Yeah, I believe I've heard of a "reverse merger.…" I think it's when a company, um, merges in reverse?
If, at the mention of "reverse mergers," something like this is running through your mind, I can relate. Prior to starting my current internship at the China Economic Review, this ominous phrase had meant almost nothing to me. And if it means next to nothing to you, allow me to explain the basics.
A reverse merger is when a private company looking for funding gets bought by a publicly traded shell company. Once the two enterprises fuse together, the public shell company changes its name to that of its newly acquired business segment. Then comes the most important (and exciting) part: The shares of the shell company symbolize ownership of the active business (the previously private company). This means that the shell company now has an active segment that, if successful, will attract investments previously unaccessible to the private company on its own.
Just to make things slightly more simple—I still have a hard time digesting the explanation myself—I include a diagram to supplement the above slab of text:
So now you have a slightly better understanding of the reverse merger, but now comes the real question: Why? Why conduct such a seemingly complicated endeavor? Easy. The cause is the root of all business transactions, some even refer to it as the root of all evil: Money.
Companies desiring greater funding face strict requirements to list in a US stock exchange. The Securities and Exchange Commission (SEC) does not allow any firm hungry for funding to enter into the public domain. As a result, many small companies have great difficulty breaking through the barriers to reach the coveted Initial Public Offering (IPO). So, to circumvent regulations, small companies participate in a reverse merger to gain exposure to US investment. Over the past few years small domestically successful Chinese companies have begun to seek entry into US exchanges through reverse mergers. The number has risen every year.
But it's okay—everyone's just trying to make a living, right? Wrong. What if they make a living with your money? In some cases, that is what happens. Investors face the problem of potential fraud due to less stringent rules placed upon newly public reverse merger companies.
As part of my internship, I analyze operations and financial data of various Chinese reverse mergers, evaluating the risks of investing in them. The stock performance and financial statements almost always look attractive. Too attractive.
Day in and day out, I come across various stock reviews promoting multiple "high-growth reverse merger companies," but after careful review I come across a few red flags here and there. However, once in a while I come across a company that redeems my hope for small Chinese companies. On a few occasions I even smile to myself. My co-workers probably just assume I'm on Facebook.
Pretty interesting right? I assume after staying awake long enough to get to this point in the post, the concept of a reverse merger has piqued a decent portion of your interest. For me, its more than a boring business transaction/acquisition, it represents the delicate balance between US and China reflected through their business practices. The world keeps getting smaller, and I believe paying attention to the intricate interactions between countries grows more and more important in understanding the world we live in. My avenue of exploration happens to be reverse mergers, and I plan to write a paper expanding upon the information I have provided here, along with analysis of the broader implications of Chinese reverse mergers.
If you feel compelled to continue your quest for knowledge of Chinese reverse mergers, here is a significantly longer piece on the subject. It's quite objective and will give you a more balanced understanding of what I outlined here.