This LinkedIn question asking about reverse mergers is a question I’ve answered for a lot of entrepreneurs who get pitched by these folks and are invariably misled confused about where, how, and whether this deal brings money into the company.
“What is a reverse merger or reverse IPO?”
Short answer: “reverse merger” is almost always spelled S-C-A-M.
There are a small handful of legitimate reasons why a non-scammy, non-scuzzy company would go through this process. It is expensive, provides little intrinsic value to the private company paying for everything, and does little else of note.
How is it structured?
Standard format: a private company enters into an agreement to merge with an existing listed (meaning on a stock exchange) company that has little or no assets, may have (preferably) gone through a bankruptcy to become a “clean shell,” and has existing stockholders whose shares probably have a fair market value of close to zero. These zombie companies may nevertheless have a stock price because of random trades, but the FMV is still close to zero. (You can do the math yourself, or just trust me.)
The merger goes through and the private company is merged into the public company with new shares issued to old private shareholders. The private company is thereby able to “take over” the securities filing status of the public company, meaning the private company is now effectively public (as if that matters!). In exchange, the shareholders of the shell get some amount of money, generally well into 6 figures (most of which will certainly go to fees for third-party advisors) and some percentage in the post-deal company (5-20% is not uncommon).
Why do people do these deals?
Because they think that now they can easily “raise money” that they couldn’t previously. Sort of true technically, but false on a practical level. Or, even worse, they think that because they’ve gone public, it magically comes with some kind of new capital. A full-form securities registration (S1) is expensive, and those companies still need brokers to sell the shares to investors. If you don’t spend the cash on the reverse merger, you could just look for underwriters to sell the shares in a regular IPO. Same result, cheaper, faster (since you don’t have to do the merger deal first), and without the equity haircut.
Are there legitimate reasons to do these deals if you’re the private company? Sure, there’s at least one: if you have an investor IN HAND who has ALREADY committed to investing but is subject to investment policy restrictions such as only investing in public companies, then the speed of getting from A to B via reverse merger might make sense. And in that scenario, the terms should be negotiated way, way down from the “typical” deal.
In general, stay away and get advice from a reputable, experienced corporate/securities lawyer who has done mainstream deals before getting into this one.
Have any of you actually done one of these deals that made sense before or after? My suspicion is that it’s a null set. #FAIL