Table of Contents
What is a Reverse Merger?
A reverse merger process is carried out to merge a thriving and potentially scalable private company with a dormant or “shell” company listed on the exchange. The foremost objective of a reverse merger process is to bypass the extensive procedures and regulations imposed by the government on a company seeking to issue an IPO. The private companies achieve this by acquiring greater than 51% of the equity share capital of the public shell company or commanding a control over the board of directors.
Think of a reverse merger as a back door entry for a private company wanting quick entry to the arena of listed entities. The private company is able to save on significant amounts of time, money and management expertise when it opts for a reverse merger against an IPO. Also, going for an IPO does not always guarantee a listing on the exchange. Insufficient funds raised during an IPO may cause all effort to go in vain. A reverse merger is therefore, an inexpensive and simple route to gain access to the exchange.
Reverse Merger Process
Stage I: Identifying a Suitable Shell
Spotting a perfect fit shell is the foremost step in a reverse merger process. An amalgamation with any abandoned shell company is not acceptable. The shell company, though out of business, must be compliant with all reporting requirements mandated by the SEC (The U.S. Securities & Exchange Commission). Moreover, a merger with a shell in extremely poor health will ultimately bog down its successor. The shell must therefore, be free of all potential debt, obligations or legal hassles.
Stage II: Financial Staff
Right people to ensure the flawless execution of the reverse merge process are crucial to find. The services of an experienced securities law firm cannot be overstated at this stage since a reverse merger process is full of trap doors and loopholes. It is therefore, always advisable to have a professional on board and run a tight ship.
Stage III: Financial Audits
After having a financial team in order, the saga of audits and due diligence begins.
• Obtain SEC qualified audited financial statements of both the private and the public shell company for at least two preceding fiscal years.
• Consolidate the financial statements of the private company with the public company before closing. Ensure conciliation in accordance with the standards of US GAAP.
Due Diligence Checks:
• Review all public filings and background checks, for example, a record of material litigations.
• Rule out potential/unforeseen liabilities related to past business or management.
• Is it DTC (Depository Trust Company) eligible? DTC provides safekeeping and electronic clearance services for corporate and municipal securities.
• Shareholder base sanctions for the target (private) company to take control.
The private company must classify the shell based on findings in the due diligence: Clean Shell Vs Messy Shell Vs Dirty Shell.
Stage IV: Transaction Documents
Letter of Intent
The LOI (letter of intent) may or may not precede the final contractual agreement. It is a non-binding or partially-binding document that formalizes the interest of both parties in a deal. The LOI is a summary document of the key points underlying a transaction and serves as a precursor to the final contract.
The Contractual Agreement
It is the most essential document of the reverse merger process. It translates the plan on paper into reality once affixed by the signature of both parties. Its major content includes:
• Consideration and mode of settlement (cash, stocks or a combination thereof).
• Changes in management control.
• Representations and Warranties
• Termination clauses and breakup fees applicable.
Reporting a change in the shell status requires filing of a super 8-K. Therefore, when a shell company undergoes a reverse merger, thereby nullifying its existence as a shell, it must make a filing under form 8-K. The 8-K in addition to reporting change in shell status also requires disclosure of information otherwise covered in Form 10. Form 10 covers all material information such as changes in control, material agreements, risk factors, information regarding directors and officers, etc.
Filing of form 8-K must be completed within 4 days of the close of reverse merger process (or any event triggering the change in the status from the shell company to a not-so-shell company).
Stage V: Issuance of Stock Certificates
The reverse merger process can be said to be complete once the paperwork has been taken care of. The stock certificates of the acquiring (previously shell) company are then issued to the directors and shareholders of the target12 company.