An Initial Public Offering (IPO) is one of the most prevalent routes for companies to access public markets. This is evidenced in 2020, which saw a combined $331.3 billion. However, despite its prevalence, an IPO is often challenging for private entities with limited resources, as it is both time consuming and financially demanding.
An alternative recourse is a process called a Reverse Takeover.
What is a Reverse Takeover?
A Reverse Takeover (RTO) is a form of merger wherein a smaller private company acquires a larger publicly listed company, essentially reversing the order of the process. For this reason, an RTO is also referred to as a Reverse IPO.
An RTO essentially bypasses the extensive requirements of a typical IPO over the course of a two-phase process: (1) Shares Acquisition and (2) Shares Exchange.
The First Phase: Shares Acquisition
In the Shares Acquisition phase, the acquirer commissions the acquisition of shares of the larger publicly listed company. During this period, the acquirer must obtain more than 50 per cent of the outstanding voting shares of the publicly listed company. Achieving this allows the acquirer to gain control of the target company and its board of directors.
The Second Phase: Shares Exchange
Once the acquirer has gained control of the public company and its board of directors, a stock swap is initiated. A stock swap sees shareholders of the private company exchange shares with shareholders of the public company. It is during this phase of an RTO that the merger and public listing take place. Shareholders of the private company essentially “pay” for the public company using their private company shares. Once the shares are exchanged and control of the company is completely transferred, the formerly private company has successfully transformed into a publicly held company.
Advantages of an RTO
Company Registration Not Required
As it is merely acquiring shares of the publicly listed company, the private company does not need to undergo company registration, which is a requirement for an IPO. Not only does this ease the regulatory friction the private company must endure to go public, but it also helps reduce overall costs.
Shorter Processing Period
A company looking to go public via IPO goes through a registration process that can last anywhere from several months to more than a year. The process grows increasingly costlier the longer the process takes. On the other hand, depending on the situation, an RTO can condense that timeframe from months into a matter of weeks.
Access to Foreign Markets
To enter the U.S. market, foreign companies must be financially prepared for company registration, legal fees, and other expenses. Furthermore, private entities aiming for public listing in the U.S. are required to meet stringent regulatory requirements, such as aligning with U.S. Internal Revenue Service (IRS) regulations. An RTO allows a private company to gain access to a foreign country’s financial market without encountering such regulatory hurdles and sustaining growing expenses.
Reduced Expenses
Due to its shorter timeframe and reduced regulatory prerequisites, an RTO does not incur the typical costs and fees associated with a traditional IPO.
RTO Red Flags
Clearly, an RTO offers significant upside over a traditional IPO. However, there are also pitfalls to watch out for when considering this alternative.
Masquerading Public Companies
One of the biggest risks marring the RTO process are masquerading public companies. These are listed companies that conceal their liabilities and litigation issues while posing as viable public market vehicles. These entities can severely hamper private companies from reaching public markets, and in some cases, derail them completely.
Liquidation Problems
Private companies considering an RTO should ensure they have sufficient liquidity post-merger to avoid a possible stock slump after the merger unfolds. This means maintaining a healthy cash flow to weather the transition.
Wrap Up
An RTO has its advantages and disadvantages. To avoid inherent pitfalls, extensive due diligence and preparation play key roles, both from a regulatory and financial standpoint.
Weigh the advantages and disadvantages of each option against the current position and capacities of your private company. At the end of the day, it is important to focus beyond such a milestone and on the bigger picture – sustainable long-term growth and expansion.
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Author: Albert Navarrete
