What Does a Reverse Merger Mean for My Stocks?

Reverse mergers allow private companies to go public on the cheap.
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A merger takes place when two companies combine to form a single business entity. Most mergers happen when one public company takes over the shares of another company, either public or private, and just gets bigger. In a reverse merger, a private company buys out a public one, then has shares of the new business listed for public trading. Basically, this means going public without the usual risk and expense of an initial public offering -- and being able to do it in weeks rather than months or even years.

Pros and Pros

In a reverse merger there's no muss, no fuss with the myriad rules and regulations of an initial public offering. The private company takes in the shares of the public company, which becomes a shell. A new, publicly traded company is born. The process does an end run around the expense of raising new capital, with all of the fees charged by stock underwriters and the market risk surrounding new share offerings.

Goodbye, Shares

If you're holding shares in a company that's going to be acquired in a reverse merger, you're going to have to sell at the price fixed by the buyer or exchange your shares for stock in the new company. This may or may not represent a profit on your investment -- but unless you hold voting control or can convince a majority of the stockholders that it's a bad idea, you won't stop it. A reverse merger generally benefits both businesses: the private company grows larger and wins new markets and products. The public company gains some business support and financial safety by becoming part of a bigger entity.

Disclosure Duties

The Securities and Exchange Commission requires Form 8-K when a merger takes place. This is a public document that is available through the SEC's online, searchable EDGAR database. The filing will reveal the new company name, the makeup of the new board of directors and the shares and capital that will be exchanged between the buyer and the shell. Wading through these fine-print documents will give you a good handle on the merger and help you make the crucial decision: either sell your shares immediately or wait for the merger to go through.

Costs and Fees

There's one final but important consideration with a reverse merger: whenever some major change takes place with a stock investment, your broker may charge a fee for any accounting work that needs to be done. E*Trade, for example, charges investors a $20 flat fee for "mandatory actions" such as stock splits, mergers and buyouts that affect your holdings. In addition, there may be tax consequences if you sell your shares at a profit, regardless of whether the trade is optional.

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