When a private company gains control of a public shell company, the shell is structured to be the parent company and the buyer’s company becomes its subsidiary. The owners of the private company exchange their shares in the private company for shares in the public company. They have now gained control over a majority of the stock of the shell, and are running a public company.
The legal structure used for this merger is called a reverse triangular merger. The process flow for a reverse triangular merger is:
The shell company creates a subsidiary entity.
The newly-formed subsidiary merges into the private company that is buying the shell.
The newly-formed subsidiary has now disappeared, so the private company becomes a subsidiary of the shell company.
The reverse triangular merger is used to avoid the cumbersome shareholder approval process that is normally required for an acquisition. Though the shareholders of the private company must still approve the deal, it is only the shareholder of the new subsidiary that must approve the deal on behalf of the shell company – and the only shareholder of the new subsidiary is its parent company.
The reverse triangular concept is particularly useful, because it allows a private company to continue operating as a going concern and without a change in control of the entity. Otherwise, the business might suffer from the loss of any contracts that would automatically expire if either of those events were to occur.
A reverse merger into a shell requires the filing of a Form 8-K with the Securities and Exchange Commission within four business days of the reverse merger. This filing contains many of the items found in a full-scale prospectus for an initial public offering, and so is a major production.
