A reverse merger is an alternative to an initial public offering (IPO), which allows private companies to become public. An IPO can take up to six months or a year to complete; however, conducting a reverse merger may only take a few weeks. In addition, while IPOs involve raising capital, reverse mergers do not. In reverse mergers, the private company first purchases buy majority ownership of a public company. When the private company has acquired adequate shares, its stockholders exchange their shares for shares in the public company. Thus the private company has become public. In most cases, the public company is a shell corporation initially. A shell corporation holds little to no assets and capital. This changes when the private company’s operating business is merged into the company.
Advantages and Disadvantages
Reverse mergers are cost-effective, timely alternatives to IPOs with valuable advantages. For example, if the target public company is registered with the SEC or listed on a stock exchange, the private company does not have to go through that same hassle, saving immense time and money. Additionally, foreign companies can quickly integrate into U.S. public markets through a reverse merger. Sometimes issuers will decide to initiate a reverse stock split; this means that the overall number of shares in the company decreases while the price per share increases. Companies typically initiate a reverse stock split to inflate share price. This keeps them from being delisted from their exchange.
A primary disadvantage is the reputation of the target shell company. Often, shell companies engage in shady market activities; they are closely scrutinized by the SEC.