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For companies that wish to go public quickly, a reverse merger can provide a company with all of these elements without the scrutiny and costs involved in an IPO.
A reverse merger is a transaction whereby a private company is acquired by a public company. However, the amount of stock that is issued to the private company causes a change in control of the public company, hence the name "reverse" merger. Often, reverse mergers occur between private companies and "public shell" companies.
A public shell is a non-operational public company that in the past sold stock to the public. The business later ceased operations, leaving a shell corporation with a base of shareholders holding free-trading stock. As long as the corporation has not had its corporate charter revoked, a new company can merge into the shell and assume the base of shareholders. The officers and board of directors of the public shell resign, and new officers and directors are appointed.
Because of the new lease on life enjoyed by the shareholders, a trading market is likely to develop once again. The private company that merged into the shell is now publicly held. Because of the trading market, it can now enjoy all of the benefits of being public.
For reverse mergers involving a public shell, the private company can control as much as 80-90% of the outstanding shares of common stock. The remaining 10-20% is held by the previous shareholders of the public shell and by promoters of the merger. While this process results in some dilution to the private company merging in, the increase in valuation to the company as a result of the new trading market often outweighs the dilution cost.
The cost of merging into a public shell company depends on a number of factors, including whether the company is a reporting corporation. A reporting corporation is one that originally went public through a registered offering, or later had its securities registered with the SEC. As a result, it is required to file periodic reports with the SEC, including reports on form 10-K (annual report) and 10-Q (quarterly report). Because of the effort involved in registering securities, this type of shell has more value.
Prices of shell corporations vary like any other product affected by supply and demand. Most parties that control public shell corporations will negotiate the price and the amount of stock to be issued to the private company. In addition to these costs, there are legal and accounting expenses as part of the transaction.
The total cost for a company going public through the reverse merger is substantially less than the cost for an IPO. However, the reverse merger does not raise any capital for the company. Also, because the private company is merging into a shell company that operated in the past, there is always the potential of liabilities or unknown factors about the public company that may surface after the completion of the merger. Therefore, it is important to know the history of the shell company.
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