Reverse takeovers: are they for you?

Why are Reverse takeovers (RTOs) popular in the UK? We look at the opportunities and challenges they bring.

A reverse takeover (RTO) or reverse acquisition is a transaction which often involves a larger, private company acquiring a smaller, publicly listed company as a means of becoming listed itself. RTOs have been common for many years. The reason for this is that shell companies, or special acquisition companies (SPACs), have been required to complete an RTO or similar transaction to maintain their listed status. Conversely, non-listed operating entities have seen SPACs as an easier route to public markets. 

But why are they called ‘reverse’?  Because commercially, the larger entity is initiating the transaction and seeking the listing. So it could be considered the acquirer but legally the smaller entity is paying the consideration and acquiring the shares of the larger entity. Therefore, the legal and commercial ‘acquirers’ are reversed.

In other words, legally, small guy acquires big guy. In reality (and in accounting terms), big guy acquires small guy.

Why undergo an RTO?

Hopping across the pond, RTOs in the US are often sought by private companies to obtain funding from capital markets quickly, without the need for a formal IPO process.

For better or for worse, in the UK, an RTO transaction frequently triggers the need for readmission of the listed entity to one of the relevant markets (Main Market, AIM or Aquis). It also requires publication of a relevant listing document (prospectus or admission document). In fact the timing, cost and practicalities are often equivalent to the IPO process.

The pros of RTOs

• Coverage of the listed entity – as the entity is already listed, it may have some existing analyst coverage or an investor following.
• Management – the management of the private entity theoretically takes over in the combined entity. But often certain directors in the listed entity are kept on for their skills and knowledge, or their experience with capital markets and the running of a public listed entity.
• Resilience in bear markets – there is some evidence that RTOs remain resilient during bearish market conditions, when IPOs all but cease. When the listed entity has ample cash reserves and limited (or nil) funds are being raised in the transaction, there is a rise in RTO activity.  

The cons of RTOs

• Similar burden to an IPO – in the UK, there is usually the same regulatory, time and cost burden as with an IPO. So it may be better to pursue an IPO or create a clean, new Listco.
• Financial or operational past – there may be historical elements of the publicly listed entity that need attention before, at or post completion. Common examples are liabilities, litigation, operational issues and residual or legacy equity instruments or capital restructuring.
• Management – there can be tensions or disagreements between management teams in the process of the RTO. Removing certain directors or other management in the accounting acquiree may not be simple.

RTO accounting

Class tests

An RTO from a UK market perspective is so defined if the transaction produces a fundamental change in its business, board or voting control or if it exceeds 100% in any of the class tests. The class tests are shown below (as defined in Schedule Three of the AIM rules*):

*The Main Market follows the UK Listing Rules (UKLR) which have slightly different definitions and only include three of the class tests (gross assets, consideration and gross capital tests).  

Accounting treatment

There are two key questions in RTO accounting that dictate the relevant accounting treatment:

• Is the entity being acquired a ‘business’?
• Which entity is the acquirer for the purposes of accounting?

Both questions seem very basic, but there are certain nuances to consider.

• Who is the acquirer?

This question is simple from a legal viewpoint. But from an accounting perspective, it must be decided which entity obtains control. In an RTO, the legal acquiree takes control over the legal acquirer (typically through the exchange of shares). Some telltale signs of this are when:

• the owners of the legal acquiree have the largest share of voting rights in the new combined entity
• the management and governance of the new combined entity is performed by the legal acquiree.

The other test is as outlined in the class tests above: a comparison of the size of each entity. In an RTO the legal acquiree is typically larger (revenues, assets, profits) than the legal acquirer.

• Is the entity a business?

Once the accounting acquirer has been identified, we must determine if the entity being acquired (the accounting acquiree) constitutes a ‘business’. Businesses must have inputs, processes to transform those inputs and, ultimately, outputs.

This decision can involve significant judgement. It should include a thorough review of:

• inputs (fixed assets, right of use assets, IP, intangible assets);
• processes (operational, resource management or strategic); and
• outputs (revenue, product or service, investment income).

To determine the entity’s status as a business, the concentration test can be applied. If the acquisition passes the test, it’s an asset acquisition. If it fails, the decision is whether the acquisition is a business in the prescribed way. To pass the test, substantially all the fair value of the gross assets acquired must be concentrated in a single identifiable asset or a group of similar identifiable assets.

To decide this, you need to ask the following questions:

• Has a single identifiable asset or a group of similar identifiable assets been acquired?
• Is substantially all the fair value of the gross assets acquired concentrated in a single identifiable asset or a group of similar identifiable assets?
• Does the acquired set of activities and assets have outputs?
• If there are no outputs, when is the acquired process considered substantive?
• If there are outputs, when is the acquired process considered substantive?

The accounting acquiree must meet the definition of a ‘business’ in order to be accounted for as a ‘business combination’ under IFRS 3 for the RTO.

Otherwise, the acquisition is treated as an asset acquisition, and as a share-based payment under IFRS 2 for the accounting acquirer.

How PKF can help

Although RTOs are common transactions on capital markets, accounting for them isn’t straightforward. PKF’s Capital Markets team are experts in identifying and accounting for both RTOs and IPOs and can guide you through the process.

To find out more, please contact Joseph Baulf, Adam Humphreys or Jack Devlin.