Why Do Companies Go For Reverse Mergers?
A deep dive into one of the most simple yet effective financial tools.
“Reverse” has a very dynamic existence in our lives. Be it in the stock market where we square-off (reverse) our bids, the reverse repo rate that RBI uses, or even in a game of UNO, it is pretty much present everywhere.
In the business world, “reverse” can take a whole new meaning. Let’s see how.
We all know what mergers are right? Two companies becoming one. When we hear of it, we assume it’s always a big fish swallowing up a smaller one.
But, that’s where we play the reverse card today.
Enter: Reverse Merger
A reverse merger occurs when a small (maybe private) company takes over a bigger/publicly listed one, or a weaker one acquires a stronger one, or maybe when a parent merges into its subsidiary. But why would they even do this, isn’t a+b=b+a? Well, not really.
We know how long, taxing, and financially draining the process of coming out with an IPO can be. Hiring bankers, getting the due diligence done, multiple verifications, and what-not.
It doesn’t come as a surprise that it can take months or even years for a private company to become public the traditional way. The worst part: even after running around, it is not necessary for the company to get approval from SEBI.
A reverse merger simplifies that.
A private company can have a guaranteed public listing by acquiring a public company. It effectively becomes a subsidiary of the company, thereby turning around the months-long process to just weeks.
Not just quicker, it’s cheaper too!
Simplified process, great outcomes. Seems like a win-win for everyone.
Like in 2005, the Industrial Development Bank of India (IDBI) reverse merged with its commercial banking arm, IDBI Bank, and became IDBI Bank Ltd.
But, IPOs are not the sole reason for which mergers happen.
If two businesses are different, they may reverse merge to make efficient use of each other’s assets and diversify further. Not just that, this process provides something every business looks for: tax incentives.
If a loss-making entity merges with a profit-making one, the healthy company can take advantage of the losses that are carried forward, and thus save on taxes (Section 72A of the Income Tax Act).
Let’s take a very famous case here.
Remember Vijay Mallya? The guy who ran away with a cool Rs. 9000 crores from the banks? His Kingfisher Airlines had not made any profits since its listing in 2006. On the other hand, Mallya was too busy in the glamorous world and kept the acquisition spree going: from newspapers, fashion magazines, to racing teams, everything was a part of his empire.
One such deal was also the reverse merger with Air Deccan, another airline company, which wasn’t doing great either. Both loss-making entities had the possibility for saving taxes by coming together, which they decided to exploit. The deal didn’t turn out too well for Mallya though.
It seems like everything’s good in the hood, no? Well, it isn’t.
Reverse mergers come with their own set of problems
If a company is going public by any means, it is only reasonable to assume that they have the required resources and capabilities to run a public company.
However, many times, this is not the case. There is a lack of expertise in the company, which leads to inefficient management, and thus, only brings bad news for its investors. There are also instances of lawsuits for various reasons during the reverse.
Of course, managers of both parties have to be on their toes, to ensure they’re teaming up with a partner who has a clean slate, as this can lead to a whole new set of problems in the future.
This is the beauty of the world of business and finance. You can get as creative as possible, and figure out ways of circumventing the law, saving some bucks, and making things run faster.
A reverse merger is a financial tool, and no tool can be defined as good or bad. Only the way we use it can.
Whether these mergers are a match-made-in-heaven, or a marriage arranged only to fail, can be known only after the deed is done.
Q for the D: There’s this one more very interesting, very famous FMCG company that went for a reverse merger and became a listed company. Any guesses?
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Patanjali <-> Ruchi Soya
Aren't SPACs the more easier & in trend way of getting listed in an easier manner!?