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What Is a Reverse Merger Shell?

March 5, 2018

When talking about a reverse merger, a shell company has to be mentioned. So, what is a shell company? This is a company that another company takes over in order to use its name to go public. A shell is usually a publicly traded company that is no longer operational. A shell company could be either very old or very new. Multiple factors could explain why a company ceases carrying out its business operations. Despite terminating its operations, however, the company still exists and its shareholders are still intact. A public company’s shareholders range from 30 individuals up to thousands.

Reverse Merger
A reverse merger is also referred to as a reverse IPO or a reverse takeover. It is a means that private companies use to go public. A reverse merger usually occurs when a publicly traded company – a shell company, merges with a private company. The private company survives and operates in the publicly traded company’s legal shell. This process is shorter, simpler, and less cost-intensive compared to the traditional initial public offering (IPO). This is probably why private companies prefer this approach when going public.

Reverse mergers let private companies go public without raising the capital. Unlike conventional IPOs that take considerable amounts of time to concretize, reverse mergers only take a couple of weeks. This sees to it that management will spend more time concentrating on the business’ core agendas. A reverse merger also reduces the risk of a company not going public after being subjected to the conventional IPO process due to unfavorable stock market conditions.

In a reverse merger, the private company will obtain a majority of the shares of the shell company. The name of the shell company is then changed to that of the private company. However, before the deal culminates, the involved parties are required to adhere to some SEC rules. The shell company can also be registered before the deal to make the process easier.

Besides changing the name of the shell company, the trading symbol is also changed if the publicly traded company shell company had one. Within 15 days of the closing, an 8-K, an information statement, has to be filled. This statement stipulates the recently merged company, information of the new directors, the stocks issues, and the financial statements. The financial statements included have to be audited to US GAAP standards.

Original shareholders in a shell company have to vote on whether or not to accept the reverse merger. Once accepted, these shareholders receive a number of shares in the new company in exchange for the original shares. It is important to note that the shares received are lesser than those in the original holding are. Moreover, some companies go with a reverse-split where the new company holds a majority of the shares. This means that the new company holds a shareholder vote in order to reverse-split the authorized number of shares. The new company keeps holding these votes in order to raise the capital.

Advantages of a Reverse Merger
• Compared to the conventional IPO process, a reverse merger can help you save a significant amount of time. The latter takes a couple of weeks, while the former can take up to a year.
• It requires less legal involvement.
• A lot of money is saved since there are no commissions or underwriter fees charged.
• A reverse merger allows companies to raise extra capital as soon as the deal is completed.
• It allows companies to convert debt to equity because it is now a public company.
• Unlike the conventional IPO, a reverse merger does not require your company to be existing
• You get to have strong control of the company
• The company, being public, can grow through acquisitions
• Acquisition of other companies is a tad easier
• There is liquidity of the stock

Disadvantages of a Reverse Merger
• It requires management to vet the investors of the publicly traded shell company seriously. This is to ensure that the shell is clean and free of debts.
• If the investors of the shell company sell a considerable number of the shares after the reverse merger, the stock price may be affected negatively.
• The private company looking for a shell company has to have products or services that indicate great growth potential. The investors have to ascertain the company’s potential is strong.

This article is by DelanceyStreet.com, a Los Angeles hard money lender, with over $200 million in loans to small business owners.

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