Many companies pursue reverse merger deals due to the speed it offers in the ability to go public. However, despite the advantages related to reverse mergers, merging with public shell companies has raised some concerns. The article will present the reasons why so many recent blockchain companies are going public via reverse merger as well as the factors that prevent companies from pursuing reverse mergers.
Why are so many blockchain companies going public via reverse merger?
Many companies are going public via reverse merger for a variety of reasons.
- Engaging in a reverse merger provides opportunities for startups to offer stock options to employees and to gain the credibility and public access information needed to get the attention of customers and suppliers.[1]
- In addition, companies pursue reverse merger transactions when the business of the company fails and intrinsic values such as the shareholder base, financial statements and trading history need to be preserved. A reverse merger is also a strategic decision for public companies to find a new business venture to maintain the viability of the company.[2]
- Reverse mergers are also less expensive and take a shorter time to process. For example, an IPO can cost $2 million in fees and other expenses, whereas, a reverse merger can cost $500,000. Furthermore, a Reg A+, IPO or DPO can take six months to one year to complete whilst a reverse merger can be completed in two to three months.[3]
- Some private companies benefit from this type of merger since they become a publicly trading company immediately following the merger with a publicly trading shell company. For example, a reverse merger can be listed in thirty to forty-five days compared to an IPO that takes a year. In addition, the private company does not have to wait to be cleared by the SEC clearance of the registration statement. On January 29, 2018, Dell Technology reported that it will pursue a reverse-merger with VMare Inc. The reverse merger will allow Dell to publicly trade without going through an IPO.[4]
- Companies that have financial constraints may use reverse merger as an alternative to raise capital and gain liquidity in the firm. The liquidity is offered to employees for their equity stake in the firm.3 Shareholders eventually gain liquidity from reverse mergers.
Limitations Associated with a Reverse Merger
Companies may not pursue reverse mergers due to certain limitations and challenges associated with reverse merger transactions.
- Although, reverse mergers are cheaper and faster to execute, the capital raised in reverse mergers is less than that from an IPO. Companies may experience financial constraints associated with regulatory costs following a reverse merger.
- The reverse merger process can be burdensome. Companies with inexperienced employees and poor infrastructure may not be equipped to manage reverse merger transactions.
- The cost of conducting due diligence and purchasing a shell company (up to $500,000, 5 to 10% of the company’s outstanding securities and excluding legal, audit and financial costs) can be a limiting factor for startups and entrepreneurs. 3 The private company must be willing to purchase the public shell company with equity, cash or a combination of both. Startups and entrepreneurs may not have the financial resources to engage in a reverse merger transaction.
- The private company may experience problems since the shell company can conceal information associated with certain obligations and processes from the private company. For example, there may be undisclosed lawsuits, liabilities or other issues affecting the shell company.
- The number of shareholders can decrease following a reverse merger since there is risk that shareholders may sell their shares.[5]
Regardless of the drawbacks associated with reverse mergers, many private companies have gone public via reverse merger. Reverse merger deals have also influenced the ecosystem of blockchain and cryptocurrency and enhanced the growth of the cryptocurrency market.
Conclusion
Many companies pursue reverse merger deals to access the capital market. Some private companies benefit from structuring reverse merger deals to raise capital due to shorter length of time and lower cost compared to an IPO as well as the potential to gain liquidity in the firm. Nonetheless, some companies may not pursue a reverse merger deal due to existing liabilities and lawsuits linked to the public shell company, limited financial resources and the possibility of losing shareholders following the close of the reverse merger.
Author Bio
Nate Nead is an Investment Banker based in Seattle, Washington. Nate assist private companies sell and divest their business assets through mergers and acquisitions. He has direct investment banking experience in real estate, software, technology, diagnostics, healthcare, events and oil and gas.
[1] Martin Zwilling, Is A Reverse Merger the Way to Fund Your Startup? (May 2, 2014), https://www.forbes.com/sites/martinzwilling/2014/05/02/is-a-reverse-merger-the-way-to-fund-your-startup/#58969a983e92.
[2] Laura Anthony, Going Public Transactions For Smaller Companies: Direct Public Offering And Reverse Merger, (June 15, 2017),  https://blog.vcexperts.com/2017/06/15/going-public-transactions-for-smaller-companies-direct-public-offering-and-reverse-merger/.
[3] James Dunn, Reverse mergers offer companies quick route to going public, (June 20, 2016), http://www.northbaybusinessjournal.com/industrynews/accounting/5741474-181/reverse-merger-going-public.
[4] Chris Nolter, Dell Could Rein in Its Massive Debt Through a Reverse Merger with VMware, (Jan 30, 2018), https://www.thestreet.com/story/14466206/1/dell-could-rein-in-its-debt-through-a-reverse-merger-with-vmware.html.
[5] Gheorghe Hurduzeu, Liviu Bogdan Vlad & Raluca Hurduzeu, The Reverse Mergers − −− − Alternatives to Initial Public Offerings, (June 2012), http://beman.ase.ro/no22/6.pdf.
