How To Go Public With a Reverse Merger
Fast-track Access to the Public Markets
Some business owners have aspirations of taking their company public and seeing it listed on an exchange someday. One of the ways to make this dream come true sooner than later is through what's known as a reverse merger.
In the face of limited opportunities for financing, reverse mergers may be increasingly viewed by some as an attractive pathway for a private company to become a publicly traded company.
You'll find investors and companies seeking reverse mergers on DealStream.
In a reverse merger, the shareholders of a private company acquire the majority shares of a public company or public shell (a public reporting company with few or no operations) and then reorganize the assets and operations of the private company into the public company which, in essence, is the remaining survivor of the merger. At that point, your former private business now has a Wall Street address without having to pursue the traditional route of an initial public offering (IPO).
Why Consider a Reverse Merger?
There are several reasons why companies might go forward in reverse (pun intended). One of the major motivators is actually no different than the reason for going public in the first place: The need to raise capital and elevate your business brand by gaining recognition on one of the exchanges. Sure, an IPO can do that too, but executing an IPO involves plenty of paperwork and regulatory reviews. A reverse merger is a way to fast-track going public because there's no need to raise capital or ramp up investor relations and marketing. Speed offers several advantages for pursuing a reverse merger versus an IPO:
Time is money.
While an IPO may take six months or longer, a reverse merger might require three or less months to complete. There are no investor roadshows or need for an IPO underwriter. Just find an undervalued and under-traded public company and you're well on your way. Less time saves money as fewer dollars are required to go public.
Time can also mean more money.
Completing a reverse merger might also enable you to grow faster. The theory is that the sooner you're public, the better your chances of being noticed by investors. An elevated profile might also improve your chances of making other acquisitions. For that reason, some companies take the reverse merger route when they can't raise money in private markets.
Timing isn’t everything.
The decision to pursue an IPO may hinge on the right market conditions, such as investor interest and demand, while the decision to pursue a reverse merger may not be as sensitive to market conditions.
It all sounds great, but not so fast. While there are some good examples of successful reverse mergers (such as Armand Hammer merging into Occidental Petroleum or Ted Turner's reverse merger with Rice Broadcasting to form Turner Broadcasting), many companies fail to remain viable.
Because there is less regulatory review than with an IPO, successful reverse mergers require more due diligence. This is also a caution for potential investors, as management's lack of experience as a public company could lead to fines or regulatory actions as well as significant costs to maintain compliance with U.S. corporate governance and accounting requirements. Less regulation also potentially raises the risk for fraud in the case of reverse mergers, which is why the reputation for these kinds of deals is not exactly stellar.
Potential Drawbacks to Reverse Mergers
As with all investments, including IPOs, there are no guarantees. This is especially the case for reverse mergers that might expect the same ready access to liquidity that many companies listed on the stock market enjoy.
Still, despite the risks, private developers struggling to find financing in these potentially uncertain economic times are turning to reverse mergers. That's the case in the biotech industry.
BiopharmDrive reports that since last summer, several biotechs have opted for a reverse merger instead of an IPO. And Bloomberg Law finds that the number of reverse mergers and SPACs (Special Purpose Acquisition Companies) is up.
An analysis of 36 reverse mergers from 2017 to 2020 by Torreya, a global investment banking boutique serving companies in the life sciences industry, found that, over time, reverse mergers underperform against the market and their IPO comparators.
"In our study, we found that the average two-year market-adjusted return following a reverse merger was -58.9%," they reported. "In contrast, the IPO cohort outperformed the market. The average IPO outperformed its peer group (the XBI ETF) by 30.6% over two years. Very few reverse merger companies beat the market. We find that 81% of reverse mergers underperform the market by 24 months post-announcement."
Many reverse mergers promise more than they deliver and end up trading on the Over the Counter (OTC) bulletin board and providing shareowners with little to no additional value.
Despite possible disadvantages, many companies are pursuing a reverse merger, says Evaluate, a market researcher in the pharma industry.
"Reverse mergers have something of a bad reputation as a route for companies too weak to undertake a full IPO, but financing options are pretty limited right now....With the number of developers ‘exploring alternatives’ growing longer every day, private developers and those listed outside the U.S. will have plenty of zombie companies to choose from,” writes Evaluate’s editorial team.
In Conclusion
Companies must be careful when considering a reverse merger. Reverse mergers don't exactly have a great reputation or track record for success. The lack of experience that a private company has as a newbie on an exchange might deter most major brokerage firms from having any interest. That plus the lack of transparency might make the vetting process a challenge for both the companies as well as future investors. On the other hand, there are clear advantages: quicker access to financing, lower costs, and higher visibility as a public company that might trigger more investors who could fund future acquisitions.
Interested in a reverse merger? One way to get started is to search for possible shell companies. DealStream lists shell companies for sale here.
Tom Schwendler is a former communications manager for GE Energy with more than 20 years of experience in corporate communications. He recently published two books and works as a freelance communications consultant. He resides in upstate New York.
