What biotech companies should consider before entering into a reverse merger 

By Tasia Blazevich and B.J. Spence, Life Sciences IPO Co-Leaders, Deloitte & Touche LLP

Talking points

• Reverse mergers fill a specific need for private biotech companies by providing a path to liquidity for current investors, and access to capital in the public markets.
• In a reverse merger, investors of a private company acquire a majority of a public company’s shares to create a new entity.
• While SPACs are one type of reverse merger, in this piece we will discuss reverse mergers with other types of shell companies.
• A reverse merger may be an efficient way to enter the public markets, but it also has certain drawbacks that private biotechs should be aware of. Deloitte can help determine whether a reverse merger is the right exit strategy for your company and assess your company's readiness to go public.

Bringing a drug to market is a lengthy and costly process, on average, lasting 10-15 years from drug discovery to marketplace, and costing $2.3 billion, according to a recent Deloitte Center for Health Solutions analysis. Under these circumstances, private biotechs may run short of capital while still developing their product.

What are a company’s options for gaining access to capital in this challenging fundraising situation? While there are many paths, let's focus on whether a reverse merger is a viable option. Here we’ll describe a reverse merger, the pros and cons of executing one, and some key considerations to determine whether it is a viable strategy for your company.

What is a reverse merger?

In a reverse merger, investors of a private company acquire a majority of a public shell company’s shares. The two companies then combine to create a new entity. 

Biotechs often fail in the pre-commercial phase of clinical trials. This may leave them with a precipitous drop in stock value, potentially a significant amount of cash and limited viable options.

To help remaining shareholders recoup some lost value, a company may wind down operations and set itself up as a public shell company (i.e., it’s still listed on a public stock exchange even though the underlying operating business no longer exists). After that, generally with assistance from an investment bank, the public shell company will attempt to find a private company, or target, to merge with. 

What are the pros and cons of a reverse merger?

A reverse merger may be attractive to public company shareholders, who may benefit from the public company acquiring a new business. Private company shareholders may benefit as the newly created company has access to the existing public shell company’s cash on hand and can potentially increase liquidity through access to the public markets once the merger is complete.

Properly executed, a reverse merger can be an efficient way to enter the public markets. The newly public company’s valuation in a reverse merger has less dependence on market conditions typically present in the traditional IPO window.

A reverse merger has some disadvantages, too: Existing shareholders may see significant dilution; the public shell company may have pre-existing issues, such as contractual or pending legal actions; there may be low demand for the new company’s stock paired with existing shareholder selloff which could drive down the stock price post-merger; this may leave you without a syndicate of bankers and analyst coverage, creating challenges to market the company to potential investors going forward.