What Is a Reverse Merger?
A reverse merger (also regarded to as a reverse IPO or a reverse takeover) is a way of private firms going public. It’s usually through a shorter, more straightforward, and more affordable procedure compared to that of a traditional Initial Public Offering, in which a private firm hires an investment bank to underwrite and distribute shares of the “about to be” public company.
What is a Shell?
A shell company is a corporation without significant business assets or active business operations. Nonetheless, the corporation of the Shell Company does not seize to exist. In fact, the firm still has stakeholders and may get quoted on an exchange such as OTCBB or Pink Sheets.)
These type of corporations are not necessarily unlawful, even though sometimes they are used illegally, such as to conceal the ownership of a company from the public or law enforcement. One can use a shell for legitimate reasons. A startup business, for instance, can use a shell corporation as a vehicle to conduct a hostile takeover, raise funds, or go public.
In Reverse Mergers, stakeholders of a private company purchase the vast majority of shares of a shell corporation, which then get combined with the purchasing organization. As mentioned before, financial institutions and investment banks usually use Shell Corporations to close such deals.
Note, a shell corporation ought to be registered with the Securities and Exchange Commission (SEC) on the front end prior to initiating the deal. This makes the entire process relatively affordable and more straightforward.
For private firms to complete reverse takeovers, they can also trade shares with Shell Corporations in exchange for the shells’ stock, transforming the private institutions into public firms.
As you can see, Reverse Mergers permit private companies to convert into public companies without raising capital, which significantly simplifies the procedure. Better yet, Unlike traditional Initial Public Offerings, which can up to 8 months (at times even a year) to materialize, Reverse Mergers only take several weeks to consummate the deal.
This saves the “soon to be” public company lots of money, time and energy, ensuring sufficient resources have been redirected toward core business functions.
Even worse, opting to adopt the conventional Initial Public Offering procedure does not guarantee that a private firm will ultimately go public. Your managers might spend hundreds of hours planning out a conventional Initial Public Offering; but if the stock market environment proves unfavorable to your proposed offering, authorities may cancel your deal. Implying that all those hours spent by your team were a waste of time.
Why not pursue a reverse takeover and mitigate this risk?
That being said, there are three challenges you should consider prior to trying out this procedure.
1. Ensure the shell corporation you choose is sparkling clean
Real stories of “pump and dump” schemes and stakeholder lawsuits have tarnished the image of most shell corporations. To ensure you stay on the safe side, I recommend you only work with brokers and financial organizations who have executed the due diligence as required.
2. It also takes real money to get done
According to the Lebrecht Group, a law firm based in California, even though Reverse Takeovers are cheaper compared to IPOs, they still need sufficient amounts of cash. Depending on the shell corporation, the cost of a shell plus the cost incurred during the navigation process can easily exceed $500,000.
3. It makes your managers’ work a lot harder
Another potential setback after a private firm goes public is that managers and supervisors may prove unqualified in the additional compliance and regulatory requirements brought about by transforming into a publicly traded company.