A reverse merger involves a transaction where a privately held company merges with a public company. Typically, it is the private company or investors that will take control of the public company, and then consummate the merger. A lot of smaller companies use a reverse merger instead of a traditional initial public offering (IPO) to go public. There are pros and cons to reverse mergers.
Underwriting
A firm that opts to go public through a reverse merger does so usually because its earnings or tangible assets don't meet the standards for what's required to be listed on Nasdaq. Such a firm does not attract underwriters such as traditional IPOs, which lure reputable firms like Goldman Sachs and Citicorp. Underwriters can raise colossal amounts of money through institutional clients.
Financial and Legal Due Diligence
Financial and legal due diligence is imperative for the private company before entering into any transaction. When the merger occurs, the privately held firm assumes all financial and legal obligations of the public entity. Reverse mergers are more expensive than a direct offering. The private company has to pay legal and accounting fees. The other disadvantage is that there is no money raised in a reverse merger.
Confidentiality and Public Reporting
There is almost no confidentiality in a reverse merger. A full financial disclosure is required. Management has to dedicate more time to public company operations. The company must issue new shares after the merger. But before that, it has to go through the U.S. Securities and Exchange Commission, a process that takes up to four months.
