Call it a reverse takeover or a reverse merger, it is a process wherein a private company acquires the ownership of a public company by a merger. This is done through a proper process wherein the control of the public shell company is purchased by the shareholders of the private company. The majority of shares of the public shell company is obtained by the private body, thereby gaining control of the board of directors (usually 90% or more).
This is done by the private firm in order to avoid the lengthy, time-consuming, expensive and complex process of converting itself into a public body. Therefore, they takeover or merge with an existing public "shell" company through capitalization and reorganization. It is known as a "shell" since the publicly listed company that is merged with the private company just consists of an organizational structure with no liabilities and assets whatsoever.
Benefits of a Reverse Merger
It is very important for the private company to select the right shell company for takeover. The 'right shell company' means that the company that you choose should meet certain parameters. It is important for the shell company to be registered under the Securities Exchange Commission.
It is also important for the private company to thoroughly go through the history of the shell company and the current shareholders, players and promoters that are associated with the shell company. These constitute some of the main parameters that a private company should consider before going forward with a reverse merger, and to reap its benefits, some of which are discussed as follows.
The conventional initial public offering (IPO) can take up to a year, or even more. This is because the entire process involves a lot of formalities including reviewing paperwork, various meetings and drafting sessions. All these necessities end up taking a lot of time which can actually prove to be disastrous in terms of the growth of the offering as the market conditions might also end up changing and may prove to be not as favorable as it could have if the process was a little faster. Therefore, most of the companies looking to go public actually go for a reverse merger because the process is shorter and doesn't take more than a few weeks or 30 days!
The entire process of a conventional IPO is very expensive. The private firm going public is benefited as it doesn't need to bear the excessive investment banking fees, and most importantly, after it goes public, it receives a higher valuation.
Raising Additional Capital
Reverse merger is an ideal option for private firms looking for cost-effective ways of raising capital as it opens ways to different financing options. A public company can issue warrants to its shareholders which gives them the right to purchase additional share units at a predetermined price. The change leads to added liquidity to the investors and additional shares in the secondary offering and private offerings. Through the future stock offerings, it becomes possible for the new public company to access greater areas of capital market which makes it more feasible for the new company to raise funds and capital.
Acquisitions and mergers become much more easy for the private company going public as the company need not spend cash but can use its publicly traded stock as their currency. So this is another benefit that a reverse merger brings in to the overall growth.
Income Tax Shelter
Remember, I mentioned that you must thoroughly check the previous history of the shell company before you go further. One of the benefits that this study can give you is corporate income tax shelter. When a public company has suffered losses in previous years, the income tax in the future is sheltered. This is known as tax-loss carry forward. This can prove to be very beneficial for the new public company.
Not Affected by the Market Condition
Conventional IPOs take a long process, during which time period, some significant changes in the market condition can take place. However in case of a reverse merger, the situation or the decision has no dependency upon the market conditions. On the contrary, it solely depends upon the management of the shell company in terms of whether or not they desire to be taken over by the private body.
Apart from the benefits, there are also certain drawbacks associated with it. Mostly, the demerits lie in the history of the shell company. Another point to be noted is that although the majority of ownership is purchased by the private company, there are still some shareholders in the board of directors. There can be various underlying issues with the shell company that can create a problem later on. So, make sure that the decision is taken after thorough scrutiny of each and every aspect of the shell company and the acquiring company. All the best!