What Is A Reverse Merger? How Do They Work?

There are many public companies with shares listed on public stock exchanges—typically over-the-counter (OTC) markets—that have few to no ongoing operations or assets. These are called “shell companies,” and they are the usual targets of reverse mergers. In a reverse merger, a private company acquires a publicly listed company. A reverse merger—also known as a reverse takeover or a reverse initial public offering (IPO)—is an alternative strategy private companies use to make their stock available to the general public. The Securities and Exchange Commission (SEC) has highlighted the fraud risks posed by some reverse mergers, warning that the public companies emerging from a reverse merger can fail or otherwise struggle to remain viable.

The first step in a reverse merger is for the owners of the public company to buy at least 51% of the shares of a shell company. Once they own a majority stake, they swap the shares of the private company for existing or new shares of the public shell company. The private company then ends up as a wholly owned subsidiary of the shell company. Given the lower levels of regulatory oversight and smaller number of investors involved in a deal, the risk of fraudulent or unethical reverse mergers is very real. But none of the costs and complications of a standard IPO apply in a reverse merger, which means they provide private companies a quick way to go public. This is especially important for companies that might not have the funding or abilities to handle an official IPO.

Why Do Companies Choose a Reverse Merger?

The term “reverse” refers to the idea of a private firm acquiring an already public company, which is the opposite of a typical IPO scenario.

  • These are called “shell companies,” and they are the usual targets of reverse mergers.
  • There are many public companies with shares listed on public stock exchanges—typically over-the-counter (OTC) markets—that have few to no ongoing operations or assets.
  • But none of the costs and complications of a standard IPO apply in a reverse merger, which means they provide private companies a quick way to go public.

First, it’s important to understand why a company may choose to go public to begin with. Companies sell shares to the general investing public to raise their name recognition and access more sources of financing than are generally available to private firms. IPOs, however, are complicated, time-consuming endeavors and usually involve hiring an investment bank to underwrite the deal and issue shares. There’s also an extensive https://1investing.in/ due diligence process, tons of paperwork and regulatory reviews. What’s more, even after all of that, unfavorable market conditions beyond any company’s control can complicate if, or when, an IPO happens. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree.

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