A Reverse Merger
A reverse merger also called a reverse takeover is a method used by private firms to go public as it is simple, shorter and cheap. A conventional IPO is expensive and complicated as private firms are supposed to hire an invest bank to underwrite and issue shares of the public company to be formed. In addition, convectional IPO is expensive and complicated because of the paper work involved. Companies are supposed to fill regulatory papers before going. This had hindered private companies from going public using the convectional method. Many companies have used reverse mergers such as Panda ethanol to go public. Reverse mergers separate the process of going public and capital raising process and this has made it an attractive option for private companies. Thesis: Reverse mergers are essential to private companies as they enable them to go public, but the also affect the companies if they do not conduct due diligence as the acquirer and the target company do not understand each other. Using reverse mergers and reverse stock split to acquire to become a publicly traded firm has an effect on shareholders as it reduces their shares.
1.Investors of a private firm get a big section of the public shell company shares and then merge with the purchasing company. Banks and other financial firs use shell firms as a method to complete the deal. This is because shell firms can be registered with SEC before the deal and this makes the registration process straightforward and cheap. To complete the deal, the private form trades shares with the public shell so as to exchange the stocks. This in turn, changes the acquirer from a private company to a public company. Using reverse mergers has advantages and disadvantages. Public companies benefit a lot from converting to public traded companies as they are able to enjoy greater liquidity. Companies having $100 million revenue or more prefer to be trade as public companies. This ensures the firms securities are traded on an exchange and increases their liquidity. Reverse mergers allow investors to liquidate their investments easily when leaving a company. In addition, reverse mergers ensure companies have a bigger access to the capital markets because the management is able to issue extra stock via secondary offerings. Reverse mergers also help companies to increase the amount if capital they have by buying extra stock. Stockholders have the right to buy extra stocks at a certain price in reverse mergers and these increases the capital. Moreover, managers are able to use different strategies to promote growth. For instance, they use mergers and acquisitions to promote organizational growth. The company stocks can also be used to acquire target companies. In addition to that, organizations can use stock as incentives to attract and retain workers and hence improve the organizational performance (Comment, 2010).
Apart from benefiting organizations, reverse mergers have a negative effect on an organization. Reverse mergers can affect the company negatively if it does not carry out due diligence. Due diligence is important when using reverse mergers as it enables managers to understand the target organization well before merging with it. Managers are supposed to examine the investor’s profile of the public shell firm. They should determine what motivated them to merger. Managers should ensure the shell is clean by examining whether there are any pending liabilities and dangerous activities affecting the public shell. This is because the shareholders of the shell company might be looking for a company to take possession of their liabilities and malicious deals. Conducting appropriate due diligence and ensuring the parties involved in the deal are transparent eliminates such issues (Comment, 2010).
Furthermore, investors of the shell firm should also carry out due diligence. They should examine the private company including its motivations, management, operations and finances. They should also examine the investors, and pending liabilities before closing the deal to ensure the public company is not affected by the merger. Additionally, private companies might not be successful after a merger as the investors might find that there is no demand for the shares. A firm should be attractive both financially and operationally for the shares to be attractive. The managers might not have appropriate regulatory and compliance requirement experience of being a public company and this might affect the company. Reverse mergers are costly as the company spends more money and time trying to conform to the regulatory requirements. This in turn, affects the productivity and performance of the organization as managers spend more time dealing with administrative issues instead of running the company. Private Managers should work with public managers to save time and money as they have adequate experience in regulatory requirements. The company should also hire adequate and experience employees (Dresner & Feldman, 2009).
2. Reverse stock split refers to the reduction in the number of a company shares so as to increase the value of the stock or shares earnings. There are various reasons why companies like Panda ethanol reverse split their shares. First, a company can reverse split its shares so as to reduce the number of shareholders. Organizations can reduce the number of shareholders in the organization by reducing the number of shares and increasing their price. The organizations eliminate small shareholders as they are chased out. Second, Companies can reverse split their shares to attract investors. Investors might find it hard to own a single share in a company if the prices for shares are low. This affects the performance and growth of the company. As a result, companies that do not attract investors decide to reduce the number of shares to increase the price. Third, organizations reverse split their shares to avoid delisting in the stock exchange markets. Companies are supposed to meet certain criteria to remain listed in the stock exchange markets. They should meet the minimum number of shares held by shareholders, total shareholders and price per share. In addition, they should meet the net income and public shares outstanding criteria. Thus, small companies use reverse split to meet the requirements above (Mladjenovic, 2009).
3.The reverse merger and reverse split of stock had a negative effect on panda ethanol and Cirracor shareholders. The shareholders shares were reduced, and they were also cashed out. The Panda ethanol and Cirracor shareholders did not have any right as shareholders, but were allowed to get a single share of Cirracor common stock per share of ethanol common. In addition, the shareholders were supposed to get a cash payment equal to their shares before the deal was closed. Therefore, the shareholders did not get consideration for their investment and profit from the deal. This is because there shares reduced and were cashed out as the companies merged (Mladjenovic, 2009).
In conclusion, reverse mergers help private companies start trading publicly, grow and increase their capital and liquidity. Private companies use different strategies such as mergers and acquisition to grow. They also purchase stock to increase their capital and liquidity. However, reverse mergers affect an organization negatively if they do not carry out due diligence to understand the target and acquirer. Panda ethanol used reverse stock split to reduce shareholders. The shareholders did not benefit from the reverse merger and reverse stock split as their shares reduced and were cashed out.
Comment, R. (2010). Going-Public Reverse Mergers. CreateSpace
Dresner, S., & Feldman, D, N. (2009). Reverse Mergers. John Wiley & Sons
Mladjenovic, P. (2009). Stock Investing For Dummies. John Wiley & Sons