct listing. In this process, a company does not sell stocks directly to investors. Instead, the company facilitates the resale of shares held by company investors, employees, and insiders.

The process is usually slightly cheaper than a normal initial public offering because the role of investment bankers is usually limited. The most recent prominent companies to use direct listing are Slack and Spotify.

What is a Reverse Merger?

A reverse merger or reverse takeover is another way in which companies go public. This is a process where a private company buys a company that is already public.

The public company that is acquired is often a dormant one or one that is not well-known. A dormant company is also known as a shell company.

According to the Securities and Exchange Commission (SEC), the company needs to be publicly traded, has nominal or no operations at all, or have nominal assets, no assets or cash only assets.

How it Works

In a reverse merger, the shareholders of the private company will send an acquisition proposal to the shell company. If the company accepts, the shareholders of the private company will become the majority owners of the new public company.

After this, they can vote to change the name of the entire company and its ticker. A ticker is the symbol that is associated with the company. For example, the ticker price of Apple is AAPL while that of Twitter is TWTR.

The chart below shows how a reverse merger happens (and its steps).

Reverse merger steps

Reverse merger steps

Practical Examples

Reverse mergers are not very popular among companies that are going public. Still, a number of companies are opting to bypass the initial public offering.

The most recent company to do that was Virgin Galactic, the space company started by Richard Brunson. Instead of going through an IPO, the company purchased a company known as Social Capital Hedosophia that was started by Chamath Palihapatiya.

Another popular company that did a reverse merger was Michael Dell’s Dell Corporation. As you recall, Dell took the company private in 2013 in a deal that was valued at more than $24 billion. In 2018, the company accepted to acquire a small publicly traded company known as DVMT.

The company is now worth more than $26 billion.

And Also MindMed

Reverse Merger VS IPO

What’s good about a Reverse Merger..

There are several reasons why a company uses reverse mergers. First, a reverse merger is usually easy to execute than an IPO. A good example of how an IPO can go wrong is what happened in WeWork. The company’s stock collapsed even before the company went public.

Second, a reverse merger is usually cost effective than an IPO. This is because it does not involve so many transaction advisors.

Third, a reverse merger is usually fast to execute provided that the company being acquired is positive about the deal.

..and what’s not

Reverse mergers too have their own disadvantages.

First, the process does not lead to a lot of publicity as an IPO does. This is because most investors focus on the theatrics of the IPO.

Second, a reverse merger can lead to lawsuits that are associated with the shell company that is being acquired. Some of these lawsuits are about accounting and other fraudulent cases.

Finally, a reverse merger leads to stock splits, which can reduce the number of shares held by shareholders.

Final Thoughts

A reverse merger is a relatively unpopular method in which companies go public. It is mostly popular among small and medium-sized companies that want to go public. Still, several popular companies like Dell and Virgin Galactic have used the process.

External Useful Resources

  • Reverse Merger Transaction: Everything You Need to Know – Upcounsel
  • Investor Bulletin about RM – Sec.gov

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