What is a reverse takeover and how does it work?

What is a reverse takeover/merger?

A reverse takeover – also called a reverse merger or a reverse initial public offering (IPO) – enables a private company to be listed on the markets without having to organise and pay for an IPO. Reverse takeovers occur when a private firm ‘takes over’ a public firm that no longer has any active operations.

How does a reverse takeover work?

A reverse takeover works by a private company merging with a public company. The publicly-listed company is often a shell corporation, meaning that it is inactive or holds very few assets. It may no longer have any operations of its own, which enables the private company to buy up the publicly-listed company’s shares. The private company – along with its shareholders – will buy enough shares in the shell company to give it majority control of the public company.

When this happens, the private company becomes publicly-listed through the shell corporation – and is at liberty to change the shell company’s name. Current shareholders in the private company will then exchange their shares to the shares of the public company to complete the takeover.

Reverse merger vs initial public offering (IPO)

Put simply, a reverse merger is a shortcut for a company to become publicly-listed. IPOs take a long time, sometimes over a year. In contrast, reverse takeovers can be completed in as little as 30 days, largely because a reverse takeover does not subject a company to the same regulatory scrutiny that would be required for a conventional IPO.

IPOs also cost a large amount of money, largely due to legal and administrative costs – including underwriting fees. Reverse takeovers on the other hand, cost relatively little – often just the price that it would cost to give the private company a controlling stake in the publicly-listed company’s stock and in the process, become the majority shareholder.

The short time frame for a reverse takeover also means that a company is not as dependent on favourable market conditions as it would be during an IPO. Many companies have committed the time and money for an IPO, only for it to be delayed because market conditions – often meaning the number of buyers in a given market – were not right for that company to be listed.

However, reverse takeovers – because of the lack of regulatory insight and scrutiny – can also mean that the company could be fraudulent or trying to deceive investors. The upside of IPOs, while time consuming and expensive, is that they are largely seen as a more legitimate method for a company to choose in order to take itself public.

Pros and cons of reverse takeovers

Pros of a reverse takeover

By carrying out a reverse takeover, a company reduces its risk when compared to holding a conventional IPO. This is because a successful reverse takeover is not as dependent on market conditions as IPOs. For instance, a company could do all the work to launch an IPO, only for market conditions to be worse than expected, prompting a delay to the launch.

Reverse takeovers are much easier to execute than an IPO. This is because they enable a company to go public without having to raise capital. As a result, the company saves time and energy that can otherwise be used to ensure the efficient running of the company.

If investors currently hold shares in the shell corporation, a reverse merger enables them to realise a profit through the private company’s acquisition of the shell. This is because a reverse merger will mean that the shell corporation becomes active once again.

Reverse takeovers offer foreign companies the opportunity to enter the markets of other countries. For instance, private Chinese firms could buy up shares in a publicly-listed American shell company and gain exposure to the American stock market.

Cons of a reverse takeover

Reverse takeovers can sometimes be fraudulent. This happened with Chinese companies in the fallout of the 2008 financial crisis that were looking to get exposure to American markets. The private companies bought up shares in publicly-listed American companies which had been abandoned in the fallout of the financial crash. American investors poured money into these companies which had revenues that were far less than they had claimed.

It has been estimated that American traders lost tens of billions of dollars by investing in these fraudulent companies, and the events were eventually turned into a documentary – such was the scope of the damage.

By becoming publicly-listed, a company will be subjecting itself to the rules and regulations of the stock markets and their governing bodies. This means that the company will be required to disclose financial information – including accounting, taxes and profits. All this information can be useful to competitors.

The shell company that is taken over during a reverse IPO might have active lawsuits against it or have debts. It will be the responsibility of the private company to take on these liabilities and ensure they are resolved.

Examples of reverse mergers

A high profile example of a reverse takeover would be when Warren Buffet took his investment firm Berkshire Hathaway public. Buffet bought the textile manufacturing company, Berkshire Hathaway, in 1965 but later liquidated the company’s textile offering and merged it with his insurance empire. He took his holding company public through one of the most famous reverse takeovers in history.

Another well-known example is Burger King’s reverse merger in 2012, in which Justice Holdings – a publicly-traded shell company – absorbed Burger King. This happened just 18 months after the fast food chain went private after being bought out by 3G Capital in 2010. The deal between Justice Holdings and 3G Capital made Burger King a public company again.

How to trade reverse takeovers

There are several ways to trade reverse takeovers. The main one is through trading on shares, which is slightly different to investing in them, because you don’t own them outright. Instead, you are speculating on the direction in which the shares will move. If you go long, you expect the price to rise; if you go short, you expect the price to fall. There are two ways to trade shares during a reverse takeover – through a contract for difference (CFD) or by spread betting.

Find out more about buying and selling in trading

If you decide to trade a reverse takeover with a CFD or spread bet, you’ll also take advantage of leverage. This means you put down a small deposit – known as margin – to get full market exposure. However, you should bear in mind that since leverage amplifies your market exposure, you have the opportunity for greater profit – or greater loss – than your original deposit. This is because your profit or loss is based on the full size of your position.

Trading reverse takeovers with CFDs

A contract for difference (CFD) is a contract in which you agree to exchange the difference in the price of the company’s stock from when you open your position to when you close it. To go long on shares, you would buy the market. To go short on shares, you would sell the market

Trading reverse takeovers with spread bets

To spread bet on a reverse takeover, you would place a bet on whether the share price will rise or fall. If the shares move as you predicted, you will make a profit; if the shares move against you, you would incur a loss.

Reverse takeovers summed up

Trading reverse takeovers can require a lot of knowledge and planning. To help, we’ve summarised a few key points for you below:

• Reverse takeovers offer companies the ability to go public without having to commit the time or money required for an IPO
• While there are significant benefits of a reverse takeover for the company, they can be risky for investors and traders
• Analysis should always be carried out before investing in, or trading on, any company’s stock
• This can be tricky during a reverse takeover as the private company is under no obligation to make its finances public until the process is complete