In their regular investor column, Les Nemethy and Sergey Glekov look at an alternative means of taking a company public.
In a typical merger deal, the bidding company acquires the target company and the bidder’s existing shareholders obtain the majority in the combined entity.
In a reverse takeover (RTO), the inverse occurs: the target firm’s shareholders become the majority shareholders of a merged public company. “Reverse” refers to the fact that the initiator of the merger is the private target, which ultimately takes control over the public combined entity.
An RTO can help private shareholders avoid much of the time, expense and tedium of an Initial Public Offering. Hence, the process is sometimes referred to as a “backdoor IPO” or a “backdoor listing”.
Quite often, the publicly traded company involved in a reverse is an inactive “shell” corporation. A merger of the public and private entities allows the private company to shift its assets and operations into a public entity with relative ease.
The first part of this article will compare the pros and cons of an IPO versus an RTO; then we will provide some statistics on the prevalence of RTO’s in Europe and North America; finally, we will finish by illustrating with some concrete examples.
An RTO can typically be accomplished for a fraction of the cost of an IPO. The process of listing a company and taking it public requires hiring an underwriter, extensive disclosure, a due diligence process undertaken by an underwriter, filings with and fees paid to the stock exchange. The underwriting process usually provides comfort to investors that securities purchased are of a certain quality.
Given that an RTO is a somewhat short-circuited process, without an underwriter, investors have less comfort as to the quality of securities purchased. This may result in securities trading at a discount.
While a traditional IPO may require months or years to complete, an RTO may be completed within weeks.
Reverse mergers initially gained popularity in the U.S. over-the-counter (OTC) markets in the 1980s. Despite more publicity given to US RTOs, back-door listings are a global phenomenon.
In Australia, RTO’s are frequent in the mining industry. In Hong Kong, RTOs are popular in the real estate development sector, according to “A Comparative Analysis Between IPOs and Reverse Takeovers: Evidence From Europe” by Vasileios G. Oikonomou, Antonios I. Tsianakidis.
RTOs are a popular mechanism for going public in Europe as well, especially in the United Kingdom and Sweden. According to a study which examines 224 reverse takeovers in Europe between 1996 and 2015, there were 167 private and 154 public companies involved in RTO transactions.
(Note that the number of public and private entities involved in RTO’s are not necessarily the same in a given country or region, given that there are many cross-border transactions.)
As we can see from the chart above, 12% of the 224 firms merged with a foreign entity.
The chart below provides examples of concrete RTOs during 2019.
A reverse takeover might be considered an option for a company that has already decided that it would like to do an IPO, as an accelerated and cheaper route to a public vehicle. Moreover, for those owners of private companies that have decided against an IPO for reasons of expense, delays, risks and effort, RTO might warrant a fresh look.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.