The current economic environment has created a unique opportunity for small to midsize private companies. No longer do they have to look at the sale of their businesses as the only viable long-term exit strategy or ultimate liquidity event for their shareholders. Because of the current depressed valuations for legitimate operating public companies, private companies can gain access to the public markets by reverse merging their businesses into an existing, operating publicly traded Company, which can be accomplished at a fraction of the cost of a traditional public offering (IPO).
This commonly used method of going public, which is currently being utilized by small and mid cap companies on a regular basis (especially in the current economic environment), is accomplished when a private company merges with an operating public company. The public entity typically has minimal assets, undervalued operating entities and few or no liabilities. Upon the completion of the merger, the merged private company has gained control of the public entity, through the issuance of common stock, thereby effecting the reverse merger.
The public corporation is often called a “shell” because the original public company typically consists of nothing more than its corporate shell structure and shareholders, although many “shells” today are actually viable, operating businesses with considerable unrealized value. Upon the completion of the merger, the private company always obtains the majority of the shell’s stock, effecting a change of control.
The private company normally will change the name of the public corporation (often to reflect its own name) and will elect its own Board of Directors, which subsequently appoints new officers. The new public corporation will usually have a base of shareholders sufficient to meet the current shareholder requirement for admission to quotation on the NASDAQ Small Cap Market or on the OTC Bulletin Board.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. ” Warren Buffett
The most obvious advantage of attaining public trading status through a reverse merger is that it allows a private company to go public at a lower cost and with less stock dilution than through a traditional IPO. In an IPO, the process of going public and raising capital are combined. In a registered spin-off or reverse merger, these two functions are unbundled – so a company can go public, utilizing this program, without raising additional capital, therefore simplifying the entire process of becoming a publicly traded company.
The Private Company, which has now gone public, has taken the first step in the process of creating enhanced shareholder value by obtaining all of the benefits of a publicly traded security, which include:
Increased liquidity for the company’s shares and shareholders.
Potentially higher per-share prices and thus higher company valuations.
Greater access to the public capital markets.
Enhanced equity funding through secondary stock offerings.
The company’s stock can be used as a currency for acquisitions.
The ability to use stock incentive and option plans to attract and retain key employees.
Going public can also be an effective retirement strategy for business owners. By merging into an exiting public company, a private corporation can increase its real market value by three to five times, create considerable tax advantages for the owners (original founders,) and the newly created value can become part of an estate planning process, providing value not only for the founders, but for their family members during the years to come.
The benefits of going public through a reverse merger, as apposed to an IPO include:
The costs are significantly less than the costs required for an IPO.
The process takes considerably less time than that of an IPO.
It is less risky than an IPO, which may be withdrawn due to an unstable market conditions.
IPOs generally require greater attention from senior management.
An IPO requires a relatively long and stable earnings history with audited statements.
There is less dilution to the existing stockholders.
The process does not require an underwriter be located.
A higher valuation for your company is usually achieved much more quickly.
Once a company is taken public through a reverse merger the financial markets fold the following future prospects into the capital markets (stock price) for the newly public corporation:
The market value of a public company is often substantially higher than a private company with the same structure in the same industry.
Capital is easier to raise for public companies because the Company’s stock, being purchased by investors, has a readily tradable market value.
The trading price of the public company’s securities serves as a benchmark for the offer price of a subsequent public or private securities offering.
Acquisitions can be made with the stock since publicly traded stock is viewed as currency for mergers and acquisitions.
Registered stock and treasury shares can be issued as payment for contracted services.
Summary: For most people, liquidity and stock value appreciation would seem reason enough to be publicly owned, but there are other advantages that a private company can gain by becoming public through this method, some of which are more personal than business related. Please give us a call at Hanover Financial Services with your questions about this process to see if it’s right for your business. We have been providing public and private companies with consulting services in this specific area of business since 1984.
