Ask Mint | Reverse merger: back-door entry for firms into the stock market

Ask Mint | Reverse merger: back-door entry for firms into the stock market
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First Published: Sun, Dec 14 2008. 11 20 PM IST

Updated: Sun, Dec 14 2008. 11 20 PM IST
Many firms use the fanfare of big-ticket initial public offerings (IPOs) to announce their arrival in the stock market. But many quietly slip in by carrying out a reverse merger with a firm already listed on the bourses.
Call it a marriage of convenience or buy one, get another free shopping bonanza, a reverse merger is one of the most popular methods of getting listed when market conditions are just not right for rolling out an IPO. So, let’s find out what makes reverse mergers a hot favourite for firms looking for a space in the stock market.
Johnny: Recently I heard about one big unlisted firm getting listed on the stock exchange simply by merging with a not-so-big listed firm. What sort of match-making is this, Jinny?
Jinny: Well, in the popular language of the stock market, this sort of arrangement in which an unlisted firm acquires or merges with a listed firm is called a reverse merger or a reverse takeover. The new entity born out of the reverse merger remains listed on the stock exchange. Due to this reason, reverse mergers can be very well used for gaining a back-door entry into the stock market.
Sounds a bit like under-the-table dealings, but a reverse merger is a perfectly legitimate way of bypassing the long and complex procedures of listing. A reverse merger is more suitable for firms interested in getting listed on the stock exchange without being interested in immediately raising additional capital through public subscription. In reverse mergers, most of the time, the unlisted company is financially better placed than the listed company with which it is going to merge.
The listed company may be a shell company created just for the purpose of facilitating a reverse merger or it may be a company on the verge of financial death or a new company which has yet to really see the light of the day.
A reverse merger is generally a union of unequals in which one party remains dominant. The merged entity retains the identity of the dominant side.
Johnny: One side may be dominant but I hope both the firms must be gaining something. Tell me, Jinny, what are the main advantages of a reverse merger for both the firms?
Jinny: In a way, both the listed as well as unlisted firms gain something by getting into a reverse merger. For an unlisted firm, a reverse merger surely provides an opportunity to access the stock market at a much lower cost and by a faster process.
A presence in the stock market ensures better visibility in the financial community. For the shareholders of the listed firm, reverse merger provides an opportunity to acquire an interest in the merged entity which they can subsequently offload in the stock market at a much better price than that of their previous firm. Since a reverse merger does not require invitation of subscription from the public, it can be carried out even during periods when market sentiments are not favourable for an IPO.
During tough market conditions, well-laid IPO plans of even good companies can go awry. But even during bad times, reverse merger transactions can be completed much like a private affair of the merging firms. Parties to a reverse merger can decide the valuation of the merging firms and other terms and conditions by using their own judgement. Subsequently, when market conditions improve, the merged entity can raise money in the stock market by bringing out a follow-on public issue. Most often, reverse mergers also bring windfall tax gains for the merged entity in the form of write-offs for previous losses sustained by the merging firms.
Losses sustained in the previous years can be used to show less future profits for tax purposes.
Johnny: Enough of advantages Jinny. Now tell me the other side of the story. What could be the main disadvantages of a reverse merger?
Jinny: Getting into a reverse merger can sometimes be a really risky business. Parties to a reverse merger no doubt enter into the deal of their own free will.
But many times one party to the deal may not be able to correctly assess the true worth of the other side. The merged entity may find itself in a precarious situation when undisclosed liabilities, pending lawsuits and so on of the previous firm start tumbling out of the closet or when disgruntled shareholders of the merging firm make the life of new firm miserable.
Further, the merged entity may find that there is no liquidity for its shares in the absence of public interest in the market, the reasons for which are not hard to find. Such back-door listings hardly generate the same appetite in the investment community that a big IPO does. So, if you are used to seeing investors make a killing on the first day of listing of an IPO, you may be a little disappointed because listing through reverse merger may look very dull in comparison.
Johnny: That’s true, Jinny. There are really no short cuts for creating a place in the hearts of the investment community.
What: Reverse merger is a popular method of getting listed when the market conditions are unfavourable for an IPO.
How: In a reverse merger, an unlisted company merges itself with an already listed company.
Why: Reverse merger is popular because it involves lower cost and is a faster process of getting listed.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at realsimple@livemint.com
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First Published: Sun, Dec 14 2008. 11 20 PM IST