Creative Business Finance: Using Reverse Mergers

Written by Dave Lavinsky

Reverse mergers, also known as reverse takeovers or reverse IPOs, occur when a private company buys a public company and then merges with it.

Most of the time, the company being acquired is considered a non-operating or “shell” corporation. These publicly traded companies are known as “shell” companies because all that is left of them is their organizational structure.

These public companies that later get acquired are typically traded on small stock exchanges such as the Toronto Stock Exchange, or the Over the Counter Bulleting Board securities market (OTCBB).

What makes reverse mergers so appealing are the cost savings for the private firm that wanted to “go public.” Undergoing an Initial Public Offering (IPO) is an extremely expensive and exhausting process. An IPO requires a private firm to raise capital as well as becoming public, meeting the appropriate public standards. However, by acquiring a public company and merging with it, a private company can bypass the IPO process and gain access to the public market at a fraction of the cost. They also do not have to raise any additional capital if they wish not to.

Some additional benefits of reverse mergers include a higher valuation for the company. This is partly due to purchases signaling strength to the market, raising stock price. It also has to do with reverse mergers not having to issue additional equity, making the stock more appealing. In addition, shareholders gain new found liquidity for the company’s stock.

Moreover, the once private company can now enjoy the additional benefits of being publicly listed. They gain the privilege of quick access to capital through the offering of futures or undergoing a Seasoned Equity Offering (SEO). It may also offer its workers stock as work incentives, or undergo transactions with stock as payment.

However, there are some negatives to reverse mergers. When a big player gets swallowed by a small player, it often means that there were some problems with the bigger company. Common problems include troubled management, sub-par company structure, financial problems, or intangible things such as brand image.

A perfect example of this is seen in the case of former public company ValuJet Airlines, which was acquired by the much smaller private company AirTran Airways.

ValuJet had just suffered a major blow to its image due to the negative publicity surrounding the Flight 592 disaster in 1996. Because of this, the company also faced immense financial problems. The much smaller AirTran Airways took the opportunity and purchased ValuJet in 1997, undergoing a reverse merger.

After going through some internal management changes, the AirTran stock started trading on the New York Stock Exchange in 2002. By completing the reverse merger with ValuJet, AirTran received all of the benefits of a public company without having to undergo the extensive process of an IPO, while also increasing its presence in the airline industry.


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