Definition
A reverse merger is a type of merger where a private company acquires a publicly traded company to bypass the lengthy and complex process of a traditional initial public offering (IPO). It allows the private company to become publicly traded without raising capital, which is traditionally why companies would go public. As a result, the private company effectively becomes a public company ‘overnight’.
Key Takeaways
- A reverse merger is a process by which a private company can go public without IPO. It’s achieved by the private company purchasing a majority stake in an already public company, and subsequently merging the two.
- Reverse mergers are often seen as a quicker and cheaper route for a private company to become publicly traded, allowing them to bypass the often complex and rigorous process of an initial public offering (IPO).
- Although reverse mergers can offer certain advantages, they also come with significant risks. These include potential lack of interest from investors due to limited documentation, operational issues from rapid growth, legal risks, and the possibility of acquiring a company with hidden liabilities.
Importance
A reverse merger is an important finance term because it represents a quick and comparatively cost-effective strategy for private companies to become publicly traded, without the conventional compliance requirements and expenses associated with an initial public offering (IPO). This process involves a private company merging with an existing publicly traded shell company, allowing the private company to bypass the lengthy and complex process associated with an IPO.
Through this strategy, companies can gain easier access to capital markets and shareholders, enabling them to secure funding for expansions, acquisitions, or other business endeavors.
Thus, reverse mergers play a vital role in finance, providing an alternative route to company growth and public trading.
Explanation
Reverse merger serves as a strategic mechanism primarily used by private companies to become public, without facing the complexities and stringent regulations tied to the traditional Initial Public Offering (IPO) process. Also known as a reverse takeover, this approach streamlines the entry into the public market by essentially allowing a private company to get listed on a stock exchange.
This is achieved by acquiring a majority stake in an already publicly traded firm, usually a shell or dormant company that possesses no significant business operations. By leveraging a reverse merger, the private company assumes control of the public entity and can exchange its shares in the open market.
This facilitates access to greater liquidity and capital, a wider pool of potential investors, and increases the company’s overall public presence, thereby helping business expansion. It comes as an effective alternative to traditional routes of going public, such as an IPO and direct public offering (DPO), especially for smaller-sized companies looking to dodge high costs and time-consuming measures related to these standard methods.
Examples of Reverse Merger
NYSE Euronext and Deutsche Börse: In 2011, Deutsche Börse, a German marketplace organizer for shares and securities, planned to acquire NYSE Euronext, which operates global exchanges including the New York Stock Exchange. However, the combined entity was to operate under the name of NYSE Group, clearly indicating a reverse merger. Although the merger was supposed to create the world’s largest owner of equities and derivatives markets, it was blocked by European Competition Commissioner.
Berkshire Hathaway and Warren Buffett: This is one of the most famous examples of a reverse merger. In the 1960s, Warren Buffett was investing in a textile company named Berkshire Hathaway. Over time, Buffett started buying other businesses and merged his holdings under the name of Berkshire Hathaway, effectively transforming it into a holding company. The original textile business eventually ceased, but Berkshire Hathaway lives on as one of the most successful conglomerates in the world.
Terra Networks and Lycos: Back in 2000, Spanish internet provider, Terra Networks, acquired US-based search engine Lycos in a $
5 billion deal. Though Terra was the purchaser, the merged entity took the name Terra Lycos, reflecting a more significant influence of Lycos in the combined entity’s operations. This fits the bill of a reverse merger, though the companies later had some financial difficulties.
FAQs on Reverse Merger
What is a Reverse Merger?
A reverse merger is a process where a private company becomes a public company by purchasing control of the public company. It is often used as a streamlined method to go public without going through the complex and costly process of an initial public offering (IPO).
How does a Reverse Merger work?
In a reverse merger, a private company buys a majority of shares in a public shell company, effectively taking the shell company over. The private company’s shareholders can then exchange their shares in the private company for shares in the public company. As a result, the private company becomes a public one.
What are the benefits of a Reverse Merger?
Reverse mergers are usually faster and less expensive than a traditional IPO. It allows a private company to bypass the lengthy and complex process of going public and gain access to capital markets for financing needs. As a public entity, the company may have a higher valuation.
What are the disadvantages of a Reverse Merger?
The disadvantages can come with scrutiny and regulations associated with being a public company. Also, if the public company has any existing problems or liabilities, these become the private company’s problems after the merger. Transparency and accountability towards shareholders are expected, often requiring expensive audits and financial reporting processes.
What is a ‘Shell’ Company in the context of a Reverse Merger?
A shell company in the context of a reverse merger is a public company with no active business operations or significant assets. These companies are often used in reverse mergers because they allow a private company to go public without going through an IPO process.
What happens to existing shareholders in a Reverse Merger?
In most cases, the existing shareholders of the public company get diluted, and the external private company shareholders gain control of the company. Shareholders of the private company becoming public usually receive a substantial majority of the shares of the public company and control its board of directors and management.
Related Entrepreneurship Terms
- Shell Corporation
- Public Company
- Private Equity
- Securities Exchange Commission (SEC)
- Stock Exchange
Sources for More Information
- Investopedia: This website provides a comprehensive definition, explains the process of a reverse merger, and discusses advantages as well as disadvantages.
- Corporate Finance Institute (CFI): CFI explains reverse merger with examples and illustrations, making it easier to understand.
- U.S. Securities and Exchange Commission (SEC): The SEC site gives in-depth information on reverse merger, providing legal aspects and regulatory guidelines.
- Entrepreneur: This website offers articles on reverse mergers from the perspective of startup companies, explaining when it might be a good idea to consider this model.
