Reverse Acquisition: Its Benefits and Guidelines
In a reverse acquisition, a private company acquires a publicly listed company in substance. The owners of the private company become the controlling shareholders of the public company. After the acquisition, they reorganize the public company’s assets and operations to absorb the formerly private company. The term “reverse” refers to a private firm acquiring an already public company, which is the opposite of a typical IPO scenario.
Guidance has been given in IND AS 103 “Business Combination” IND AS 103 primarily deals with the following:
- Accounting for mergers and acquisition
- Accounting for consolidation on date of acquisition
- Acquisition of business
- Common control transactions, including demerger
Note – Asset acquisition is out of the scope of this standard, but still, guidance has been given for asset acquisition. Note – Common control transactions are not covered by IFRS – 3. It is considered in carve-in. However, detailed guidance has also been given on reverse acquisition under IND AS 103. Let us summarize reverse acquisition and how the accounting will be done in the books of the Legal Acquirer (or Accounting Acquiree). Sometimes acquirer identified legally may not be the accounting acquirer (i.e., real acquirer). This situation is considered a reverse acquisition. This is generally in cases where small entities acquire large entities in a legally structured acquisition. Example – Suppose an entity A is listed in recognized stock exchange but does not have significant operations; another entity B having significant operations in the market, wants to list itself in the stock exchange. So, legally a share purchase agreement is drafted in such a manner between A and B, which primarily reflects that A is acquiring B (here, A would be “Legal Acquirer” and B would be “Legal Acquiree”), but after the execution of share purchase agreement shareholding pattern would be such that entity B will be having majority portion of the aggregate share capital and acquiring ultimate control over A (here B would become “Accounting Acquiree” and A would become “Accounting Acquire”). This scenario would be called “Reverse Acquisition.”
Reasons for Reverse Acquisition or Benefits of Reverse Acquisition
- It provides a mechanism to convert a private company into a public entity without needing to appoint an investment bank or raise capital.
- The practicality and lower cost of the reverse acquisition process can benefit smaller companies in need of quick capital.
- Reverse acquisitions allow owners of private companies to retain greater ownership and control over the new company, which could be a huge benefit to owners looking to raise capital without diluting their ownership.
Step 1 – Identification of reverse acquisition
A general hint for identification of reverse acquisition is “small entity taking over the larger entity.” We should calculate the relative size of shareholding post-combination/acquisition. An accounting acquirer will generally be an entity holding a bigger percentage of shares. Other factors should also be considered apart from relative size. This can be:
- Presence of large minority shareholders,
- Agreement to govern financial and operational matters of entity,
- Appointment of key management personnel,
- Power to compose governing body, etc.
Step 2 – Once it is identified that reverse acquisition exists, the following entries should be journalized (Assuming NIL balance in all ledger balance of legal acquirer).
|1||Sundry Assets of Accounting Acquirer as Book Value||XXXX|
|To Sundry Liabilities of Accounting acquirer at Book Value||XXXX|
|To Reserve & Surplus of Accounting Acquirer at Book Value||XXXX|
|To Share Capital of Accounting Acquirer at Book Value||XXXX|
|(Being an accounting acquirer recognized as Book Value)|
Step 3 – Purchase Consideration – It will always be equal to the fair value of accounting.
Step 4 – Journal Entries for acquisition
|1||Sundry Assets of Accounting Acquirer as Fair Value||XXXX|
|To Sundry Liabilities of Accounting acquirer at Fair Value||XXXX|
|To Vendor A/c (Purchase Consideration)||XXXX|
|(Being Sundry Assets/Liabilities acquired)|
|2||Vendor A/c (Purchase Consideration)||XXXX|
|To Share Capital||XXXX|
|To Securities Premium||XXXX|
|(Being Purchase Consideration Paid)|
These were the Journal entries that were passed at the time of reverse acquisition in the books of “Legal Acquirer or Accounting Acquiree.” Despite the advantages associated with the reverse acquisition, there are certain disadvantages as well an entity should keep into consideration while entering into an agreement affecting reverse acquisition. Shell companies often come with a history of problems that accompany their financial downfall, such as:
- Poor record-keeping and even pending lawsuits.
- The shell company’s shareholders may also take a stance against the merger, making it more lengthy and difficult.
- Reverse mergers for shareholders are the likelihood of performing a reverse stock split. During the process of merging, shareholders may decide to reduce the number of shares and issue new shares, diluting the value of the original shares. This can be an unattractive proposition for the original shareholders.
At AJSH, we assist our clients in bookkeeping, payroll, auditing, taxation, secretarial compliances, and presentation of financial statements ensuring compliances with applicable standards. If you have any questions or wish to know more about reverse acquisition, kindly contact us.