Reverse Takeovers Prove A Risky Way To Go Public

Tuesday, February 14, 2006

Prof. Kimberly Gleason, Prof. Leonard Rosenthal, and Prof. Roy Wiggins III, Journal of Corporate Finance, http://

Better Business Management & Planning Practices

Abstracted from: Backing Into Being Public: An Exploratory Analysis Of Reverse Takeovers
By: Prof. Kimberly Gleason, Prof. Leonard Rosenthal, and Prof. Roy Wiggins III Florida Atlantic University (KG); Bentley College (LR and RW)
Journal of Corporate Finance - Vol. 12, No. 1, Pgs. 54-79

Buying the way into public listing.
Private companies have varied reasons for going public. In addition to raising capital, the owners may wish to diversify their personal assets while retaining some control. The company may wish to pay employees partially in stock or stock options. Public shares are more liquid than private shares, and the broader investor base may raise value. Professors of finance Kimberly Gleason, Leonard Rosenthal, and Roy Wiggins wondered if the reasons for going public by reverse takeover ­a private company's acquisition of a public company ­are different. The desire for growth is most often cited as the reason for a reverse takeover, but the cost and timing of an IPO and the private company's own financial status rank highly. Entering a complementary line of business and economies of scale are also mentioned. The public entities in reverse takeovers are often small and financially troubled. Some are nothing more than shells left from a failed enterprise; others operate at a loss. The private company's bid gives the target's shareholders a chance to cash out above the market price. For a functioning public company, it may hope to achieve profitability with backing from the more successful private firm.

A risky alternative.
Reverse takeover, the authors indicate, is a risky alternative. Fewer than half of the entities resulting from a reverse takeover still exist two years after the maneuver. Among the defunct, 6% have gone private again, 5% have morphed through another reverse takeover, and 40% have been acquired. An unfortunate 38% have filed for bankruptcy, and others have been delisted. Despite the financial soundness of the private company before the reverse takeover and despite the relatively easy access to a listing, the resulting entities suffer a very high mortality rate. Companies that had previously been distressed are more likely to go under than companies that initially had better finances. Failure was also more likely for a company that chose to brand itself with the less successful partner's brand.

Success even among the survivors is the exception.
A mere 9% of the surviving companies moved from NASDAQ to the New York or American stock exchanges in the two years after the reverse takeover; 25% changed their listings in the other direction; and 66% remained on the original listing board. The small group that moved up to a major exchange contains companies that took over previously functional and previously nonfunctional public companies, but the companies that lost their listings much more often sprang from seriously distressed predecessors. Survival also seems to depend on the industrial compatibility of the two partners. Acquiring a public company from an unrelated industry poses particular hazards, the authors conclude. Among all reverse takeovers, only 27% are from the same industry, but 52% of the survivors come from the same industry. Another 15% come from a closely related industry.

Abstracted from Journal of Corporate Finance
published by Elsevier Science
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