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What is a Reverse IPO? Simply Explained

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It takes a bit of theoretical know-how to get a good grasp of a reverse IPO. Terms like reverse takeover (RTO) and reverse merger add to the problem, and many become frustrated by the ordeal of having to go through these unfamiliar terms.

To make matters worse, the topic itself is rife with economic jargon that further deters even avid readers. However, there are those who, against all odds, have decided to try their hand at the material. And the results?

Those who have managed to brave the initial hardships have realized that the topic is relatively easy to understand.

Today, we will be covering the ins and outs of reverse IPOS without any extra nebulous concepts and unexplainable terms.
So, without further ado – what is a reverse IPO?

The Nature of a Reverse IPO

At its core, a reverse IPO is a process that allows private companies to acquire public companies. This process, also known as a reverse merger or reverse takeover, exists because companies come to a point where they need to go public. Now, going public is a lengthy endeavor, as there are many hurdles that companies need to go through to finalize the process. So, what happens?

As a result, there are cases where private companies are looking to bypass this process. During such cases, private companies can opt to branch out and acquire a given public company to avoid the ordeal of having to go public through normal means.

Now, I can probably guess what you are going to ask. Is it that profitable? Yes. Many companies have decided to take this route and it’s all public information. In fact, 398 reverse mergers took place in 2021 alone, which shows precisely how worthwhile reverse IPOs are. It is worth noting that SPAC reverse mergers are also part of this number. In short, SPAC reverse mergers are reverse mergers that involve public shell companies.

I am sure that the entire process seems vague. After all, what good does knowing about the process do without an in-depth look into the pros and cons? Many people have heard about reverse takeovers, but few understand why they are that important.

Let us focus on the technical aspects of it all.

Understanding the Process

As we mentioned, companies employ reverse mergers, IPOs, and takeovers for practical reasons. One of the main reasons is that reverse IPOs can save the company a lot of money. Many costs come with going public, and it often involves hiring teams dedicated to successfully finalizing the process. After all, companies that go public need to raise funds and appeal to a lengthy list of government regulations.

The reason why there are so many regulations is that a public company gains the ability to be publicly listed and can be part of the capital market. This is usually done through companies without active operations and allows private companies to enter the market without constraining fundraising.

Private companies that decide to undergo this process are either already affiliated with a public company or have managed to find a shell company to aid them in this process. The private company needs many shares (often between 50% and 80%) to make the process worthwhile and effectively gain control of the other company.

The process can ultimately benefit both sides. A private company can avoid many problematic aspects of going public while a public company can end up owning shares of a growing business and even enter a new market.

As you can imagine, reverse mergers can involve various companies and are often followed by many variables. In reality, no two reverse mergers are the same, and the reasons for them can be drastically different. However, as a general overview, here are some of the benefits and drawbacks that analysts associate with reverse takeovers:

Benefits From A Reverse IPO

  1. Fewer expenses – as previously mentioned, not all companies can go public, even if they want to. Reverse IPOs are often the only option for companies that cannot afford IPOs. After all, fundraising and hiring dedicated legal teams cost a fortune.
  2. Less time – part of why reverse takeovers are cheaper is that they also take less time. Even if companies still need some dedicated teams, the number of assignments the team has to complete is smaller, and so are the expenses.
  3. More exposure – reverse mergers can sometimes be crucial to companies looking to branch out and reach more markets. Whether it is through reputation alone or ease of access, foreign investments are often vital for developed businesses.

Drawbacks

  1. Stocks slump – private companies that are part of a reverse merger can end up with a sharp decrease in stock worth when the process finishes. If the private company lacks the means to deal with the transition, it may be in for a rough patch and even bankruptcy.
  2. Legal troubles – if the merger is not conducted properly, companies can end up with more expenses than expected, and might even be considered a public company but still pay the expenses that a private firm is liable to cover. This can lead to potential violations that can end even a reputable company.
  3. Shell fails – in some cases, private companies go through shell companies to aid them for help. When mergers occur, companies inherently entangle reputations. Therefore, a private company can leave a mark on its reputation by association and vice versa.

Let’s Conclude

Reverse IPO, mergers, and takeovers are varied and sometimes difficult to grasp. The reason is that the process is not one that many people are aware of and even less understand thoroughly.

Should that deter you, as a reader, from reading up on it? Absolutely not. Although seemingly niche, reverse mergers play a significant role in the stock market and can be quite useful to seasoned investors. Analyzing them, on the other hand, is harder than it seems, as there are numerous benefits and drawbacks that are involved.

Still, when researching investment opportunities, you should pay careful attention to these terms and give them the time and effort they require – it can help you capitalize on an investment!

FAQ:

What is a reverse merger?
A reverse merger is a process that allows private companies to acquire public companies and effectively go public.

Is a reverse IPO a good strategy?
A reverse IPO can be a good strategy, although it does come with its fair share of risks.

How does a reverse IPO work?
A reverse IPO works by allowing private companies to attain a number of shares in a public company which, in turn, grants them a wider reach and the benefits that come with the status of having a publicly listed company.

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