Key takeaways
Shells provide ready-made route to market
Existing listed shells offer fast, efficient pathways for private targets.
RTOs offer flexible, negotiable deal structures
Share-based consideration enables creative terms attractive to target owners.
Built-in shareholder base supports free float needs
Shell investors help meet free float requirements without major fundraising.
For many international companies evaluating a UK listing, a reverse takeover (RTO) can be an effective way to reduce the risks of the listing process by helping to cover some of the associated costs and by providing an existing shareholder base to support free float. It is particularly attractive where a company needs bridging funding ahead of a deal, or would otherwise come to market with very few shareholders and/or limited familiarity with the UK listing process. In this article we explain what an RTO is, how it works in practice and the key issues management teams need to be aware of when considering an RTO.
Introduction - what is a 'Reverse Takeover'?
In simple terms, a 'reverse takeover' or 'RTO' is when a listed company acquires something bigger than itself or fundamentally changes its business. There are various tests (called 'class tests') to determine whether a target company (Target) is bigger than the issuer (the buyer in an RTO transaction), including a comparison of their profits, their turnover, their capital, their assets, and the consideration being paid although the tests vary slightly by market. Where a smaller company acquires a larger company (as determined by 'class tests') the transaction is considered an RTO.
If a transaction is an RTO, the enlarged listed company (taking account of the larger Target it is proposing to acquire) must apply for a new listing, requiring the issuer (the buyer) to go through the same process that a company coming to the market for the first time would need to follow. In particular, if the enlarged company wants to readmit to the Official List (and the Main Market) this will generally mean publishing a prospectus. In the case of an AIM company this will require a new Admission Document to be published.
The consideration paid by the listed vehicle to the shareholders of the Target is usually wholly or mainly shares in the listed issuer, and so although the private company is the one being acquired, its shareholders will usually make up the majority of the shareholders of the listed vehicle post-transaction. The executive team of the target would also typically become the executive team of the listed entity and generally most of the listed entities’ directors resign.
Listed companies looking to find RTO Targets
The classic RTO is where a 'cash shell' or 'SPAC' (special purpose acquisition company), which is a listed company whose assets consist predominantly of cash, purchases a larger private company. Historically there were more pure listed cash shells on the market. These entities were listed and raised capital specifically to carry out one or more acquisitions and have not operated a trading business. However, choppy equity markets have meant investors are less willing to lock their capital up in a shell and so shell listings have been few and far between over the last few years.
More commonly shell companies arise where they have divested their trading operations or they have retained a small trading business that they wish to divest or wind-down. In other cases, the listed entity may have a trading business, but it lacks the scale and/or capital to grow, and the management team is keen to acquire a larger target in the same sector that will complement its business. Such shells may or may not have access to cash to fund an RTO and vary greatly in how they reached their current position. Some have no legacy liabilities and have shareholders willing to capitalise them for a deal, other issuers are zombie businesses that are unloved by the market and have significant legacy creditor issues to address.
Why private companies choose an RTO rather than an IPO
There are a number of reasons why an RTO might appeal to a private company looking to list in London (rather than seeking a direct listing by way of IPO):
More certain route to market – where there is cash already in the shell, a private company may be able to use these funds to cover some or all of the listing costs as the listing costs are mainly the responsibility of the listed entity.
Ability to access bridge-funding – following execution of a binding acquisition agreement, and pending completion of the listing (via an RTO), it is common for the listed company to bridge-finance the operations or growth investments made by the Target. The listed acquiror, as a listed company (and often with a diverse list of existing shareholders) is usually able to access capital more easily than the private target company, as it can offer investors liquidity. Sometimes this bridge capital might provide critical working capital quickly that the Target would otherwise be unable to raise directly.
Some degree of certainty around valuation - direct listings involve no price negotiation with a sponsor or broker - the market determines the price on day one of trading (where no new capital is being raised), or as part of the marketing for the proposed IPO (if new shares are being issued to raise capital concurrent with the IPO). By contrast, RTO deals allow the Target to negotiate a fixed valuation with the shell based on the actual listed price of the shell at the time of such negotiations. In a scenario where no new funds are being raised concurrent with the merger, or only limited additional capital is needed, this can be particularly attractive to a Target that wants certainty.
Experienced management team and plumbing – typically the 'shell' has existing directors that are familiar with the listing process and can guide a private company through an RTO; similarly a shell will have all the advisers needed to achieve a listing in situ, and all the plumbing needed for a public company (i.e. for shares to be traded and settled internationally electronically in a system called CREST).
Built-in shareholder base – all cash shells have a base of investors. Sometimes these can be strategic investors who are willing to provide capital for the right deal, on other occasions the shareholders are investors seeking exposure to a particular sector such mining or technology who may reinvest at IPO or in the aftermarket if the company does well. This is not always the case though!
Free Float – Companies listing their shares on the Official List need at least a 10% free float i.e. 10% of their shares need to be held outside of the issuer’s management team and insiders. Likewise AIM Regulation requires new issuers to have a free float of at least 10% (typically 20-25%). Unless a large amount of capital is being raised from third parties at admission, it can sometimes be difficult for private companies with a small shareholder base to achieve the free float necessary for a direct IPO. Shells often have a large number of small shareholders who will all count towards the free float which means fewer new investors need to be found at the time of admission.
Greater flexibility in deal structures – RTOs often use shares rather than cash as consideration providing more flexibility for Targets, particularly in terms of any future deferred compensation payable to the Target shareholders, which may be based on the Target achieving agreed milestones. This allows the value of a Target to be unlocked (as a public company) over a period of time and for the original shareholders of the private Target to receive additional future consideration as milestones are achieved. This consideration may be shares, or it might be cash (which is also attractive as potentially only limited cash is available at the time of the original RTO). Other flexible terms can be accommodated, including royalty arrangements, promoter fees and in relation to current and future financing of the Target business.
Conclusion
RTOs are not a 'lesser' form of IPO. They are simply a different, highly credible route to market, offering a combination of speed, flexibility and execution certainty that can make them the preferred option for certain private companies.
On both the Main Market and AIM, RTOs remain an integral part of the UK’s sophisticated capital markets ecosystem. When planned and executed well, with appropriate due diligence, governance, and communication, an RTO can provide an efficient and powerful mechanism for companies seeking to unlock the benefits of a public listing.
If you’re a private company exploring the London markets - whether considering an IPO, an RTO, or simply looking to understand the process - our Corporate team is here to help. We work closely with businesses at every stage of their growth and can connect you with the right people, including corporate finance advisers, brokers, accountants, PR specialists and registrars.
We also support listed companies seeking potential acquisition opportunities and can facilitate introductions to suitable targets.
To speak with our team and explore how we can support your plans, please get in touch with Jonathan Morris.
