When a privately held company acquires a public company in order to become public, it is referred to as a reverse takeover. This type of transaction may sometimes be referred to as a reverse merger or reverse Initial Public Offering (IPO). There are several reasons why a company might use this type of merger.
A company will sometimes execute a reverse takeover in order to become a public company without having to mount an initial public offering. Initial public offerings can be expensive and time consuming, and, in some economic climates, may be difficult to accomplish. If a company wishes to go public when there has just been a large sell-off in the market, for example, its best option may be to do a reverse takeover.
Reverse takeovers can also be used by a public company that cannot meet the criteria to be listed on a stock exchange, either because its price per share is too low, it doesn’t meet the thresholds for certain financial ratios, or other reasons. In this case, the company performing the reverse takeover simply acquires a listed company. This type of maneuver is sometimes called a back door listing, as the company that is taking over the listed company is gaining its stock market listing ‘through the back door.’
In order to mount a reverse takeover, the private company must buy enough shares in the public company to have a controlling interest. The private company can then vote for the merger with the public company. Once the merger is complete, the shareholder or shareholders in the private company simply exchange their shares in that company for shares in the public company. In this way, because the merged company is publicly traded, the transaction is effectively making the private company public.
The downside to using a reverse takeover to take a private company public is that the private company must have enough cash to purchase a controlling interest in the public company. For this reason, a reverse takeover typically does not produce additional capital for the resultant public company. An initial public offering will provide an influx of capital into the now-public company, sometimes a significant one. A reverse takeover will not have this effect. On the other hand, the value of the stock of the privately held company is not diluted as much, so the holdings of the executives usually remain virtually intact in this type of takeover.