Going Public
There are many benefits, and some downsides, to taking a company public. Going public can be a great way to raise capital[1], monetize the investments of early investors[2], and achieve a higher profile in the market[3]. There are many benefits, and some downsides, to taking a company public. Going public can be a great way to raise capital[1], monetize the investments of early investors[2], and achieve a higher profile in the market[3]. On the other hand, public companies face more exposure to lawsuits[4], regulatory compliance costs[5], and mandatory reporting of financial and business information for all the world (including competitors) to see[6].
But once you have decided to take a company public, there are several ways to go about it. The most well-known method of going public is an Initial Public Offering (“IPO”). In an IPO, a private company will hire an underwriting firm to help it determine the details of the public offering[7]. It must also endure a lengthy review process by the Securities Exchange Commission (“SEC”)[8]. Once that is done the company may then begin selling its shares on the public market.[9]
Despite their popularity, there are many problems with IPOs. They are expensive, they are slow, and they are risky.[10] Because of this, many private companies who want to go public will choose a different method.
Reverse Merger
One of the most popular methods to take a company public while circumventing many of the hassles of an IPO is a reverse merger (also called a reverse IPO or a reverse takeover).[11] In a reverse merger, the private company will obtain a controlling number of shares of a public company (often a shell company) and control of the Board of Directors[12]. The private company’s shareholders then transfer their private company shares into the public company’s shares.[13] Together, the change of control and transfer of shares convert the private company into a public company.
The advantages of a reverse merger over an IPO are that a reverse merger is less expensive[14], it can happen much quicker[15], there can be less stock dilution for the shareholders,[16] and a reverse merger is not as dependent on market conditions as an IPO.[17]
However, there are some risks to a reverse merger, including shareholders who don’t want to cooperate with the merger and inexperienced officers managing the public company. Fortunately, there are some different types of reverse mergers, several of which take care of these concerns.
Types of Reverse Mergers
Reverse Triangular Merger:
One of the most common types of reverse mergers is a reverse triangular merger.[18] In a reverse triangular merger, instead of doing a reverse merger directly with the public company, the public company will set up a subsidiary company that the private company will do a reverse merger with.[19] Once that reverse merger is complete, the once-private company is now the public company’s subsidiary.[20] One advantage to this process is that it allows the merger to occur without the need to get the public company’s shareholders’ approval since the merger is technical with the subsidiary and not the public company itself.[21] So all that is needed is approval from the public company’s board of directors.[22] Another benefit is that, since the once-private company still exists, all contracts and licenses should continue to affect.[23]
Forward Triangular Merger:
In a forward triangular merger, as in a reverse triangular merger, the public company will form a subsidiary company.[24] The difference is that in a forward triangular merger the subsidiary will acquire the private company and the private company will cease to exist.[25] One major drawback to this type of merger is that because the private company no longer exists some contracts and licenses, as well as any goodwill associated with the private company’s brand, may be lost.
Share Exchange Merger:
Another common type of reverse merger is a share exchange merger. In a share exchange merger, the public company acquires the private company by issuing some of its own shares or paying cash, or a combination of the two, for all of the private company’s shares.[26] The private company then becomes a wholly-owned subsidiary of the public company. Unfortunately, a share exchange often requires shareholder approval,[27] which can result in a serious holdup on the merger.
True Merger:
Under a true merger, also called a direct merger or statutory merger, the public company will acquire the private company and the private company will then begin to operate under the public company’s name.[28] A true merger also has the downside of requiring shareholder approval.[29] However, companies that do choose to use a true merger receive the benefit of a much smoother transition because the public company can continue business without changing its structure or control.[30]
[1] Richard A. Booth, Going Public, Selling Stock, and Buying Liquidity, 2 Entrepreneurial Bus. L.J. 649, 660 (2008).
[2] Id.
[3] GOING PUBLIC, FIBM MA-CLE 7-1 §7.1.1.
[4] Mod. Corp. Checklists §19:29.
[5] Proposed Rules: Crowdfunding, Federal Register, Vol. 78, No. 214 (Nov. 5, 2013), p. 66509 (col. 2).
[6] https://www.sec.gov/answers/comppublic.htm.
[7] Initial Public Offerings: Why Individuals Have Difficulty Getting Shares, http://www.sec.gov/answers/ipodiff.htm.
[8] Jennifer Gardner, VII. the Sec’s Operation Shell Expel, 33 Rev. Banking & Fin. L. 60, 62 (2013).
[9] Investing in an IPO, https://www.sec.gov/investor/alerts/ipo-investorbulletin.pdf.
[10] Initial Public Offerings: Why Individuals Have Difficulty Getting Shares, http://www.sec.gov/answers/ipodiff.htm.
[11] Shannon D. Kung, The Reverse Triangular Merger Loophole and Enforcing Anti-Assignment Clauses, 103 Nw. U. L. Rev. 1037, 1046 (2009).
[12] Gardner, 33 Rev. Banking & Fin. L. at 61-62.
[13] R. Franklin Balotti and Jesse A. Finkelstein, DELBCO §9.8 REVERSE TRIANGULAR MERGER, 2006 WL 2453714.
[14] Gardner, 33 Rev. Banking & Fin. L. at 62.
[15] Id.
[16] Gariel Nahoum, Small Cap Companies and the Diamond in the Rough Theory: Dispelling the Ipo Myth and Following the Regulation A and Reverse Merger Examples, 35 Hofstra L. Rev. 1865, 1904 (2007).
[17] Josh Steinman, Reversing the Tide: A Targeted Approach to the Regulation of Chinese Reverse Mergers in the United States, 34 Nw. J. Int’l L. & Bus. Ambassador 1A, 10A (2014)
[18] Kung, 103 Nw. U. L. Rev. at 1040.
[19] Id.
[20] 13 Mass. Prac., Business Corporations § 26:1 (2015-2016 ed.).
[21] Kung, 103 Nw. U. L. Rev. at 1047, footnote 56.
[22] Id.
[23] Id. at 1040-41.
[24] TAKEOVER CONSIDERATIONS AND DEFENSES, FIBM MA-CLE 8-1 §8.1.1(b)
[25] Kung, 103 Nw. U. L. Rev. at 1045.
[26] Appendix A—Revised New Hampshire Business Corporation Act 293-A; 11.03(a)(1), available at http://legiscan.com/NH/text/ SB41/id/869728/New_Hampshire-2013-SB41-Chaptered.html.
[27] Jennifer J. Johnson, Corporate Mergers: Redefining the Role of Target Directors, 136 U. Pa. L. Rev. 315, 317 (1987).
[28] TAKEOVER CONSIDERATIONS AND DEFENSES, FIBM MA-CLE 8-1 §8.1.1(b).
[29] David N. Feldman, Reverse Mergers + Pipes: The New Small-Cap Ipo Reprinted and Updated from Pipes: Revised and Updated Edition-A Guide to Private Investments in Public Equity (Bloomberg Press, 2005), 3 Bus. L. Brief (Am. U.) 34, 35 (2007).
[30] Samuel C. Thompson, Jr., Introduction to This Symposium and A Guide to Issues in Mergers and Acquisitions, 51 U. Miami L. Rev. 533, 564 (1997).
