Reverse Mergers: Advantages and Disadvantages

This can be very risky for investors as there is no way to make an educated guess about the future of the company. In June 2020, Phoenix-based Nikola completed a reverse merger with VectoIQ, a special purpose acquisition company (SPAC). The merger allowed Nikola, a private company established in 2015, to raise more than $700 million. Nikola said the capital would allow it to increase production of its electric batter and hydrogen fuel-cell vehicles.

What Is A Special Purpose Acquisition Company (SPAC)?

A buyout is when a firm or individual acquires a controlling stake in another company, typically funded by debt. Additionally, the process of integrating the two merging entities can be complex and time-consuming. This is particularly true if the two companies have vastly different cultures, systems, and business processes. Failure to navigate these challenges effectively can result in a lack of synergy between the two companies, ultimately impacting the success of the merger. The primary benefit of a reverse merger is the ability to go public quickly and with less expense than a traditional IPO. It also allows companies to avoid some of the regulatory hurdles and requirements of a traditional IPO.

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Private companies are held privately, and they are almost always owned by the people who establish them. While they may have access to private equity, they are generally closed off from the public, including stock markets. Contrast that with public companies, which have access to capital markets by giving up a stake to public investors. And there are several options that private entities have, including the reverse merger. A reverse merger strategy involves a smaller company acquiring a company that’s already publicly traded—usually a relatively small public company with relatively few operations.

• Check out our directory of the best M&A lawyers in Canada as ranked by Lexpert.
• Stockholders who would otherwise be entitled to receive a fractional share will be entitled to receive a cash payment.
• Identifying reverse mergers before they are announced can be a tricky process.
• Prosper is a self-taught financial analyst and investor with years of experience.

But the returns can be tremendous for investors who snatch up shares in advance. And this can translate into impressive double-digit returns in a relatively short space of time. Understanding reverse mergers is crucial for companies considering this route to going public.

A less reliant on the market

A privately operating business may decide it wants to fast-track its public listing process without the delays and costs of an IPO. In this case, investors of the private company acquire a majority of the shares of a public shell company, which is then combined with the purchasing entity. For example, Nikola, a private company established in 2015 that makes hydrogen fuel-cell electric trucks, completed a reverse merger with VectoIQ, a special purpose acquisition company (SPAC) in June 2020. In contrast, a reverse merger involves a private company merging with a public company, often referred to as a “shell” company.

If so, shareholders of the public shell may merely be looking what is reverse merger for a new owner to take possession of these problems. Thus, appropriate due diligence should be conducted, and transparent disclosure should be expected (from both parties). As stewards of the acquiring company, the management can use company stock as the currency with which to acquire target companies. Finally, because public shares are more liquid, management can use stock incentive plans to attract and retain employees. But if a struggling firm has been acquired, corporate restructuring almost always occurs. The firm will assess the quality of the assets and dispose of anything deemed economically unviable.

There’s also an extensive due diligence process, tons of paperwork and regulatory reviews. What’s more, even after all of that, unfavorable market conditions beyond any company’s control can complicate if, or when, an IPO happens. To alleviate this risk, managers of the private company can partner with investors of the public shell who have experience in being officers and directors of a public company. The CEO can additionally hire employees (and outside consultants) with relevant compliance experience. Managers should ensure that the company has the administrative infrastructure, resources, road map, and cultural discipline to meet these new requirements after a reverse merger. The shell company can be registered with the Securities and Exchange Commission (SEC) on the front end (before the deal), making the registration process relatively straightforward and less expensive.

The public company effectively acts as a shell company by ceding these shares to the private one. The deal is completed when the private company trades shares with the public shell in exchange for the shell’s stock, making the acquiring company a public one. A reverse merger is a corporate tactic utilized by private companies seeking to “go public” – i.e. become publicly listed on an exchange – without formally undergoing the initial public offering (IPO) process. A Reverse merger is the process where a private company acquires a majority stake in a publicly listed company. Through this acquisition, the private company can save time and money which the traditional IPO route might take. A reverse merger—also known as a reverse takeover or a reverse initial public offering (IPO)—is an alternative strategy private companies use to make their stock available to the general public.

In order to reclaim its previous status in the market—that of a public limited company—Aerospatiale reverse-merged with Matra’s defense division to create Aerospatiale-Matra. There is no assurance of the investors obtaining sufficient liquidity after the merger. Due to financial and operational crises, sometimes, small companies may not be ready to be in public. Here both the private, as well as public parties, are benefitted, such that, Private investors obtain shares through the primary market, whereas, public investors get a chance to be a part of this globalized offering.

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But none of the costs and complications of a standard IPO apply in a reverse merger, which means they provide private companies a quick way to go public. This is especially important for companies that might not have the funding or abilities to handle an official IPO. Reverse mergers have advantages that make them attractive options for private companies, such as a simplified way to go public and with less risk.

This alternative method of going public has become increasingly popular in recent years, particularly among smaller companies seeking to expand their access to capital and increase their visibility in the market. The concept of a reverse merger involves a private company merging with a public shell company that has no real business operations but is already publicly listed on a stock exchange. By merging with the shell company, the private company gains immediate access to the public markets and can start trading its shares without going through the lengthy and costly traditional IPO process. The standard path for a private company going public typically involves an initial public offering (IPO), which is often a complicated and timely endeavor.

• This involves working with legal and financial advisors to ensure that the terms of the merger are favourable to both parties.
• It is therefore imperative to conduct appropriate due diligence and to expect transparent disclosure (on both sides).
• Reverse mergers have advantages that make them attractive options for private companies, such as a simplified way to go public and with less risk.
• Typically, this is also accompanied by a reverse stock split, where the previous shareholders of the public company see their stakes diluted.
• Once they own a majority stake, they swap the shares of the private company for existing or new shares of the public shell company.

When we say that a company is smaller, it’s a relative statement which only refers to the idea that because it’s a private company, it’s smaller compared to public ones. However, it doesn’t mean that these so-called smaller private companies are powerless and empty of capital. Finally, it is important to note that a reverse merger may not be the best option for every company.

By paying attention to the financial media, it is possible to find opportunities in potential reverse mergers. On the other hand, reverse mergers have various risks, namely the lack of transparency. If you’re interested in effective M&A strategies, take some time to listen to the M&A Science podcast, where transactions experts cast a critical eye over reverse mergers and every other corner of M&A transactions. A prominent example of a reverse merger is Ted Turner merging his company with Rice Broadcasting.

After the reverse merger is consummated, the original investors may find little demand for their shares. For a company’s shares to be attractive to prospective investors, the company itself should be attractive operationally and financially. Significantly increased liquidity means that both the general public and institutional investors (and large operational companies) have access to the company’s stock, which can drive its price up.

Step 5: Closing the Deal

Reverse mergers typically occur through a simpler, shorter, and less expensive process than a conventional IPO. With an IPO, private companies hire an investment bank to underwrite and issue shares of the new, soon-to-be public entity. Identifying reverse mergers before they are announced can be a tricky process.

Insufficient demand shares

It can take a company from just a few weeks to up to four months to complete a reverse merger. A conventional IPO is a more complicated process and tends to be considerably more expensive, as many private companies hire an investment bank to underwrite and market shares of the soon-to-be public company. In a reverse merger, an active private company takes control and merges with a dormant public company. These dormant public companies are called shell corporations because they rarely have assets or net worth aside from the fact that they previously had gone through an IPO or alternative filing process. The first step in a reverse merger is for the owners of the public company to buy at least 51% of the shares of a shell company.

The success of this approach is heavily dependent on investor interest and the overall state of the stock market. If market conditions are unfavourable, the company may struggle to generate interest in its shares and may be unable to raise the necessary capital to fund its operations. In a reverse merger, a private company buys an existing, smaller company, generally by purchasing more than 50% of the public company’s stock. Once the private company effectively controls the public company, it can begin merging operations. A typical initial public offering process takes months at a minimum—sometimes, it takes more than a year.