Reverse Takeover (RTO)

What Is a Reverse Takeover (RTO)?

A reverse takeover (RTO) is a process whereby private companies can become publicly traded companies without going through an initial public offering (IPO).

To begin, a private company buys enough shares to control a publicly-traded company. The private company's shareholder then exchanges its shares in the private company for shares in the public company. At this point, the private company has effectively become a publicly-traded company.

An RTO is also sometimes referred to as a reverse merger or a reverse IPO.

How a Reverse Takeover (RTO) Works 

By engaging in an RTO, a private company can avoid the expensive fees associated with setting up an IPO. However, the company does not acquire any additional funds through an RTO, and it must have enough funds to complete the transaction on its own.

While not a requirement of an RTO, the name of the publicly-traded company involved is often changed as part of the process. For example, the computer company Dell (DELL) completed a reverse takeover of VMware tracking stock (DVMT) in December 2018 and returned to being a publicly traded company. It also changed its name to Dell Technologies.

Additionally, the corporate restructuring of one — or both — of the merging companies is adjusted to accommodate the new business design. Prior to the RTO, it is not uncommon for the publicly-traded company to have had little to no recent activity, existing as more of a shell corporation. This allows the private company to shift its operations into the shell of the public entity with relative ease, all while avoiding the costs, regulatory requirements, and time constraints associated with an IPO. While a traditional IPO may require months or years to complete, an RTO may be completed in just weeks.

For a company that wants to become publicly traded, reverse takeovers (RTOs) can be a cheaper and quicker option than an IPO. However, they tend to pose greater risks for investors.

Sometimes RTOs are referred to as the "poor man’s IPO." This is because studies have shown that companies that go public through an RTO generally have lower survival rates and performance in the long-run, compared to companies that go through a traditional IPO to become a publicly traded company.

Special Considerations

Unlike conventional IPOs — which can be canceled if the equity markets are performing poorly — reverse mergers aren’t generally put on hold. Many private companies looking to complete a reverse merger have often taken a series of losses, and a percentage of the losses can be applied to future income as a tax loss carryforward.

On the flip side, reverse mergers can reveal weaknesses in the private company’s management experience and record keeping. As well, many reverse mergers fail; they end up not fulfilling the promised expectations when they eventually begin trading.

A foreign company may an RTO as a mechanism to gain entry into the U.S. marketplace. For example, if a business with operations based outside of the U.S. purchases enough shares to have a controlling interest in a U.S. company, it can move to merge the foreign-based business with the U.S.-based business.