Valuation Considerations in Reverse Mergers

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The concept of a reverse merger, in short, holds that a privately held company acquires a publicly traded company. In so doing, the private company can gain access to public equity markets without going through the lengthy process of an IPO filing. Although a reverse merger typically has the advantage of a shorter timeline over an IPO, there are still some requirements pertaining to valuation assessments that companies involved in a reverse merger should keep in mind.

Among these requirements are the fair value measurements related to ASC 805, Business Combinations. In a reverse merger, like with all acquisitions, ASC 805 ties the allocation of the purchase consideration to identified tangible and intangible assets. However, in a reverse merger, the establishment of the purchase consideration to be allocated can be more difficult to accomplish. Oftentimes, shares of the acquiring (private) company are issued as consideration, so the shares of the acquiring company may need to be valued.

"Although a reverse merger typically has the advantage of a shorter timeline over an IPO, there are still some requirements pertaining to valuation assessments that companies involved in a reverse merger should keep in mind."

The value of private company shares to be issued might not always align exactly with the value of the acquired publicly traded company; market conditions and other forces may bring about changes in the respective stock prices between the time that the transaction is announced and the time that it closes. Therefore, the valuator should keep in close communication with the management of the acquiror, and the respective auditor, to ensure that there are no surprises when the transaction closes and the final purchase price allocation is performed.

Sometimes in a reverse merger, a question may arise as to whether a control premium should be applied to the consideration being paid. This will require the valuator to understand the terms of the purchase agreement and to understand whether a control element has already been priced into the transaction. For example, in the acquisition of a limited partnership, a general partner may have also been acquired in the transaction. Often, the amount paid for this general partnership interest may represent the “control” factor, i.e., the ability to affect change in the projected cash flows, above and beyond the acquisition of the limited partnership.

In the event of a reverse merger, these considerations make it more critical than ever to have a strong, defensible valuation supporting the purchase price allocation.

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