We have seen the IPO market stall, and the SPAC boom is now bust. So, what options are there for private companies looking to enter the public market in today’s economic climate? A transaction structured as a “reverse merger,” also known as a reverse takeover or reverse IPO, could be an attractive option that offers numerous benefits, particularly for non-U.S. companies looking to enter the U.S. market.
In a reverse merger, a private company becomes a public company by acquiring or merging with a publicly traded company. This allows the private company to become publicly traded company without going through the costly and time-consuming traditional IPO process.
Reverse mergers are often considered a less traditional route to becoming a publicly traded company and do offer several benefits that can make them an attractive option. However, some drawbacks must be considered as well. Below, we look at some of the pros and cons of a reverse merger.
Potential Benefits of a Reverse Merger
Access to Capital
One of the most significant benefits of a reverse merger is access to capital. Going public through a reverse merger provides the private company with access to the public markets and the ability to raise capital through the sale of stock for cash to public investors. This can provide a significant influx of capital that can be used to fund growth, research and development, and other strategic initiatives.
A company can increase its visibility and profile in the marketplace when it goes public. A higher level of visibility to potential customers, partners, and employees can help the company grow, expand its reach, and attract new opportunities.
In general, public companies have higher valuations than private companies, making them more attractive to investors. Additionally, being publicly traded can provide the company with the funds to engage in further acquisitions, which is essential for strategic growth over time.
Liquidity for Shareholders
A reverse merger can also provide liquidity for shareholders of the private company. Before going public, the private company’s shareholders may have had limited options for selling their shares. However, once the company becomes publicly traded, the shares can be sold on the public markets, providing liquidity for the shareholders.
The traditional IPO route does not guarantee that a company will successfully go public. Various obstacles, such as unfavorable market circumstances, can impede or even terminate the process. Opting for a reverse merger can reduce the possibility of a failed IPO and prevent the potential waste of substantial time and money.
Reduced Time and Cost
Finally, a reverse merger can be a quicker and less expensive way to become a publicly traded company compared to a traditional IPO. A reverse merger can be completed in just a few weeks to up to four months, while an IPO can take 18 months and sometimes longer. Additionally, a reverse merger’s legal and accounting fees are typically lower than for an IPO.
Potential Drawbacks to a Reverse Merger
Dilution of Ownership
One of the main drawbacks of a reverse merger is the potential for dilution of ownership. In a reverse merger, the private company acquires a controlling interest in the public company, and shareholders of the private company will likely own a smaller percentage of the merged entity. Additionally, the public company may issue new shares as part of the merger, further diluting the ownership of the private company shareholders.
A reverse merger also comes with increased regulatory requirements, as with a traditional IPO. Public companies are subject to more stringent reporting and disclosure requirements than private companies, which can be costly and time-consuming.
This issue is timelier now than ever with a market that swings on a daily basis. While the increased liquidity provided by a public listing can be beneficial, it also means that the stock price can fluctuate significantly based on market conditions and investor sentiment. This can impact the valuation of the merged entity and the value of the shareholders’ holdings.
Excessive Selling Pressure
Existing shareholders may rapidly sell substantial portions of their shares upon completion of the merger, flooding the market and pushing the company’s stock price down. However, this risk can be mitigated by requiring shareholders to agree to restrictions on the timing and volume of shares that can be sold following the merger.
Although the reverse merger process is less complex than an IPO, it still requires a significant amount of due diligence. Both the private and public entities involved must conduct comprehensive investigations to scrutinize the prospective business combination as well as potential liabilities, including liabilities associated with any legacy business of the public company.
A reverse merger can be challenging from an integration standpoint. The private company and the public company may have different cultures, processes, and systems, which can make it challenging to integrate the two entities. Additionally, the merger may require significant changes to the management structure and operational processes, which can be disruptive and time-consuming.
While there are many benefits to a reverse merger, it may not be the right choice for every company. It is worth considering as a viable option for those looking to raise capital and expand their reach in the marketplace. Companies considering this option should work with expert advisors to weigh the alternatives and their benefits and drawbacks and negotiate the best deal possible.