A reverse acquisition occurs when there is a business combination in which the entity issuing securities is designated as the acquiree for accounting purposes. This arrangement usually takes place so that a privately-held company can be acquired by a smaller shell company that is publicly-held, resulting in a combined entity that is publicly-held.
Subsequent to the reverse acquisition, the management of the formerly private company takes over the combined business, and issues all public filings expected of a publicly-held entity. There are three major risks to consider when engaging in reverse acquisitions, which are:
- The shell entity may contain undocumented liabilities
- The resulting public entity has not yet raised any money, as would have been the case with an initial public offering (IPO)
- There is unlikely to be much of a market for the entity's shares, making it difficult for investors to sell their shares
Given the issues just noted, reverse acquisitions tend to be used by smaller organizations that cannot afford a full IPO.