A reverse takeover or reverse merger takeover (reverse IPO) is the acquisition of a public company by a private company so that the private company can bypass the lengthy and complex process of going public. The transaction typically requires reorganization of capitalization of the acquiring company.
In a reverse takeover, shareholders of the private company purchase control of the public shell company and then merge it with the private company. The publicly traded corporation is called a "shell" since all that exists of the original company is its organizational structure. The private company shareholders receive a substantial majority of the shares of the public company and control of its board of directors. The transaction can be accomplished within weeks.
The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing, the shell company issues a substantial majority of its shares and board control to the shareholders of the private company. The private company's shareholders pay for the shell company by contributing their shares in the private company to the shell company that they now control. This share exchange and change of control completes the reverse takeover, transforming the formerly privately held company into a publicly held company.
In the U.S., if the shell is a SEC-registered company, the private company does not go through an expensive and time-consuming review with state and federal regulators because this process was completed beforehand with the public company. However, a comprehensive disclosure document containing audited financial statements and significant legal disclosures is required by the Securities and Exchange Commission for reporting issuers. The disclosure is filed on Form 8-K and is filed immediately upon completion of the reverse merger transaction.
The advantages of public trading status include the possibility of commanding a higher price for a later offering of the company's securities. Going public through a reverse takeover allows a privately held company to become publicly held at a lesser cost, and with less stock dilution than through an initial public offering (IPO). While the process of going public and raising capital is combined in an IPO, in a reverse takeover, these two functions are separate. A company can go public without raising additional capital. Separating these two functions greatly simplifies the process.
In addition, a reverse takeover is less susceptible to market conditions. Conventional IPOs are risky for companies to undertake because the deal relies on market conditions, over which senior management has little control. If the market is off, the underwriter may pull the offering. The market also does not need to plunge wholesale. If a company in registration participates in an industry that's making unfavorable headlines, investors may shy away from the deal. In a reverse takeover, since the deal rests solely between those controlling the public and private companies, market conditions have little bearing on the situation.
The process for a conventional IPO can last for a year or more. When a company transitions from an entrepreneurial venture to a public company fit for outside ownership, how time is spent by strategic managers can be beneficial or detrimental. Time spent in meetings and drafting sessions related to an IPO can have a disastrous effect on the growth upon which the offering is predicated, and may even nullify it. In addition, during the many months it takes to put an IPO together, market conditions can deteriorate, making the completion of an IPO unfavorable. By contrast, a reverse takeover can be completed in as little as thirty days.
Reverse takeovers always come with some history and some shareholders. Sometimes this history can be bad and manifest itself in the form of currently sloppy records, pending lawsuits and other unforeseen liabilities. Additionally, these shells may sometimes come with angry or deceitful shareholders who are anxious to "dump" their stock at the first chance they get.
One way the acquiring or surviving company can safeguard against the "dump" after the takeover is consummated is by requiring a lockup on the shares owned by the group from which they are purchasing the public shell. Other shareholders that have held stock as investors in the company being acquired pose no threat in a dump scenario because the number of shares they hold is not significant.
On June 9, 2011, the United States Securities and Exchange Commission issued an investor bulletin cautioning investors about investing in reverse mergers, stating that they may be prone to fraud and other abuses.
Reverse mergers may have other drawbacks. Private-company CEOs may be naive and inexperienced in the world of publicly traded companies unless they have past experience as an officer or director of a public company. In addition, reverse merger transactions only introduce liquidity to a previously private stock if there is bona fide public interest in the company. A comprehensive investor relations and investor marketing program may be an indirect cost of a reverse merger.
The greater number of financing options available to publicly held companies is a primary reason to undergo a reverse takeover. These financing options include:
- The issuance of additional stock in a secondary offering
- An exercise of warrants, where stockholders have the right to purchase additional shares in a company at predetermined prices. When many shareholders with warrants exercise their option to purchase additional shares, the company receives an infusion of capital.
- Other investors are more likely to invest in a company via a private offering of stock when a mechanism to sell their stock is in place should the company be successful.
In addition, the now-publicly held company obtains the benefits of public trading of its securities:
- Increased liquidity of company stock
- Possible higher company valuation
- Greater access to capital markets
- Ability to acquire other companies through stock transactions
- Ability to use stock incentive plans to attract and retain employees
In all of these cases—except for that of US Airways and America West Airlines—shareholders of the acquiree controlled the resulting entity. With US Airways and America West Airlines, US Airways creditors (not shareholders) were left with control.
- The corporate shell of REO Motor Car company, in what amounted to a reverse "hostile" takeover, was forced by dissident shareholders to acquire a small publicly traded company, Nuclear Consultants. Eventually this company became the modern-day Nucor.
- ValuJet Airlines was acquired by AirWays Corp. to form AirTran Holdings, with the goal of shedding the tarnished reputation of the former.
- Aérospatiale was acquired by Matra to form Aérospatiale-Matra, with the goal of taking the former, a state-owned company, public.
- The game company Atari was acquired by JT Storage, as marriage of convenience.
- US Airways was acquired by America West Airlines, with the goal of removing the former from Chapter 11 bankruptcy.
- The New York Stock Exchange was acquired by Archipelago Holdings to form NYSE Group, with the goal of taking the former, a mutual company, public.
- ABC Radio was acquired by Citadel Broadcasting Corporation, with the goal of spinning the former off from its parent, Disney.
- Frederick's of Hollywood parent FOH Holdings was acquired by apparel maker Movie Star in order to take the larger lingerie maker public.
- Eddie Stobart in a reverse takeover with Westbury Property Fund allowing transport by ship, road, rail, or boat to and within the UK, using only one company.
- Clearwire acquired Sprint's Xohm division, taking the former company's name and with Sprint holding a controlling stake, leaving the resulting company publicly traded.
- Snowworld acquired Fornix Biosciences for the sole purpose of rapidly becoming a public company. 
- Capital formation
- Initial public offering
- Private company
- Public company
- Private investment in public equity
- Limited company
Reverse Mergers and Other Alternatives to a Traditional IPO, 2d Edition (Bloomberg Press, 2009), by David N. Feldman
- "Investor Bulletin: Reverse Mergers". U.S. SEC Office of Investor Education and Advocacy. June 2011.
- http://truecapitalfp.com/reverse-mergers The Advantages of a Reverse Merger
- Gallu, Joshua (June 9, 2011). "‘Reverse-Merger' Stocks May Be Prone to Fraud, Abuse, SEC Says in Warning". Bloomberg.
- Bloomberg Business NEws (February 14, 1996), Atari Agrees To Merge With Disk-Drive Maker, New York Times: 1
- "Frederick's of Hollywood goes public with merger." Reuters. December 19, 2006.
- William K. Sjostrom, Jr., The Truth About Reverse Mergers, Entrepreneurial Business Law Journal
- Reverse Take Over Over a Back Door Market
- Are Chinese Reverse Mergers Toxic?, Prof. Charles Lee, Stanford Graduate School of Business