With the US initial public offering markets continuing to remain largely closed, and special purpose acquisition company combinations being costly and complex, there’s a new kid in town for foreign companies looking to go public in the US: reverse mergers. We’ve seen a material increase in reverse merger transactions – particularly with cross-border elements, and we expect many more will follow given current market conditions. Cross-border reverse mergers are gaining momentum, particularly in the life sciences sector, due to the increasing number of US public companies with healthy cash levels but poor or failed product pipelines, proving to be a viable path to going public in the US in the near term.
In a nutshell, a cross-border reverse merger is a transaction where a private or public foreign company merges or combines with an operating US public company (which can either be a domestic or a foreign private issuer), with the shareholders of the private or public foreign company receiving stock in the US public company as transaction consideration – and typically owning a majority or greater controlling stake in the combined entity. A reverse merger can be achieved in multiple ways, and the ultimate structure will depend on the legal status and jurisdiction of the parties and their shareholders.
Here we highlight 10 key points to consider in assessing whether a cross-border reverse merger is the way to turbocharge your business and achieve a US listing.
In an ideal scenario, you agree exclusivity with the US company to negotiate a smooth and fast deal, but we often see reverse mergers in the context of an auction process where the US public company is hotly looking for an entity to merge with and is in discussions with multiple targets at the same time. Competition is therefore stiff, and so it pays off to pre-plan with your accountants and legal advisers to determine deal structure certainty. For UK companies, structuring the deal as a share purchase agreement with all shareholders signing up to the transaction or as a scheme of arrangements – which requires majority shareholder approval (50% by headcount and 75% by value of votes represented in a shareholder meeting) – are the preferred routes. For further detail on the scheme of arrangement majority tests – see our blog post – “Schemes of Arrangement: Dodgy Plots or Effective Ways to Purchase UK Companies”.
If it is possible to obtain signatures from all shareholders, a share purchase agreement may give you a timing and certainty advantage to other bidders. Some reverse mergers involving a U.S. public company and a private target are being done on a simultaneous sign and close basis, with the issuance of common stock and non-voting preferred stock that does not require prior U.S. public company shareholder approval. Deals closed this way would be subject to a subsequent shareholder vote by the combined group to approve the issuance of shares upon conversion of the preferred stock to common stock. For UK companies, this structure requires a share purchase agreement (rather than a scheme) and the availability of an exemption under U.S. securities laws for the share issuances. Also, shares issued in this structure would not be freely tradeable and would need to be registered for resale after closing. If this structure is not available or desired, a scheme of arrangement will qualify the U.S. company’s share issuance for an exemption from registration and negate the need for a registration statement on form S-4.
Your largest shareholders, directors and officers who own securities will be expected to sign up to voting agreements or irrevocable undertakings in favour of the cross-border reverse merger by the time the transaction is announced. This tends to be easier to obtain with private companies or closely held public companies. It is important to consider whether there are US securities laws registration exemptions that can be relied upon as part of the process. Consideration should be given as to whether your shareholder base will qualify you for a securities law exemption or if you are a UK company, whether you should use a scheme of arrangement to get the benefit of a securities exemption that would provide freely tradeable securities.
You should also assess potential difficulties in obtaining the U.S. company’s shareholder approval to the deal, taking into account a retail shareholder base and the trading price of the U.S. company. While the U.S. company typically would only require the vote of a majority of the shares voting on the share issuance proposal, the U.S. company could face activist or other shareholder opposition that could derail a deal or result in an alternative buyout proposal. Parties should consider implementing deal protections to reduce the risk of interloper intervention. Deal certainty and speed in execution are key to a successful cross-border reverse merger process.
3. Tax-free basis
Often cross-border reverse merger transactions can be accomplished on a tax-free basis. This, however, warrants early involvement from your tax advisers for adequate tax structuring and review, to ensure this can be the case and that any specific requirements are taken into account.
4. Valuation and consideration
Your valuation will be agreed upon at the time of announcement, unlike pricing in an IPO, which is exposed to market fluctuations. Projections may be used to value the target company, and the transaction can be flexibly structured with consideration of stock, cash and/or contingent value rights, which is an increasing trend in life sciences combinations where there is an asset that is undervalued by one of the parties or a future regulatory event or approval that takes place post-closing.
Absent any prolonged review by a regulatory body, conducting a reverse merger can be a faster route to being public when compared to a traditional IPO. An IPO generally takes between four to six months, whereas a reverse merger can be completed in as little as three months. Contrary to IPOs, reverse mergers do not necessarily trigger registration requirements with the Securities and Exchange Commission and can be done via private placements or other registration exemptions.
6. Due diligence and integration
You should be prepared to conduct a heightened due diligence process, as you may be taking on the liabilities and legacy products of the US public company that you’re merging into. As with all combinations, there also will no doubt be challenges with respect to integration, particularly if the two companies are headquartered and historically operate in different jurisdictions.
Consider your run rate for the years after closing of the transaction. What will the cash balance of the combined group be, and do you need to consider a private investment in public equity (PIPE) financing alongside the transaction? While the headline cash balance of the US public company may look promising, you also need to factor in costs associated with the transaction, including any severance costs. If you conclude that you need PIPE financing, you must work closely with your advisers to ensure that the PIPE process can run alongside the transaction, with a PIPE typically being baked into the deal at the time of announcement. From a registration perspective, given that the PIPE will warrant registration, it is typically the case that the PIPE is structured as a concurrent financing to the transaction, and both the transaction and the PIPE shares are registered under the same registration statement.
8. US public company readiness
Consider whether you are ready to be a US public company. For that, you need to understand the US regulatory and shareholder litigation landscape, retain the right board and management teams taking into account applicable independence and diversity considerations, and gear up for US public company reporting and internal controls. This can be a big change to your current governance and reporting structure, so preparing for it with the help of your advisers will prove key to the success of your cross-border transaction.
9. Financial readiness
You will need one to two years of audited financial statements and pro forma financial statements of the combined entity for inclusion in the US registration or proxy statement compliant with US audit requirements. This process can be time- and resource-consuming, so the earlier you get to it, the better. Depending on whether you combine with a domestic US issuer or a foreign private issuer, the pro forma financial statements and your post-closing financial statements may need to be prepared under US generally accepted accounting principles.
While a cross-border reverse merger may be a faster route than an IPO, it is not necessarily a cheaper one. An IPO may have greater legal and accounting costs given underwriting fees and legal and audit opinion requirements, but reverse mergers typically include significant fees paid to bankers for securing the deal – and in connection with any PIPE financing conducted alongside the process.
A cross-border reverse merger transaction might be your path for going public in the US in the near term. Reach out to the Cooley team if you want to think it through together.