Reverse Mergers: Going Public Without Underwriting

The use of so-called “reverse mergers” in the United States has blossomed in recent years. What formerly was an “on-the-cheap” method of attaining public company status — employed by sometimes shady promoters — has developed into a mainstream capital markets technique using sophisticated financial, legal and accounting strategies and techniques. Reverse mergers are new to the satellite industry, but for companies seeking the advantages of public company status, should be considered as part of the toolbox.

Technically a reverse merger is any merger structured so that the target company, rather than the acquirer, is the surviving entity. However, in this context it means a private company target that goes public through the expedient of merging with an already public company shell target that has no operating business. (Normally, a “reverse triangular merger” structure is used, with the private target merging with the public shell’s wholly owned subsidiary). The transaction is usually non-taxable.

The public shell may be a former holding or operating company that has divested its assets or a SPAC (special purpose acquisition company), a public shell formed and registered in an initial public offering (IPO) with no operating business, and a business plan stated in its registration statement to acquire a private company, using as acquisition currency the capital raised in the IPO.

A reverse merger generally involves a share exchange by which the private operating company stockholders receive a certain number, or certain value, of public shell shares for each of their private company shares. The public shell stockholders may remain as minority stockholders in the merged public company or be bought out completely.

Capital raising is not always part of the transaction, but many private companies couple a reverse merger with a private investment in public equity, or PIPE, financing transaction. A typical PIPE transaction is conducted either before or after the reverse merger as a private placement of restricted securities, but the merged public company subsequently files a registration statement with the U.S. Securities and Exchange Commission to register the securities and permit their public resale.

PIPE financings are not the only means for the merged public company to raise capital; it may also register and offer its shares for sale to the public. Also, presuming that one of the goals of public status is to obtain greater liquidity and improved credit, the merged company may find subsequent capital raises easier and/or cheaper than its private predecessor.

A few practice points to note: The transaction probably will result in the appointment of new directors to the merged company, either from the private company’s directors and stockholders or otherwise. If so, since the merged company is a reporting company under the U.S. Securities Exchange Act of 1934 (the Exchange Act), it will have to file an “information statement,” akin to a proxy statement, containing substantial financial and non-financial disclosures mandated by Exchange Act rules. Also, since the merger is a material event for the public shell, it will have to file a “super 8-K” current event report containing the financial and non-financial information that a registration statement for the merged company would contain. (In practice, the burden is reduced because there is substantial overlap between the required contents of the information statement, any offering document used to raise capital, any subsequent registration statement and the super 8-K).

The principal advantage of using a SPAC, instead of a preexisting public shell, is that it is clean. Since it is newly formed for the express purpose of acquiring a private operating company and has no history of operations itself, it has no hidden potential liabilities, messy corporate governance history or other issues that may afflict public companies that became shells through divestitures.

SPACs typically are taken public with a registration statement that sets a limited period of time —usually 12 to 24 months— in which an acquisition will be completed, failing which the investors’ capital, usually held in escrow, will be returned. The model is akin to a public version of private equity fund formation in that the investors, like private equity fund limited partners, essentially are betting on the SPAC’s management team to find, price and complete acquisitions that are appropriate for the SPAC’s investment objectives, in advance of any opportunity to examine the prospective portfolio assets and business themselves.