The limitations of a reverse merger

The limitations of a reverse merger

On Behalf of | Aug 9, 2021 | Mergers & Acquisitions |

If you’re a business owner in Hawaii who wants to take your company from a privately held entity to a publicly traded one, it’s important that you understand what reverse mergers are and how they work. It’s also crucial that you understand the limitations and disadvantages of reverse mergers.

What is a reverse merger?

Reverse mergers also referred to as reverse takeovers, are a tool used by companies to transition into being publicly traded without having to deal with IPOs. In a reverse merger, investors in a privately held company obtain the majority of shares in a shell company, which is then combined with the purchasing company. While these transactions take IPOs out of the equation, they do have certain disadvantages.

The risky stock gets dumped

If the investors in the publicly traded shell company decide to sell a large portion of their shares after the merger, they may negatively impact the stock price. In order to prevent this from happening, clauses have to be included in the merger agreement that prohibits the investors from selling out as soon as the reverse merger is complete.

Lack of demand for shares

If a small privately held company makes the leap into being publicly traded before it’s ready, the investors may not obtain sufficient liquidity. Additionally, if the company is too small, it won’t receive adequate coverage from Wall Street. Ideally, mergers increase the overall value of a company, but if a reverse merger takes place too early, it can have the opposite effect on the company.

It’s important that you fully understand all the pros and cons associated with a reverse merger. While they are a useful tool for taking a private company to the next level, they can also have a negative impact on its long-term viability.