Introduction
A reverse merger is a desirable strategic option for managers of private companies seeking to attain the status of public companies. It is the cheaper and faster alternative to traditional initial public offerings, or IPOs.
There is more flexibility on the part of public company management as regards financing alternatives, and the investors enjoy greater liquidity of the company. Public companies will continue to face additional compliance burdens and have to allocate adequate time and energy for running and growing the business.
A successful reverse merger can increase the value of a company’s stock and improve its liquidity.
Reverse Merger
When a publicly listed company acquired by a private company and owner of private company become largest shareholder of public company known as reverse merger. A reverse merger is also known as reverse takeover and reverse (IPO) Initial Public Offer.
Companies may also prefer this kind of merger to avoid the process undertaken in a traditional IPO since it takes much less time and usually costs less. When a traditional IPO can take months or even more than a year to eventually conclude and requires hiring many banking professionals to underwrite and issue shares for the company, a reverse merger avoids this process.
Advantages of Reverse Merger
- Quicker access to financing: Where reverse mergers only take a few weeks to 30 days, an IPO could take six months or over a year.
- Not dependent on market condition: Where the success of an IPO depends on market condition, if the market condition becomes unfavorable, the IPO may fail, but reverse mergers don’t depend on market condition, so they have less risk than an IPO.
- No middleman: Unlike an IPO, a reverse merger does not need to be underwritten by an investment bank. The deal is directly between the public company and the private company.
- Easy entry into a foreign market: It’s expensive to convert a private company to a public company in a foreign market, but a reverse merger will make it easier to go public in a foreign market by bypassing some of the IPO regulations, costs, and capital-raising requirements.
- Less expensive: Reverse mergers are relatively cheaper since they do not require payment of fees to financial institutions and take less time to go through compared to the case of an IPO.
Disadvantages of Reverse Merger
- More due diligence is necessary. That applies equally to investors and the companies going through a reverse merger. Consumers in particular would do well to pay attention to this part of the SEC fraud warning above: Investigate the company that results from a reverse merger, because far less regulatory scrutiny goes into the process of completing a reverse merger than an IPO.
- Lack of interest and liquidity after the merger is done: The kind of small businesses usually involved in reverse mergers may not be equipped to handle the role of public companies. They lack the scale and viability needed to support the burdens of being a public company and sustain investor interest in their shares, which can make them harder to trade long-term.
- A risk of no big return on the investment: Reverse mergers don’t get much fanfare, aren’t widely followed by Wall Street analysts, and probably won’t produce the fat investment gains that a solid IPO business might. And remember: Even IPOs are not money-back guarantees when it comes to getting a return on your investments, but companies going public through reverse mergers are on even shakier grounds.
- No demand for shares post-merger: A reverse merger does not ensure liquidity for investors as smaller firms lack the scale and fundamentals to attract demand for their shares or attract analyst coverage. The fundamentals, however, are key to investor appeal.
Why company choose reverse merger
First, it can be helpful to understand why a company might go public in the first place. Companies sell shares to the general investing public in order to raise their name recognition and access more sources of financing than are generally available to private firms. Traditionally, this has been done through an initial public offering, or IPO.
IPOs, however, are complex and time-consuming undertakings and typically involve engaging an investment bank to underwrite the transaction and sell the shares. There is quite a lot of due diligence, significant paperwork, and regulatory checks.
Furthermore, even after all this, unfavorable market conditions outside of any company’s control can make things complicated if, or when, an IPO occurs.
In a reverse merger, all of the costs and complexity associated with an IPO do not apply, making it an easy transition for private companies to go public. This is especially significant for companies that would not have the funding or abilities to address a proper IPO.
Conclusion
Running a private company allows the owners to have more control over how the company is run and its future. On the other hand, it comes with certain hurdles, like not having access to capital from average investors.
One of the ways by which a private company can gain access to public markets is through a reverse merger. It involves the acquisition of a public company by a private one without the rigorous process and costs associated with an IPO.
However, it entails risk, especially for investors who have limited knowledge of the parent history of the private company. Inexperienced leadership leads to the loss of capital for investors. FBS