Back to Blog

The Advantages and Disadvantages of a Reverse Merger


Thanks to their speed and cost-efficiency, reverse mergers are often the method of choice for private companies to start being traded publicly without performing an initial public offering (IPO). Whether you're considering a reverse merger for your own organization or you just want to learn more about the process, here's an overview of everything you need to know.

What Is a Reverse Merger?

A reverse merger is a tactic that private companies use to go public without having to go through an IPO. During the merger, the private company takes control of a public shell company with an existing hierarchical structure but little in the way of assets or net worth.

First, the private company's shareholders purchase enough shares of the public company to seize control and merge the two companies together. Then, the public company's name, stock symbol and corporate structure are usually changed to correspond with the private company.

What Are the Advantages of a Reverse Merger?

Typically, IPOs are an expensive process in both time and money; they can take up to 6-12 months to complete. During the time it takes to carry out the IPO, market conditions may change adversely, making it a risky proposition.

By contrast, reverse mergers are significantly cheaper and can often be finished in a matter of weeks. For example, if the public shell company has already registered with the U.S. Securities and Exchange Commission, the private company doesn't need to repeat the process, saving time and paperwork.

This means that reverse mergers are often a good choice for small private companies that need a quick way to raise capital. In addition, private foreign companies can use a reverse merger with a U.S. public company as an easier way to enter the U.S. market.

Using the public shell company as a tax shelter can be another advantage of reverse mergers. Shell companies are usually in that state because they have experienced a series of losses and currently operate in name only. As a result, the merged company can use these losses on its future tax statements, protecting some of its profits from taxation.

What Are the Disadvantages of a Reverse Merger?

Despite the benefits listed above, reverse mergers aren't the right choice for every private company that wants to go public. For one, performing a reverse merger isn't without its own set of risks. Shell companies often come with a history of problems that accompany their financial downfall, such as poor record-keeping and even pending lawsuits. The shell company's shareholders may also take a stance against the merger, making it more lengthy and difficult.

Another disadvantage of reverse mergers for shareholders is the likelihood of performing a reverse stock split. During the process of merging, shareholders may decide to reduce the number of shares and then issue new shares, diluting the value of the original shares. This can be an unattractive proposition for the original shareholders.

In addition, the speed of accomplishing a reverse merger can actually be a detriment. Although public companies usually have a higher valuation, this comes at the cost of greater complexity. CEOs of private companies who have little experience with publicly traded companies may need the time provided by an IPO to prepare to lead the new merged company.