May 29, 2020 is a daily online magazine covering small business news. We help entrepreneurs transform ideas and innovations into greatness.

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Going Public Through a Reverse Merger

A Reverse Merger may be the quickest way to go public but is it the best? We look at a few drawbacks of using a reverse merger to take your company public.

For many business owners, the transition from a private company to a publicly-traded corporation is just out of reach.
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An IPO is a daunting process, and the combination of limited resources and limited expertise can intimidate even the hardiest entrepreneurs. But what if there was a way to take your company public without the hassle and expense of an IPO?

The idea of circumventing the usual IPO process sounds like it should be illegal, unethical, or both. However a reverse merger provides a shortcut that is both legal and logical. Although it may seem complicated, a reverse merger can be a lot easier than you think. Here's what you need to know:

What is a reverse merger?

In its simplest form, a reverse merger is when a smaller company takes over a larger one for the benefit of becoming a publicly-traded corporation. Usually, the publicly traded corporation is known as a "shell corporation" because it has little or no assets. Even though it continues to be a publicly traded corporation, its assets have evaporated through bankruptcy or liquidation and now all that remains is its internal structure and shareholders. The private company obtains the shell company by purchasing controlling interest through a new issue of stock.

Typically, the new, merged company will take the name of the private company, installing a new board of directors and corporate officers. At that point, the merged corporation files a few forms with securities regulators and works to maintain the minimum number of shareholders required for inclusion in stock exchanges.

What are the benefits of a reverse merger?

The benefits of a reverse merger are fairly obvious. From the private company's perspective, a reverse merger eliminates the expense of an IPO as well as the time and hassle involved with making the transition to a public entity. The time factor should also be taken into consideration since a reverse merger will usually allow you to make the transition more quickly than an IPO.

Are there any drawbacks to doing a reverse merger?

Unfortunately there can be some drawbacks involved in using a reverse merger as a tool for taking your company public. The first may be the cost of the shell company itself. As more people have become aware of the benefits of reverse mergers, the cost of shell companies has risen sharply. It's possible that you could end up spending $500,000 or more in a reverse merger scenario and the owner of the shell company could retain a percentage of ownership in the new company.

Additionally, a reverse merger involves the same risks you would incur in buying any business. Pending litigation, hidden debts, and inaccurate reporting can all come back to bite you if you fail to perform adequate due diligence. It is especially worthwhile to explore the reasons why the shell company went out of business in the first place. If the issues aren't resolved or haven't been explained to your satisfaction, you're probably better off moving on to another candidate.

Finally, be wary of reverse merger promoters. In some cases, reverse merger promoters have taken advantage of naive business owners. Essentially, they tie the owner up with "locked up" stock in the new public company, and then proceed to "pump and dump" their own stock, which is not similarly restricted. By the time the owner can sell, the stock price is in the toilet because the promoters have sold their stock and moved on to their next victim.

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