An Analysis of Private Firm Owner Wealth Following Reverse Mergers

Abstract

I compare the wealth of private firm owners that exit their firms through reverse mergers (RMs) to the wealth that could have been obtained in initial public offerings (IPOs), sellouts, or by remaining private. Private firm owners that use the RM exit mechanism have significantly less post-exit wealth than the wealth that could have been obtained in an IPO. This result is driven by differences in the pre-exit characteristics of firms that choose a RM compared to an IPO (a selection effect), not by use of the RM exit mechanism itself (a treatment effect). The gap between post-exit wealth and the wealth that could have been obtained in an IPO disappears for owners of RM firms whose pre-exit characteristics are sufficiently similar to propensity-score matched IPO firms. The post-exit wealth of RM firm owners is approximately the same as the wealth that could have been obtained in a sellout. The median change in private firm owner wealth as a result of the RM is positive when the pre-exit private firm value is inferred from valuations in private-private takeovers. However, the median change in wealth is negative when pre-exit private firm value is obtained from valuations provided in fairness opinions. These conflicting findings appear to be driven by upwardly biased fairness opinion valuations.