What is Reverse Merger?

Forms of the Reverse Merger

  • A public company may acquire a significant proportion of the privately held company, thereby giving in exchange a majority of usually more than 50% of the public company. The private company now becomes a subsidiary of the public company and can now be considered public.A public companyPublic CompanyPublicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read more may sometimes merge with a private company, usually through a stock swap, wherein theA privately held company refers to the separate legal entity registered with SEC having a limited number of outstanding share capital and shareowners. read more privately held company Privately Held Company A privately held company refers to the separate legal entity registered with SEC having a limited number of outstanding share capital and shareowners. read more shall keep significant control over the public company.

Example of Reverse Merger

Example #1 – Diginex Reverse Merger

source: cfo.com

Diginex is a Hong Kong-based cryptocurrencyCryptocurrencyCryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service.read more firm that became a public company by closing a reverse merger deal. It exchanges shares with 8i enterprises Acquisitions Corp, a publicly listed company.

Example #2 – Ted Turner-Rice broadcasting

A prominent example of a reverse merger is Ted Turner merging his company with Rice broadcasting. Ted had inherited his father’s billboard company, but the operations were bad. However, with his bold vision for the future, he managed to get a little investment cash in 1970 and purchased Rice Broadcasting, which is today a part of The Times Warner group.

Example #3 – Rodman & Renshaw and Roth Capital

Small boutique firms like Rodman & Renshaw and Roth Capital went on to bring more than 40 Chinese companies to the American investors and stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more by undertaking reverse mergers with ‘shell’ American public companies that were defunct or had little or no business with deals worth 32 million USD.

Advantages

  • Simplified process: The conventional method of offering a public issue through IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more usually takes months or years to materialize, whereas a reverse merger is done swiftly within weeks. It saves a lot of time and effort for the company’s management.Risk minimization: Though several months are put into planning the IPO, it is conventionally never guaranteed if the company would go in for the IPO. At times the stock market may seem unfavorable, the deal may get canceled, and all of the efforts sometimes go to waste.Less dependence on the market: All the laborious tasks of undertaking roadshows to gauge the market sentiment and convince the potential investors to undertake subscriptions of the upcoming issue is not a matter of concern when a company adopts the route of reverse mergers. Since this merger is merely a mechanism to convert a private company into a public one, the market conditions have little or no bearing on the company that wants to go public. It even need not be concerned about subscription and market acceptance of the offer.Less costly: Since there are no hefty fees for investment bankers, unlike in the case of public issuances, this adopted measure of reverse merger becomes cost-efficient to the company. Further, it may also exempt itself from all of the lengthy procedures involved in regulatory filings and prospectus preparation.Gains the benefits of a public company: Once a private company goes public, it provides an excellent exit opportunity for original promoters. The companies’ shares will now be traded on a public stock exchange and thus would help it gain the advantage of additional liquidity. The company now will have further access to capital markets to issue further sharesIssue Further SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner’s equity on the Company’s balance sheet.read more through even secondary offerings.

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Disadvantages

Of course, the process comes with certain drawbacks, as listed

  • Information asymmetry: Since the process of due diligence is often overlooked, the letters and bank statements may often be forged by dishonest management as there is little transparency, thereby causing information asymmetryScope for fraud: There is scope for huge fraud as there are times when the shell or defunct company may have little or no underlying business along with the private company. They will have themselves audited with the franchise of famous audit companies by some dubious financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more provided by the management. However, there shall be little or no operations underneath. Boutique firms, too, misuse this opportunity to make bucks out of taking such companies public through the scope of reverse mergersMergersMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read moreNew burden of compliance: When a private company goes public, managers are often sometimes inexperienced when it comes to all of the requirements that come along in being a public company. These burdens may often affect the company’s performance if managers tend to focus more on all of the administrative concerns than having to run the business.

Limitations

  • It is often noticed that the IPO process raises more money, contrary to a reverse merger process.It lacks the market support for the stock, which is usually prevalent in the case of an IPO.

Conclusion

Reverse merger stands as an excellent opportunity for private companies to bypass all of the procedures generally involved as a part of the IPO process. It tends to be a cost-effective route for companies to get themselves listed on any stock exchange and thereby become public.

However, given the limitations and scope of misuse of such routes due to limited transparency and information asymmetry, many in the financial sectorFinancial SectorThe financial sector refers to businesses, firms, banks, and institutions providing financial services and supporting the economy. It encompasses several industries, including banking and investment, consumer finance, mortgage, money markets, real estate, insurance, retail, etc.read more sphere have taken advantage of such loopholes. It becomes imperative that ethical frameworks be well imbibed to avoid such occurrences.

Once such issues are taken care of, the only factor the private companies need to consider becomes the limited scope of such routes as a contrast to that of the IPO route and the essential nitty-gritty involved in managing the regulatory requirements demanded from that of a public company.

This article has been a guide to Reverse Merger and its definition. Here we discuss a reverse merger’s example and its advantages and disadvantages. You can learn more about accounting from the following articles –

  • Examples of Vertical MergerHorizontal Merger DefinitionStatutory Merger Definition