What Is a Reverse Takeover (RTO)?

A reverse takeover (RTO) is a type of merger that private companies engage in to become publicly traded without resorting to an initial public offering (IPO). Initially, the private company buys enough shares to control a publicly traded company. The private company's shareholder then exchanges its shares in the private company for shares in the public company. At this point, the private company has effectively become a publicly traded company. An RTO is also known as a reverse merger or a reverse IPO.

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Reverse Takeover

How a Reverse Takeover - RTO Works 

Under a reverse takeover (RTO), a private company does not need to pay the expensive fees associated with setting up an IPO. However, the company does not acquire any additional funds through the merger, and it must have enough funds to complete the transaction on its own. While not a requirement of an RTO, the name of the publicly traded company involved is often changed as part of the process. Additionally, the corporate restructuring of one or both of the merging companies is adjusted to meet the new business design.

It is not uncommon for the publicly traded company to have had little to no recent activity, existing as more of a shell corporation. This allows the private company to shift its operations into the shell of the public entity with relative ease, all while avoiding the costs, regulatory requirements, and time constraints associated with an IPO. While a traditional IPO may require months or years to complete, an RTO may be complete within weeks.

RTOs are cheaper and quicker than IPOs when it comes to going public, but they tend to pose greater risks for investors.

Special Considerations

A foreign company may use a reverse takeover (RTO) as a mechanism to gain entry into the U.S. marketplace. If a business with operations based outside of the U.S. purchases enough shares to have a controlling interest in the U.S. company, it can move to merge the foreign-based business with the U.S.-based one, gaining access to a new market without the costs traditionally involved.

To complete the process, the final resulting company must be able to meet all Securities Exchange Commission (SEC) reporting requirements and other regulatory standards, including the filing of an SEC Form 8-K to disclose the transaction.

Key Takeaways

  • RTO is a type of merger that private companies engage in to become publicly traded without resorting to an IPO—also known as a reverse merger.
  • Cheaper and quicker than an IPO, but there can often be weaknesses in an RTO’s management and record keeping, among other things.
  • Foreign companies use RTOs to gain access and entry to the U.S. marketplace.

Reverse Takeover - RTO vs. Share-For-Share Exchange

A reverse takeover can also refer to an instance where a smaller company takes over a larger one through a share-for-share exchange. It is so named due to the fact that it is the lesser expected arrangement of the traditional takeover of a smaller business by a larger one. RTOs have often been referred to as the poor man’s IPO mostly due to studies showing that companies that go public through a reverse merger generally have lower survival rates and performance compared to companies who go public through a traditional IPO.

Advantages and Disadvantages of Reverse Mergers

Reverse mergers can allow a private company to come public for lower cost, and quicker, than an IPO. Reverse mergers can get companies to the public market in less than a month. As well, unlike conventional IPOs that can be canceled if the equity markets are performing poorly, reverse mergers aren’t generally put on hold. Many private companies looking to complete a reverse merger have often taken a series of losses, and a percentage of the losses can be applied to future income as a tax loss carry-forward.

Computer company Dell, Inc. completed a reverse takeover of VMware tracking stock DVMT in Dec. 2018 to return to the public marketschanging its name to Dell Technologies, Inc.

On the flip side, reverse mergers can reveal weaknesses in the private company’s management experience and record keeping. As well, many reverse mergers “fail,” in that they end up not leading up to the promised expectations eventually trade on the OTC bulletin board. After the boom and eventual bust of Chinese reverse mergers in the early 2010s, the Nasdaq increased scrutiny and requirement for mergers.