How to Spot a Reverse Merger - Business And America

What Is a Reverse Merger?

Reverse mergers, also known as reverse takeovers, are an alternative to more traditional forms of raising capital. A reverse merger is when a private company goes public by purchasing control of another public company. The private company’s shareholders usually receive large ownership stakes in the public company and control of its board of directors.

Once this is complete, the private and public companies merge into one publicly traded company.

Key Takeaways

A reverse merger is when a private company goes public by purchasing control of a public company.
When a company plans to go public through an IPO, the process can take a year or more to complete, but with a reverse merger, a private company can go public in as little as 30 days.
Generally, reverse mergers succeed for companies that don’t need the capital right away.
Look for companies trying to raise at least $500,000 and are expected to do sales of at least $20 million during the first year as a public company.
Some reverse mergers come with unseen circumstances, such as liability lawsuits and sloppy record keeping.

Factors to Consider When Investing in Reverse Mergers

There are many benefits and disadvantages to investing in reverse mergers. To be successful, you must ask yourself if you can handle investing in a company that could take a long time to turn around.

You should also learn how the merger works and in what ways the reverse merger would benefit shareholders for the private and public company. While this can be a time-consuming process, the rewards can be tremendous—especially if you find the diamond in the rough that becomes a large, successful publicly traded company.

Signals of Reverse Mergers

To be successful in identifying reverse mergers, stay alert. By paying attention to the financial media, it is possible to find opportunities in potential reverse mergers.

It is also wise to participate in opportunities that are trying to raise at least $500,000 and are expected to do sales of at least $20 million during the first year as a public company.

Some potential signals to follow if you’re looking to find your own reverse-merger candidates:

Look for appropriate capitalization. Generally, reverse mergers succeed for companies that don’t need the capital right away. Normally, a successful publicly traded company will have at least sales of $20 million and $2 million in cash.
The best companies for a possible reverse merger are those that are looking to raise $500,000 or more as working capital. Some good examples of successful reverse mergers include: Armand Hammer successfully merging into Occidental Petroleum, Ted Turner’s completion of a reverse merger with Rice Broadcasting to form Turner Broadcasting, and Muriel Seibert taking her brokerage firm public by merging with J. Michaels, a furniture company in Brooklyn.

Fast Fact

In 2024, the Securities and Exchange Commission enacted major restrictions on security issuances by reverse mergers that may make these mergers less attractive.

Advantages of Reverse Mergers

There are many advantages to performing reverse mergers, including:

The ability for a private company to become public for a lower cost and in less time than with an initial public offering. When a company plans to go public through an IPO, the process can take a year or more to complete. This can cost the company money and time. With a reverse merger, a private company can go public in as little as 30 days.
Public companies have higher valuations compared with private companies. Some of the reasons for this include greater liquidity, increased transparency and publicity, and most likely faster growth rates compared to private companies.
Reverse mergers are less likely to be canceled or put on hold because of the adverse effects of current market conditions. This means that if the equity markets are performing poorly or there is unfavorable publicity surrounding the IPO, underwriters can pull the offering off the table.
The public company can offer a tax shelter to the private company. In many cases, the public company has taken a series of losses. A percentage of the losses can be carried forward and applied to future income. By merging the private and public company, it is possible to protect a percentage of the merged company’s profits from future taxes.

Disadvantages of Reverse Mergers

Reverse mergers also have some inherent disadvantages, such as:

Some reverse mergers come with unseen circumstances, such as liability lawsuits and sloppy record keeping.
Reverse stock splits are very common with reverse mergers and can significantly reduce the number of shares owned by stockholders.
Many chief executive officers of private companies have little or no experience running a publicly traded company.
Many reverse mergers do little of what is promised and the company ends up trading on the OTC bulletin board and providing shareholders with little to no additional value or liquidity.

Pros

Reverse mergers allow a company to go public in as little as 30 days
Reverse mergers are less likely to be delayed by underwriters.
The losses of the acquired company can be used as a tax shelter for the acquiring private company.

Cons

Some target companies may come with liabilities or sloppy record keeping.
Reverse stock splits can reduce the number of shares owned by prospective stockholders.
Many reverse mergers fail to generate new shareholder value.

How Does a Reverse Merger Work?

A reverse merger is when a private company goes public by buying a controlling stake of a public company. Shareholders of the private company then receive a large number of shares, allowing them to choose the board of directors and integrate their operations into the new company.

What Happens to My Shares During a Reverse Merger?

In a reverse merger, a private company acquires a controlling stake in a public company. Typically, this is also accompanied by a reverse stock split, where the previous shareholders of the public company see their stakes diluted.

What Happens to My Options During a Reverse Stock Split?

If you hold options in a company that executes a stock split, your options are typically adjusted to reflect the change in the number of shares. For example, if a company executes a two-for-one split (each shareholder has twice as many shares as they had before) the number of contracts represented by each option will be doubled, and the strike price will be cut in half.

The Bottom Line

Reverse mergers are an alternative route to going public that avoids the lengthy, expensive process of launching an IPO. Because the typical targets of a reverse merger tend to have low valuations, they can be profitable to savvy investors who can spot the signs of a potential acquisition.

Source link

Chris Seabury