What Does a Reverse Merger Mean for My Stocks?
A reverse merger happens when a publicly trading company merges with a private company and the private company survives, occupying and operating in the publicly traded company's legal shell. The private company takes over controlling ownership of the stock of the public company and management of the company, usually changing the company's name to its own and changing the stock symbol. It is not necessary for both companies to be in the same business; in fact, usually they are in very different businesses.
Reasons for a Reverse Merger
When a public company begins a decline into financial failure, the only asset left often is the legal public corporate shell. The stock continues to trade, generally supported at a specific price by market makers. If the stock is trading on an exchange, the price is supported to meet the share price requirements of that exchange, but only a minimum number of shares actually trade. This is done to maintain the value of the trading shell. The most common reason for a reverse merger is the desire of a private company to quickly become a public company. The alternative is a long process involving SEC registration. A reverse merger circumvents the SEC registration process and replaces the failed company with a company that has operations and, hopefully, better prospects. Foreign companies seeking to trade on U.S. markets also make use of reverse mergers. Once the reverse merger is completed, the new company usually issues additional stock to raise capital.
Original Shareholders
If you are an original shareholder in a failed company that is planning to go through a reverse merger, you will have a chance to vote on whether to accept the merger. Since your stock is essentially worthless, voting for the reverse merger might seem to present hope of eventually recovering your investment. You will receive a certain number of shares in the new company in exchange for your original shares, but that number will be considerably smaller than the number of shares in your original holding. For example, the new company may trade 25 percent ownership for the public shell. If the new company has 100 million shares authorized, it gives 25 million to the original company's shareholders. If the original company had 250 million shares issued, each shareholder will receive one share of the new company in exchange for 10 original shares. In this example, if you owned 1,000 shares of the original stock, you would receive a certificate for 100 shares of the new stock.