Reverse Merger via a SPAC

For a private business owner who wants an exit, an IPO is a great way to gain liquidity at a premium. However, sometimes the business isn’t big enough to take public through an IPO and other options must be considered. In such circumstances, a reverse merger can be a practical way to go public and receive the desired liquidity. It costs less and takes less time. Even so, SPACs can offer a better exit than the traditional reverse merger.

What is a reverse merger?

A reverse merger is an expedient and cost-efficient way for a private company to put its shares on a public stock exchange. The private company accomplishes this by merging with a dormant publicly-traded company – they call these “shell corporations” because they have no active business operations and rarely have much net worth. The upside is that the shell companies offer a way to get publicly traded. While an IPO would take 6 to 12 months to execute, a reverse merger takes less than a few months (maybe even weeks) and costs significantly less.

What are the pros and cons of a reverse merger?

There are many benefits to doing a reverse merger as an alternative to an IPO. For example, going public allows private business owners to enjoy greater liquidity without forfeiting ownership and control of the new company. Moreover, there is reduced stock dilution versus an IPO. And as far as future operations are concerned, the new public company can now issue additional shares to help fund M&A activity and management can use stock incentive plans to attract and retain new talent.

There are also other points to consider before deciding on a reverse merger. For instance, due diligence must be conducted to make sure there aren’t any “worms in the apple” of the shell company. If shell investors aren’t interested in the new company, then they could dump their shares immediately after the transaction and cause the stock price to drop. To make sure this doesn’t happen a holding period should be incorporated into the merger agreement, requiring the shell investors to hold their shares for a specified time after the transaction. Additionally, regulatory and compliance requirements that come with going public might be too much for the inexperienced private management – make sure you have the right people in place for the transition. Finally, while an IPO raises capital, a reverse merger acquires no additional capital and the private company must have enough funds to do the transaction on its own.

What is a SPAC?

A Special Purpose Acquisition Company (SPAC) is a type of “blank check” company, a publicly-traded buyout company that raises money to execute the acquisition of an existing company. The money raised is a blind pool, as the public invests in an unspecified merger. However, SPACs are generally formed by a management group with experience in a certain industry and will typically search for a target company that falls within their sphere of experience. If an acquisition isn’t made after two years, then the money is returned to the original investors.

What is a reverse merger via a SPAC?

In this case, the private company is the target rather than the acquirer. Therefore, its shares are acquired by the SPAC along with control of operations. In an all-cash deal, which is most likely since the SPAC has already raised capital for the acquisition, the private business owner will receive liquidity without further interest in the new entity.

This can be an attractive option for those who are interested in exiting their business. Typically, initial shareholders can realize greater returns through SPAC acquisitions than through a traditional IPO – a great alternative for those who don’t think their business is strong enough to pull of an IPO. And for those who want an exit but also want to make sure the future of the new company is secure, it is assuring to know that SPACs come with significant capital and an experienced management team. They typically raise more money than reverse mergers at the time of their IPO – an average of $75M compared to $5.24M raised in secondary offerings after reverse mergers. Plus, in contrast to private equity firms, SPACs are usually more transparent since they are regulated by SEC rules.

Some requirements for this transaction include:

  • The target company must have a fair value in excess of 80% of the SPAC’s net assets; any residual capital will be used as working capital for the target
  • A majority shareholder approval is required to execute the acquisition
  • The transaction must take place within two years of the SPAC’s going public
Andrew Dunnington
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