If you own stock in a company that is about to engage in a reverse merger, you own what is referred to as shell stocks. Shell stocks have very little value, if any. These are referred to as shell stocks because the public company that issued the stock is no longer conducting business operations and is known as a shell company.
About Shell Companies
When a public company no longer conducts its regular business operations, has no real assets or has assets that are comprised of only cash and cash equivalents, it is considered what is known as a shell company. Real assets are assets that have value based on its utilization, such as a piece of machinery or a factory plant. This is the opposite of nominal assets such as cash and cash equivalents. Although shell companies do not conduct regular business activities, they maintain their stock trading status.
A reverse merger occurs when a privately held company wants to become a publicly traded company, but does not want to go through the lengthy and costly process of an initial public offering (IPO). In a reverse merger, the private company buys controlling interest in the shell company by purchasing a shell stock. After the merger, the private company and the shell combine to form one publicly traded company. The private company controls the post-merger company.
Decrease in Stock Value
Investors can decide to dump or sell off their shares after the reverse merger, if the shell company shareholders determine that the merger is not a financially sound decision. Reasons for doing so can be due to legal issues, or a history of financial malfeasance on the private company’s part, for example. This causes the stock price to decrease in value. If after the reverse merger, the private company has not yet received the financial backing or capital it needs to compete in its industry as a publicly traded company, investor demand for the stock typically is low. Low demand decreases the value of the stock.
Increase in Value
If a private company requires majority shareholders of a shell company to hold their shares for a certain period after the merge is complete, it prevents company stock from decreasing dramatically post merger. This can lead to an increase in investor demand, and an increase in stock value. If the private company has the financial backing to compete in its industry as a public company when the merger is complete, this can also increase its stock's value.
- U.S. Securities and Exchange Commission; Investor Bulletin--Reverse Mergers; June 2011
- Bristol Capital: What is a Reverse Merger with a Public Shell?
- Shell Stock Review: What is a Reverse Merger?
- U.S. Securities and Exchange Commission. "Investor Bulletin: Reverse Mergers," Page 1. Accessed April 15, 2020.
- U.S. Securities and Exchange Commission. "Investor Bulletin: Investing in an IPO," Page 2. Accessed April 15, 2020.
- Corporate Finance Institute. "Reverse Takeover (RTO), 2020." Accessed April 15, 2020.
- Harvard Law School Forum on Corporate Governance. "2017 IPO Report, May 2017." Accessed April 15, 2020.
- The Lexis Practice Advisor Journal. "Reverse Mergers, 2020." Accessed April 15, 2020.
- U.S. Securities and Exchange Commission. "Rule 144: Selling Restricted and Control Securities, Jan. 2013." Accessed April 15, 2020.
- U.S. Securities and Exchange Commission, Investor.gov. "Reverse Mergers, June 2011." Accessed April 15, 2020.
Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.