Reverse Merger: A Vision Without A Strategy Is A Prescription For Failur
Whether you're a startup founder looking to generate a little buzz for your company, or are simply interested in knowing more about reverse mergers, this blog post is for you. In it, I'll cover what reverse mergers are, why one might consider doing so as a business strategy and what precautions prospective entrepreneurs should take when planning to conduct one. This will also serve as a handy resource if you decide to do your own research in the future.
Reverse mergers are not uncommon; in fact they make up the majority of the M&A deals completed each year (about 40%). However there usually aren't those many articles or resources that talk about them - and that's precisely because they're not always successful.
It can be difficult to get a clear understanding of what reverse mergers are, so let's start by defining the key components of a reverse merger. First, they're essentially a merger between two publicly traded companies that have similar names.
Second, the purpose of the reverse merger is to allow one company to be listed as a subsidiary of the other company. This means that certain shares or securities in one entity become securities (or stock) in the other entity. But before we get too far into that discussion, let's start with how reverse mergers actually work.
How Reverse Mergers Work
The most common scenario for a reverse merger occurs when one of the companies decides that it wants to get into the public market but doesn't have sufficient ownership of its target. So instead of going through the time consuming and expensive process of trying to get corporate approval to merge with the target, a company may decide that it would rather purchase enough stock from an existing publicly traded company (preferably one where it already has a majority stake), then spin off the subsidiary as a new, independent company. In this way, there are no shareholders in the acquired company that will be adversely affected by any merger or gaining control over their shares in the future. It's like getting all of your tax dollars back.
The parent company's shares will then be transferred over to the new, publicly traded subsidiary that is created and listed on a stock exchange. This will effectively swap the parent company's existing shares for the new ones listed on the newly formed publically traded company. The reverse merger can take effect in one of two ways:
· Upon completion of a public offering by the publically traded parent Company, or; · By concluding a tender offer and then conducting a merger without an acquisition or another public offering.
If you're having trouble visualizing how this all works in plain english, don't worry. I'll walk you through it so you'll see that it's not so complicated after all. I'll be using an example of two fictional companies called The Company, Inc. and My Little Pony, Inc. because I'm a grown adult who watches My Little Pony and playing with ponies is clearly more productive than doing the things that grown ups are supposed to do. Ready? Here we go:
My Little Pony, Inc. was started by a group of equine enthusiasts who wanted to create a toy line for pre-school children (their target market). It was listed on the OTCBB exchange in 2008. In 2017, The Company, Inc., decided it wanted to enter the toy business for kids as well and it therefore targeted MLP for acquisition. The Company, Inc. had a majority of shares in MLP and so it decided to acquire it outright. The deal went through and the company decided it wanted to spin off its subsidiary My Little Pony, Inc. as a separate publicly traded company.
In order to complete the reverse merger successfully, The Company, Inc. had to do one thing: Get approval from the stock exchange so that its subsidiary MLP would be listed as an independent publicly traded company (and not simply just transfer ownership of all of its shares to another entity). To this effect, The Company made a tender offer and offered all of the shares in MLP to the public at $1 each (which was probably above market value). In combination with all of the existing employees becoming employees of MLP and all of the existing shareholders receiving stock in MLP, this effectively swapped the entirety of all the shares in The Company, Inc. for all the shares in MLP at $1 each (thereby shedding its entire balance sheet, which was likely unprofitable).
The new publicly traded company was named My Little Pony, Inc. and it subsequently went on to tremendous success as a toy company. Because it had never been a publicly traded company before, it wasn't subject to federal regulations for financial reporting. As a result, The Company didn't have to worry about how it was going to produce consolidated financial statements or file an annual report. The company was able to avoid having to hire a Chief Financial Officer, the associated costs of reporting under different rules, regulatory filings, and their associated professional fees.
Reverse Mergers Vs Initial Public Offerings
So what exactly is the difference between a reverse merger and an initial public offering (IPO)? In a reverse merger, a parent company acquires or becomes the majority shareholder in another private or public company. The new parent company then spins off some or all of its shares in an IPO (which can be subsequently listed on either an exchange or OTCBB). In a reverse merger, the subsidiary that is acquired goes public and replaces the parent company's stock as a new publicly traded entity.
In an IPO, the newly formed public entity uses internal funds to acquire its parent company. It then starts issuing shares (or sometimes debt) to members of public in exchange for cash and other assets. There are usually several rounds of funding in an IPO, but unlike a reverse merger, everything that happens after the initial offering is all internal to one publically traded entity. With an IPO, investors have no access to existing stockholders or existing shareholders receive a cash payment instead of new shares in their own company - thus creating a substantial change in ownership.
Reverse Mergers Vs Other Acquisitions
So what's the difference between a reverse merger and an acquisition? Similar to an acquisition, a reverse merger is when a publicly traded company acquires another private or public company and then spins it off as a new subsidiary. In either event, there is no change in ownership of existing shares, but existing shareholders don't need to worry about what happens if the parent company gets acquired by someone else - they're safe. The only difference between a reverse merger and an acquisition is that with a reverse merger, there isn't any public money involved. It's just done within the confines of one publicly traded entity.
Conclusion
There are certainly a number of reasons why companies choose to engage in reverse mergers, but the most common reason is to become publicly listed without having to go through all of the formalities and costs associated with an initial public offering. This can be especially beneficial to private companies who don't have much in the way of operating cash flow and struggle to raise capital through an IPO.
Now that you know (and hopefully understand) how a reverse merger works, take some time out of your day to think about how you might be able to use one yourself.