The reverse merger is a transaction in which a shell company purchases a private company. Once the transaction is completed, the private company’s identity is changed. The older leadership is removed and replaced when the new company is formed. The entire processes can take anywhere from a few weeks to several months to complete.

What is a reverse merger?

The SEC regulates reverse mergers under the Securities Exchange Act of 1933 and the Securities Exchange of 1934. The merger happens between a public and a private company. The shell company is the public company, and it purchases the private company, who then assumes its identity. From then on, the company is referred to as the public company’s name and is traded publicly on the exchange.

What is the purpose of the shell company in this process?

Shell companies can be recommended by brokers or financial firms. The shell company functions to hold and manage funds on behalf of another entity in major financial transactions. In a merger, this entity can serve as a place to hold money until the company is ready to formally conduct business. The shell company is a public company that will absorb the private firm once the transaction has been completed. A company that is in the beginning stages of a reverse merger can choose to hold its assets in that company until the entire process is completed.

What are the disadvantages of completing a reverse merger?

Reverse mergers come with their share of vulnerabilities. The shares can be dumped, devaluing the overall value of the stock. This means that the company will have a harder time staying afloat and competitive. The public company will likely incur more expenses becoming a public company. Once the company goes public, it may become increasingly difficult to make certain decisions and moves without the approval of directors and stakeholders. Any unresolved liabilities could become the newly formed company’s problem if the public company is properly researched prior to the merger. There is also the risk of a reverse stock split occurring. In this scenario, the values of the stock could be reduced if more stocks are offered during the course of the merger. As a result, any of the prices associated with the original shares would be reduced.

Why do companies do reverse merger?

If the correct shell is selected for the merger process, the company can avoid commission and various underwriting fees. The company achieves liquidity following the transactions. Companies can accelerate growth through a reverse merger. Companies also have the advantage of raising more money for their ventures. Stock incentives now available can put a company in a better position to attract the best and brightest talent. Estate planning can be facilitated because of the values assigned to specific stock.

What kind of company would be a good fit for a reverse merger?

A company that already observes best practices in the area of accounting. Financial statements compliant to GAAP accounting standards will have to be submitted. The company should already be well-established with millions in annual revenue. CEOs that have been primed on the entire process and led by a financial expert will know what’s expected of them and be able to respond to any requests to facilitate the merger process.

In a reverse merger, a smaller company merges with a larger shell company that is public. After all of the due diligence is performed, a form 8-K is filed with the SEC. From then on, the corporation becomes a new entity with a new identity. Most reverse mergers are completed in only a few weeks. The reverse merger is designed to take a private company public.

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