Reverse Mergers: A Basic Primer

Why Reverse Mergers?

Most people think “IPO” when they hear that a company is going public.[1]  A cheaper and faster alternative to the traditional IPO, however, is through a reverse merger. In a reverse merger,

“the shareholders of the private company exchange their shares for a large majority of the shares of the public shell company. Although the public shell company survives the merger, the private company’s shareholders gain a controlling interest in the voting power and outstanding shares of stock of the public shell company. Also, the private company’s management typically takes over the board of directors and management of the public shell company. The assets and business operations of the postmerger surviving public company are primarily, if not solely, those of the former private company.”[2]

Reverse mergers are typically consummated in two to three months—a substantially shorter period than the usual six months required for an IPO. [3] As no capital is actually raised as part of a reverse merger, most companies raise capital during or immediately after the merger, in addition to restructuring their capital and changing the company name. [4]

Reasons for entering a reverse merger may vary, but generally its primary purpose is to raise capital.[5] Another reason may be to provide shareholders of the shell company with an exit strategy in the event the company is unlikely to otherwise provide a return on their investment.[6]

Reverse merger transactions are treated as share acquisitions for tax purposes[7] and are typically structured as a reverse triangular merger, as follows:

  • Public shell company forms a subsidiary;
  • Private company negotiates with the public company to merge with the subsidiary;
  • Private company survives the merger with the public subsidiary;
  • Public shell issues shares to the private company;
  • Private company is a subsidiary of the public shell, while stockholders of the private company own a majority (usually 90% or more) of the public shell and the private management becomes management of the public shell.[8]

It is important to note that not all public shell companies are created equal and can be one of four varieties of shells: OTCBB traded, SEC reporting but non-trading, non-reporting, or Nasdaq/AMEX. OTCBB traded shells are listed on the OTCBB but were once operating companies. SEC reporting but non-trading shells have the sole purpose, upon formation, of becoming shell and never performed business operations. They are not listed or quoted but do comply with all Exchange Act requirements. Non-reporting shells, or Pink Sheet shells, are not listed or quoted and do not comply with Exchange Act requirements. Finally, Nasdaq/AMEX shells do not technically exist and must requalify at the time of the reverse merger.[9]

There are a number of actions, documents, and filings to take into consideration when planning a reverse merger. These are detailed below and include the internal preparation of the two companies, due diligence of possible shell companies, closing the reverse merger transaction, making all necessary filings with the SEC, and meeting any applicable listing or resale requirements.

Steps to Executing a reverse merger

Internal Preparation of Companies

It is important to ensure that both companies have obtained “SEC qualified audited financial statements . . . for at least the last two fiscal years or the date of organization if less than two years. The financial statements of the private company will need to be consolidated with the public company’s financial statements prior to closing.”[10]

Due Diligence of Shell Company Candidates

Once the private company locates a potential shell company, the parties should create a letter of intent to guide their dealings. It is at this stage that the parties negotiate the main elements of the transaction, such as “percentage ownership, board membership, management of the company, ability to sell stock, representations and warranties, claw backs . . . as well as any simultaneous financing component.”[11] It may also be wise to enter into a confidentiality agreement at this stage so that the private party may conduct due diligence.[12]

Conducting effective due diligence on the shell company is essential, as merging with a “dirty” shell (i.e., a shell whose management failed to follow proper SEC reporting procedures) could prove fatal for the private company.[13] In searching for “clean” shells, private companies should consider the shell’s number of stockholders, reporting record, and how and where it is listed.[14]

All public filings should be read closely, and there should be a focus on any past delistings and trading halts. Diligence should decrease risks relating to the shell, including risks relating to management and controlling stockholders. Background checks on management are also highly advisable, as are litigation searches. Shells that use more well-established auditing firms should be pursued. Most important, a dose of skepticism during the review may serve a company’s interests.[15]

Additionally, the shell company should be able to close the transaction “without undue difficulty or delay,” be eligible to pass DTC scrutiny, and be able to issue the requisite amount of shares.[16]

Closing the Reverse Merger Transaction: The Agreement

The documents used to consummate a reverse merger between the private company and public shell is a share exchange agreement, or stock purchase agreement, which usually takes two to four weeks to draft.[17] Board and shareholder approval must be obtained and a “Super” 8-K form (detailed below) drafted.[18] Financing documents may also be needed.[19] Prior to closing, the shell company must file its proxy statement with the SEC and, as detailed below, a number of other filings.[20]

Additionally, the private company will usually want to mail to the shareholders a 14-C Information Statement in order to “change the name and/or capital structure of the newly acquired public company vehicle.”[21] If the company does not file the 14-C and “if a majority of the Board of Directors is being replaced as a result of the change of control transaction,” the company will later be required to file a Form 14f-1.[22]

SEC and Related Filings

While a traditional IPO would require registration pursuant to the Securities Act of 1933, as amended, no such registration is required of shell companies undergoing a reverse merger. [23] However, shell companies must report the transaction to the SEC by filing “Super” Form 8-K (detailed below).[24] The resulting company will no longer be private, so it will be “subject to Sarbanes-Oxley compliance, corporate governance issues and other public company issues. These obligations will be greater if the company is listed on a national securities exchange.”[25] Once public, it will “be subject to several, and ongoing, time-sensitive filings with the SEC and will thereafter be subject to the disclosure and reporting requirements of the Securities Exchange Act of 1934, as amended.”[26] Finally, officers, directors, and 10% shareholders must make certain filings—“primarily Section 16 filings (Forms 3s)” “primarily Section 16 filings (Forms 3s)”—in conjunction with the transaction.[27]

Registering Shell-to-Private Issued Shares

The issuance of the securities from the shell company to the private company stockholders must “either be registered under Section 5 of the Securities Act or use an available exemption from registration. Generally, shell companies rely on Section 4(a)(2) or Rule 506 of Regulation D under the Securities Act for such exemption.”[28]

Shell to Provide Notice to FINRA under Rule 6490

The Financial Industry Regulatory Authority (“FINRA”) requires many issuers (Form 10 shell issuers in particular), pursuant to Rule 6490, to receive FINRA approval prior to consummation of a reverse merger. [29] The shell company must provide notification to FINRA ten days prior to the anticipated closing date of the reverse merger. [30] FINRA may “request additional documents, conduct detailed and selective reviews of the issuer submissions and cause the issuer to delay the announcement of its corporate action.” [31] The following items must be disclosed to FINRA:

  • “Share Exchange/Purchase Agreements;
  • Reverse Merger Transactions;
  • Holding Corporation Reorganizations;
  • Dormant Shell Revivals including custodianship and receivership actions;
  • Changes of Corporate Control; and
  • Reinstatement of the state of incorporation.”[32]

Additionally, shell companies may need to provide the following:

  • “Stamped filed certificate of amendment;
  • Notarized and executed Board of Directors resolution authorizing the corporate action subject to the notice;
  • Notarized and executed shareholder approval authorizing the corporate action; New CUSIP number or confirmation that CUSIP will not change as a result of the corporate action; and
  • The appointment(s) of the officer(s) listed on the Issuer Notification Form; along with executed resolutions appointing the current officers or filings previously made to the SEC, such as on Form 8-K.”[33]

Resulting Company to File “Super” 8-K

The main document to file with the SEC is the “super” 8-K, which is essentially a Form 8-K that demands most of the same disclosure required in Form 10.[34] The 8-K must be filed within four business days of closing and must describe the reverse merger.[35] It must “provide[] investors with comprehensive information about the company’s new business, risks, management, beneficial owners,”[36] in addition to “audited financial statements for [the private company] and unaudited pro forma financial statements for the combined company.”[37]  If the target was a non-shell company, then this process is not so expedited.

Resulting Company to Find a Market Maker to File a Form 211 Application

In order to obtain a trading or ticker symbol following the reverse merger, the resulting company must find a market maker willing to file a Form 211 application with FINRA.[38]  Approval of Form 211, which requires compliance by the market maker with SEC Rule 15c2-11 and FINRA Rule 6432, enables the company to “initiate or resume quotations for a security on the OTC Bulletin Board, OTC Markets or any similar quotation medium.” [39]

Post-Merger Considerations

Requirements to be Listed on an Exchange

Upon completion of the reverse merger, the resulting company will almost always “initially be quoted on the OTC Bulletin Board or the Pink Sheets,” which are far less liquid than national exchanges. [40] In order to qualify for listing on one of the main national exchanges, the company must obtain “minimum numbers of existing shareholders (300 to 400), minimum market valuations, [and] minimum bid prices,”[41] and must have traded over the counter and timely filed all reports for one year following the ‘Super 8-K.’”[42] The closing stock price must be maintained at a certain level for at least 30 of the 60 trading days prior to applying for listing.[43] Trading over the counter includes the U.S. market or a foreign exchange, and must be done for one year following the transaction.[44]

There are some exemptions from these exchange-enacted rules for companies who consummated a firm commitment offering amounting to at least $40 million,[45] and for those who have

[s]atisfied the one-year trading requirement and filed with the SEC at least four annual reports (must have all required audited financial statements) while satisfying all other applicable requirements for listing, including the minimum price requirement and the requirement not to be delinquent with SEC filings.[46]

It is also possible that if the private company “files a Form 10 registration statement prior to the reverse merger, the merged entity can avoid the one year seasoning period.”[47]

Requirements for Resale and Obtaining Financing

If the resulting company desires to obtain financing through a private investment in public equity (“PIPE”), the investors will obtain registration rights requiring the company to enable public trading by registering the investor’s shares through a registration statement.[48] The company will likely be required to “keep the registration of the investor’s shares effective until the earlier of (i) the sale of all shares that were registered by the company for the investor, or (ii) such time as the holder of the shares can sell in reliance on Rule 144.”[49] -The company should use a registration on Form S-3 instead of Form S-1 if possible, as the Form S-1 is longer and generally requires more amendments and supplements.[50] If a shell company has had a history of filing it may reduce the waiting time for S-3 eligibility.[51]

Reselling securities under Rule 144 is not generally available for current or former shell company securities.[52] However, under a SEC release effective February 15, 2008, these securities can be resold under Rule 144 on certain conditions, or otherwise only through a resale registration statement.[53] The conditions for Rule 144 resale, in addition to other applicable Rule 144 requirements, are:

  • “the issuer of the securities has ceased to be a shell company;
  • the issuer is subject to the reporting requirements of section 13 or 15(d) of the Exchange Act;
  • the issuer has filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months, other than Form 8-K reports; and
  • one year has elapsed since the issuer has filed current ‘‘Form 10 information’’ with the Commission reflecting its status as an entity that is no longer a shell company.”[54]

However, the SEC also requires such companies to “remain current in [their] reporting requirements, essentially forever, if [their] shareholders ever desire to sell their shares after the initial 12 months of reporting.”[55]

Finally, companies should be aware that their stock may be subject to chilling through a Depository Trust Company (“DTC”) review.[56] Essentially, “DTC can review a public company’s eligibility if the company undergoes a corporate change transaction . . . . So if the private company merges with a shell company with problems and then changes the name or reverse splits the stock, for example, DTC could review the company’s DTC-eligibility.”[57]


In sum, planning a reverse merger is a complicated and fact-dependent process, requiring various legal and other considerations. Whether a company is preparing itself internally, performing due diligence, negotiating and drafting the share exchange agreement, filing necessary reports with the SEC, attempting to list on a securities exchange, or anticipating resale of its securities, working with a competent securities law firm will ensure that the process goes as smoothly as possible.


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[1] I would like to acknowledge Joshua Bishop for his hard work in preparing this blog post.






[7] (“see generally Rev. Rul. 73-427, 1973-2 C.B. 301, 1973 IRB LEXIS 264 (I.R.S. 1973)”).


[9] See:







[16] Due diligence of the private company is “not as critical” as for direct IPOs “since the private company entity does not become the public company. . . . This review is primarily related to the securities offerings and sales of the company due to the fact those shareholders will be exchanging their shares for shares of the public company.”












[28]; see also,%20An%20Alternative%20to%20the%20IPO.pdf.


[30] (“Issuers undertaking corporate actions must notify FINRA by completing the Electronic Issuer Company-Related Action Notification Form found on FINRA’s website.”).




[34] (Form 10 “is the disclosure form used by companies that are required to register under the Exchange Act without a related public offering under the Securities Act of 1933.”).

[35],%20An%20Alternative%20to%20the%20IPO.pdf (This description should include, “among other things, a description of the new company and the new shares issued, information regarding directors/officers, a description of the business, and a full set of the company’s audited financials.”).



[38]; see also









[47] For more information on listing requirements generally, see

[48] 20Merger.pdf.

[49] 20Merger.pdf.






[55] 20Merger.pdf.