Photo: A reverse merger can help private companies become public easily
When news spreads that a merger and acquisition (M&A) happens, we usually think of a larger, hostile company taking over a smaller, weaker entity. However, what if it’s the other way around, where the smaller company acquires a larger one? This is what happens in a reverse merger.
What is a reverse merger?
A reverse merger, also called reverse takeover, occurs when a smaller private company acquires or takes over a larger publicly listed company. The private company acquires a public listing, or becomes public, through a merger with an already publicly listed company. It’s called “reverse” because of how a smaller entity acquires a larger one, which is unusual when we talk about typical M&As. It’s uncommon, but it’s also not impossible.
When we say that a company is smaller, it’s a relative statement which only refers to the idea that because it’s a private company, it’s smaller compared to public ones. However, it doesn’t mean that these so-called smaller private companies are powerless and empty of capital.
Here are some of the features of reverse mergers:
- faster way for a private company to get publicly listed
- improves liquidity for the shareholders of the acquired public company
- may skip some regulatory requirements depending on the jurisdiction
This video briefly explains how a reverse M&A works and an actual example of it – the case of Dell, a private company, and VMWare, a publicly listed company:
You can also consult an M&A lawyer to find out more about reverse mergers. Check out our directory of the best M&A lawyers in Canada as ranked by Lexpert.
What is the difference between a merger and a reverse merger?
In Canada, companies that want to be listed in the Toronto Stock Exchange (TSX) or in the TSX Venture Exchange (TSX-V) may do so:
- by doing a reverse merger
- by undergoing an initial public offering (IPO)
- through a special purpose acquisition vehicle (SPAC)
This is why a reverse merger is always compared with a typical merger, which undergoes an IPO. The IPO would be our normal process of going public, while the reverse M&A is the unconventional one.
Advantages of a reverse merger
There are a lot of reasons why companies prefer doing reverse mergers rather than an IPO or a SPAC:
- acquiring of stocks: in a usual M&A, the target company receives the stock from the buying or acquiring company; while in a reverse merger, it’s the acquiring company that receives the target company’s stocks
- time: in most cases, companies do a reverse M&A to avoid the time-consuming process of IPOs, which is also related to an IPO’s legal compliance when dealing with government regulators
- stability: IPOs heavily rely on the conditions and status of the public market, which may prevent a private company going public; this is not the same for reverse mergers since the success is not dependent on the stock market
- costs: as for the costs needed to complete the whole transaction, reverse mergers are cheaper than the IPOs because they’re easier to close and there’s less regulatory processes to comply with
- easier for foreign entities: companies that want to be publicly listed in a foreign state can do so easily by doing reverse mergers, rather than converting a currently private entity into a public one
Being a shell company that has limited to no assets, the public company can now acquire the necessary shares and assets to operate fully. On the other hand, private companies become public, giving them more opportunities to acquire capital from wider sources.
All of these make reverse mergers more appealing to investors. However, it’s still advised to consult an M&A lawyer who can deeply evaluate whether a reverse M&A or an IPO would be a better option if a private company wants to go public.
Disadvantage of reverse mergers
Compared to IPOs, there’s no immediate cash that is generated as a result of reverse mergers. This is why when an entity needs instant capital after (or even during) the process of M&A, a reverse merger may not be for them.
What is the process of a reverse merger?
Here’s an overview of how this type of mergers work:
- The private company acquires sufficient shares in the publicly listed company to obtain majority ownership
- After the merger, the publicly listed company is retained, but may change its ownership because of the new shareholders from the former private company
This is where reverse mergers are somehow like a typical M&A transaction: the process of M&As, especially the most important ones, are still done in reverse mergers. Across these two general steps mentioned above, the crucial steps in an M&A transaction also applies, such as:
- conduct of due diligence: among others, the private company ensures that the public company doesn’t have significant liabilities that would hamper the business of the new, retained entity
- handing out disclosure documents: to close the transaction, the public company usually provides the private company with disclosure of all relevant matters (e.g., corporate governance, etc.)
What laws govern reverse mergers in Canada?
As with your classic M&As, most of the aspects of reverse mergers are governed by Canada’s competition and antitrust laws, specifically the federal Competition Act. As such, the review processes for M&As may still apply to these types of mergers, especially when certain thresholds are already met by the transaction.
Aside from the competition laws, other statutes may apply depending on the circumstances of the transaction. For instance, the federal Investment Canada Act would apply when the transaction involves foreign capital. There are other provincial laws that can also restrict M&A transactions.
Since each case is unique — whether it be your usual M&A or a reverse merger — it’s important to consult with a lawyer, on top of the corporate legal team.
We also have a different directory of the top law firms in the field of M&A if you need help regarding a possible reverse merger. Head over to our page on the Lexpert-ranked best law firms for M&As in Canada.