There are many companies that perform reverse mergers, also known as reverse takeovers, as opposed to other, more traditional forms of raising capital. A reverse merger is when a private company becomes a public company by purchasing control of the public company. The shareholders of the private company usually receive large amounts of ownership in the public company and control of its board of directors (B of D). Once this is complete, the private and public companies merge into one publicly traded company. Read on to find out how investors can profit from these situations by understanding the risks and drawbacks. (For more, see The Wacky World of M&As.)

Advantages of Reverse Mergers
The following are the many advantages to performing reverse mergers.

  • The ability for a private company to become public for a lower cost and in less time than with an initial public offering (IPO). When a company plans to go public through an IPO, the process can take a year or more to complete. This can cost the company money and time. With a reverse merger, a private company can go public in as little as 30 days.
  • Public companies have higher valuations compared with private companies. Some of the reasons for this include: greater liquidity, increased transparency and publicity, and they have a faster growth rates compared to private companies.
  • Reverse mergers are less likely to be canceled or put on hold because of the adverse effects of current market conditions. This means that if the equity markets are performing poorly or there is unfavorable publicity surrounding the IPO, underwriters can pull the offering off the table.
  • The public company can offer a tax shelter to the private company. In many cases, the public company has taken a series of losses. A percentage of the losses can be carried forward and applied to future income. By merging the private and public company, it is possible to protect a percentage of the merged company's profits from future taxes.

Disadvantages of Reverse Mergers
The following are the disadvantages of a reverse merger:

  • Some reverse mergers come with unseen circumstances, such as liability lawsuits and sloppy record keeping.
  • Reverse stock splits are very common with reverse mergers and can significantly reduce the number of shares owned by stockholders.
  • Many chief executive officers (CEOs) of privately traded companies have little or no experience running a publicly traded company.
  • Many reverse mergers do little of what is promised and the company ends up trading on the OTC bulletin board and providing shareholders with little to no additional value or liquidity.

Signals of Reverse Mergers
The following are potential signals that you can use to find you own reverse merger candidates:

  • Appropriate capitalization. Generally, reverse mergers succeed for companies that don't need the capital right away. Normally, a successful publicly traded company will have at least sales of $20 million and $2 million in cash.
  • The best companies for a possible reverse merger are those that are looking to raise $500,000 or more as working capital. Some good examples of successful reverse mergers include: Armand Hammer successfully merging into Occidental Petroleum (NYSE:OXY), Ted Turner's completion of a reverse merger with Rice Broadcasting to form Turner Broadcasting, and Muriel Seibert taking her brokerage firm public by merging with J. Michaels, a furniture company in Brooklyn. (For more, see The Merger - What To Do When Companies Converge.)

Conclusion
To be successful in identifying reverse mergers, you must stay alert. By paying attention to the financial media, it is possible to find opportunities in potential reverse mergers. It is also wise to participate in opportunities that are trying to raise at least $500,000 and are expected to do sales of at least $20 million during the first year as a public company.

There are many benefits and disadvantages to investing in reverse mergers. To be successful, you must ask yourself if you can handle investing in a company that could take a long time to turn around. You should also understand how the merger works and in what ways the reverse merger would benefit shareholders for the private and public company. While this can be a time-consuming process, the rewards can be tremendous - especially if you find the diamond in the rough that becomes a large, successful publicly traded company.

Related Articles
  1. Fundamental Analysis

    Will Health Care Continue to Drive IPOs in 2016?

    Learn why health care IPOs may be slowing in 2016, and how Obamacare, poor previous filings and economic factors are affecting the health care sector.
  2. Stock Analysis

    The Top 10 Small-Cap Stocks for 2016 (ATI, ARCB)

    Discover the top 10 small-cap stocks expected to grow in 2016, complete with summaries and growth outlooks for each company and its expected price target.
  3. Investing Basics

    Inside IPO Roadshows

    Understand more about IPO road shows. Learn the reasons why an IPO road show is important for the success of a company's public offering.
  4. Stock Analysis

    If You Had Invested Right After Berkshire Hathaway's IPO (BRK.A)

    Learn how much you would now have if you had invested right after Berkshire Hathaway's IPO, and find out the classes of shares that you could invest in.
  5. Stock Analysis

    Is Now the Right Time to Buy Coty? (COTY)

    Find out whether fragrance and color cosmetics powerhouse Coty deserves a place in your portfolio. Will recent acquisitions help turn the company around?
  6. Stock Analysis

    Moderna Therapeutics: An IPO Candidate in 2016?

    Find out the reasons why 2016 may be the year when highly valued biotech company Moderna Therapeutic files for an initial public offering (IPO).
  7. Stock Analysis

    Domo Inc: An IPO Candidate in 2016?

    Learn about key information on Utah-based technology startup Domo Inc. and how the Domo dashboard differentiates itself in the world of business intelligence.
  8. Stock Analysis

    GoDaddy Inc: How It's Fared Since the 2015 IPO (GDDY)

    Evaluate GoDaddy's stock performance since its April 2015 IPO, and determine how you would have fared had you invested in the company on day six.
  9. Stock Analysis

    If You Had Invested Right After Comcast's IPO (CMCSA)

    Evaluate how Comcast's stock has performed since the company's 1972 IPO, and learn how you might be a millionaire today had you invested a small sum in the IPO.
  10. Stock Analysis

    TransUnion - How It's Fared Since the 2015 IPO (TRU)

    Learn about the business of financial services company TransUnion and how the company's stock fared after its initial public offering in 2015.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. When did Facebook go public? (FB)

    Facebook, Inc. (NASDAQ: FB) went public with its initial public offering (IPO) on May 18, 2012. With a peak market capitalization ... Read Full Answer >>
  3. Do penny stocks trade after hours?

    Penny stocks are common shares of public companies that trade at a low price per share. These companies are normally small, ... Read Full Answer >>
  4. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  5. How long does it take to execute an M&A deal?

    Even the simplest merger and acquisition (M&A) deals are challenging. It takes a lot for two previously independent enterprises ... Read Full Answer >>
  6. What kind of assets can be traded on a secondary market?

    Virtually all types of financial assets and investing instruments are traded on secondary markets, including stocks, bonds, ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center