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“Reverse Mergers are gradually taking the space earlier occupied by IPOs due to the complexities and slowness of the IPO method for going public. If done with sufficient checks, the ill effects associated with Reverse Mergers could be mitigated.”
The standard mechanism for accessing capital market is by listing the firm on the recognized stock exchange i.e. by exploiting the apparatus named ‘Initial Public Offer’ (hereinafter referred to as ‘IPO’).  Be that as it may, there is a secondary passage of getting ticket to capital market under the aegis of ‘Reverse Merger or Reverse Takeover’ (“RT”).  RT is a transaction where a private company gets acquired by a public ‘shell’ company/Special Purpose Acquisition Company (“SPAC” is a company created specifically with an objective to effectuate a RT transaction) and former uses the shell as a channel to go public. The Security Ownership Structure during and after the transaction is been delineated in the figure beneath:
The transactions are generally structured in two ways-
  1. Direct Reverse Merger: Where the public shell directly takes over the private company. After the consummation of transaction, the private company’s owners become the majority stakeholder in the merged entity. Subsequently, the public shell is wind up being acquired by the private company.
  2. Reverse Triangular Merger: In such transactions, the public shell forms a new wholly owned subsidiary (“WHS”). WHS then merges with private company and thereafter the WHS gets merged with the parent public shell. The transaction is designed in such a way that the private company’s owners becomes the majority stakeholder in the public shell through share swap.
RT is preferred by some over the IPO because of floatation cost associated with the IPO. The primary argument in the favour of RT is that it is expedient and cost-efficient than IPO which usually takes 5 to 12 months to complete. In the words of Hennessey,“A reverse merger is far simpler. A company identifies a shell stock, pays what is usually a modest fee and suddenly, it is listed.”
Another factor that may persuade the companies’ decision to prefer RT over IPO is disclosure requirement during the process of IPO. A private company may lose its competitive advantage pursuant to disclosure during the process of IPO.
Another determinant which motivates small sized companies to choose backdoor listing over IPO is SEBI (Issue of Capital and Disclosure Requirement) Regulation 2009. Regulation 6 enumerates ‘Eligibility Requirements’ to go public which needs to be complied by company intends to get listed. It might be strenuous for small companies with limited financing and investing opportunities to fulfill the requirements to be eligible for IPO. In such a scenario, a private company prefers to get access to capital market through the mechanism of Reverse Mergers.
LEGAL REGIME: Application in Indian Scenario
In India, the legal policy does not directly deal with ‘Reverse Merger or Reverse Triangular Merger’. The regulator is involved indirectly in the transaction because it implies an acquisition, exchanges of share or a change in ownership. As per § 230 of CA 2013, a scheme of arrangement must be approved by not less than seventy five percent of the shareholders [in a meeting in pursuance to the order of the National Company Law Tribunal (“Tribunal”) under § 230(1)] and such scheme of arrangement shall also be sanctioned by the Tribunal. In a Direct Reverse Merger, the parties have to comply with the requirements of § 230. Also, as per the Regulation 3, SEBI Circular CFD/DIL3/CIR/2017/21 dated March 10, 2017, when an unlisted company merges with a listed company, prior approval of Securities and Exchange Board of India(“SEBI”) is required. In the event that the scheme of arrangement appears to be irregular, an observation letter to judicial authorities will be issued by SEBI. In case of direct Mergers, the listed entity of the merger also needs to comply with the conditions enumerated Regulation 3 of the above-mentioned circular to proceed with the scheme. However, the parties can bypass the above requirements if transaction is structured as a Reverse Triangular Merger. In RTM, the WHS of the listed entity merges the unlisted private entity and thereafter WHS subsidiary gets absorbed within the parent company. An RTM transaction can be divided into two parts:
  1. Merger of WHS and the private company and,
  2. Merger of WHS with its parent listed entity.
Part 1 of the transaction does not attract SEBI guidelines as it is a merger between two unlisted entities and as for the part II of the transaction, the SEBI Circular CFD/DIL3/CIR/2018/2 dated January 3, 2018 asserts that the provision of the Circular on Schemes of Arrangement does not apply to arrangement which solely provides for the merger of wholly owned subsidiary or its division with the parent company.  Sub-Regulation 6 of Regulation 37 of SEBI (Listing Obligation and Disclosure Requirement) Regulations, 2015 provides for the same.
The RTM, even though there is a change in control, transaction does not trigger ‘Mandatory Open Offer’ under Regulation 3 & 4 of SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2015.
In Short, RTM can be used as a secondary passage to go public without going through the cumbersome procedure of IPO.
A Special Purpose Acquisition Company (SPAC) is a public company created solely for the purpose of acquiring a private company. SPAC, an updated version of ‘Blank Check Companies’, has been designed to strike a sensible balance between the investor protection and encouraging business environment. The only asset that a SPAC has at the time of the IPO is the option of making an acquisition in future. However, in India, section § 4(1)(c) of CA 2013, a company shall state the object for which it is proposed to be incorporated, has been considered as a major impediment in the floatation of SPAC. CA 2013 has done away with any flexibility that was provided by CA 1956 under the umbrella of ‘other objects’ within the definition of Object Clause.
Another impediment in the way of SPAC is SEBI (ICDR) Regulation which provides for the minimum ‘eligibility criteria’ to get listed through IPO. Regulation 6 of SEBI (ICDR) provides that an issuer is eligible to make an Initial Public Offer if, a) it has net tangible assets of atleast three crore rupees, b) it has an average operating profit of atleast fifteen crore rupees, c) it has a net worth of at least one crore rupees in each of the preceding three full years. Plainly, the above-mentioned requirements cannot be satisfied by a SPAC.
A Thorough, balanced idea of apt regulatory approaches to manage reverse mergers must consider the interests of private entities as well as the interest of the investors. Reverse Merger and SPAC provides the opportunity to small and mid-sized private entities to avoid the cumbersome procedure of IPO and provided mass investors with an opportunity to take part in their growth.
The primary question is whether, all else being equals, investing in public firms that list through IPO is safer to and preferable over firms that list through RT. The answer is definitely ‘Yes’. However, the shortcoming of asymmetric information, in case of RT, can be mitigated through proper regulations. To deal with the problem of ‘asymmetric information’, we can draw inspiration from FCA’s criteria of ‘Sufficient Information’ in the market.
With regards to SPAC, it is presented that SEBI needs to make a qualification between Shell Companies and SPAC. The regulatory authorities need to move past the observation that shell companies are created with the end goal of tax evasion and other corporate fraud. Whenever managed appropriately, it will give a cost-effective and convenient channel to small and medium sized companies to get listed.





Vishal Singh is a fourth-year law student at Dr Ram Manohar Lohiya National Law University, Lucknow.




In content picture credit: The Hindu Business Line

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