Best of the ISP-Lists

Is a Reverse Merger a Free IPO?

Members of the ISP-Investor list discuss a procedure known as the "reverse merge" in which a private company buys a public company to avoid the drama and expense of an IPO.

[October 25, 2000]

On the ISP-Investor list in October, a befuddled JM asked:

"What is a reverse merge? Is it legal?"

A couple of respondents filled JM in on the concept:

[CSM explained] "A reverse merge is the purchase of a publicly traded company by a private company that wants to become public. Instead of spending all the time and money doing an IPO road show, getting underwriters, lawyers, etc., the private company simply purchases a non-operating company and suddenly becomes a public company. The procedure has been around a long time and is pretty widely accepted."

[TH added] "You become a combination of your company and the assets and liabilities of the other company. It allows you to bypass the process of going public, and that benefit may be worth the cost of buying a majority of the company. I'd assume the biggest dangers are that the company has some hidden liability, such as debt, a lawsuit, or some other defect that becomes something you have to deal with." EL responded to the second half of JM's question with a significant concern:

"It's legal, but not for long: I am told the IRS is about to close this tax loophole."

[BL concurred] "I could understand that. Let's say you have a profitable ISP, and in a reverse merge you buy a company that has a tax loss carry forward. You would get the benefit of that tax loss. If this is true, you could buy a company with a $1 million tax loss carry forward, and thus shelter $1 million of your current income. I'm sure that the IRS doesn't like this, but I have not heard that it is no longer allowed."

Others contended that the IRS has nothing to do with the issue:

[CJS suggested] "I don't believe that a reverse merge is a tax issue but rather an expense issue: it avoids a lot of the expenses involved in an IPO. Of course, once you are a public company you fall under all of the reporting requirements. The problem with this procedure has been that the investment community usually discounts the stock value because of the reverse merge."

—End