offering (IPO) is the most common way to take
a company public, other options exist for making a firm’s shares available
to the public markets. One of those is through a reverse takeover (RTO) or
reverse merger.
Reverse Takeover
Explained
An RTO or reverse
merger is a process where a private company goes public by acquiring a
publicly-held shell business. The acquisition makes the owners of the private
firm the controlling shareholders of the existing public business.
Upon completing the
transaction, the owners absorb the once private entity through reorganization
of the public company’s assets and operations. In other words, the private
company is restructured or eliminated, making the already public shell business
the sole entity.
Reverse Takeover and
Initial Public Offering
Many companies decide
to make a public listing, so they can sell their shares to the overall
investing community to become more well-known and tap on financial sources that
were previously inaccessible to them as a private business.
That is where an IPO
usually comes in. However, this approach can be complicated and time-consuming
and often requires assistance from investment banks in underwriting the
agreement and issuing shares.
Moreover, the IPO
involves broad due diligence, a great deal of paperwork, and regulatory
assessments. And once that is all done, there are poor market situations that
are out of the company’s hands to consider since such unfavorable conditions
can get in the way of a successful IPO.
But in an RTO, private
companies don’t need to undergo such a comprehensive process, which allows them
to go public more quickly than they can with the traditional IPO route.
That is a huge help for
private entities that cannot perform an official IPO. Plus, they can take
themselves public through reverse mergers with a relatively small amount of
money.
How a Reverse Takeover Works
Many publicly-listed
companies‘ ongoing operations or assets, which usually trade over-the-counter
(OTC), can be quite few or sometimes none at all. Such entities are referred to
as shell companies, and they are the ones commonly used for RTOs.
To conduct a reverse
merger, owners of the public firm must first purchase approximately 51% of the
shell company’s shares.
Once they have a
majority stake, they exchange the private entity’s shares for the public shell
company’s existing or new shares. The private company then becomes the shell
company’s wholly-owned subsidiary.
Unlike an IPO, reverse
mergers allow companies to go public without generating new capital, making the
process easier and faster to complete. It also eliminates the need to raise
publicity and capture institutional or retail investors‘ interests.
The Major Risk of a
Reverse Takeover
Considering the
regulatory oversight and number of investors are less in an RTO, this method
can carry fraud and compliance risks.
That is why a reverse
merger needs more due diligence than a conventional IPO. Additionally, RTOs
tend to fail because many of the companies that take this route only do so when
they can’t raise funds in private markets and don’t have sufficient publicity
to conduct an IPO.
The Securities and
Exchange Commission (SEC) has indicated the fraud risks of some RTOs, saying
public firms that were a product of an RTO can collapse or otherwise have a
hard time staying attractive and valuable.
Despite that, several
companies still try to perform a reverse
merger. The method could work best for companies that are not in a rush to
raise new capital and have enough profits to counter the costs of being
publicly listed.