What Is a Back Door Listing?

Companies that want to go public have several options available to them. The most popular is the traditional route: filing regulatory paperwork and issuing an initial public offering (IPO). When it happens, there's usually a lot of fanfare. Consider how the market reacted when social media giant Facebook first went public.

But what happens when you don't have that option available to you? What if you're a private company that doesn't meet the requirements to trade public, but you still want to be listed?

Here we look at back door listings, a strategy available to private companies who want to be public.

A back door listing is one way for a private company to go public if it doesn't meet the requirements to list on a stock exchange. So, in a nutshell, the company gets on the exchange by going through a back door. This process is sometimes referred to as a reverse takeover, reverse merger or reverse IPO.

By going through a back door listing, the private company avoids the public offering process and gains automatic inclusion on a stock exchange. Following the acquisition, the buyer may merge both companies' operations or, alternatively, create a shell corporation that allows the two companies to continue operations independent of each other.

Although not as prevalent, a private company will sometimes engage in a back door listing simply to avoid the time and expense of engaging in an IPO.

Say a small private firm wants to go public but it just doesn't have the resources to do so. It may decide to buy out an already publicly traded company to meet the requirements. The company would need a lot of cash on hand in order to make this possible.

Let's take a hypothetical example of two companies—Company A and Company B. Through its shareholders, Company A (the private company) buys control of Company B. Company A's shareholders will then control B's Board of Directors. Once the transaction is complete, the merger is negotiated and executed. Company B will then issue a majority of its shares to Company A. Company A will then start to do business under Company B's name and merge the operations of both. In some cases, as noted above, Company A may open up a shell corporation and keep the two operations separate.

One of the major upsides of going through a back door listing is that it is considered a cost-effective measure for a private firm to go public. Because it can strike up a deal with an already public company, it doesn't have to go through the expenses of regulatory filings or funding to go public.

Private firms may also inject life into a troubled company without the need to raise more money from the market. Not only does this bring a new set of people to the table, but it may also bring new technology, products, and marketing ideas.

There is also some upside for existing stock owners. Shareholders in the target company may also get some cash for the deal. If the merger is successful and the two companies' synergy is compatible, it may mean added value for the new entity's shareholders as well.

As with any other process, there are also disadvantages to undergoing a back door listing. Since it doesn't happen very often, it may be cumbersome to explain to shareholders, leaving them confused and upset.

This process can also lead to new shares being issued for the incoming private company. This leads to share dilution, which can decrease existing shareholders' ownership and value in the company.

While a back door listing may help boost a flailing public company's bottom line, it can have the reverse effect as well. If the two companies don't have a natural fit, it may hurt profits in the end.

Finally, depending on which country the listing is in, trading of the listed company can be halted or suspended until the merger is fully executed.

One of the biggest examples of a back door listing was when the New York Stock Exchange (NYSE) acquired Archipelago Holdings. In 2006, the two agreed to a $10 billion deal and created the NYSE Group. Archipelago was one of the exchange's main competitors, despite the fact that it offered trading services electronically, compared to the open outcry system of the NYSE.

While they don't happen very often, back door listings are a strategic way for private companies to go public. Without the need to issue an IPO, a private company can save itself money by foregoing the need for regulatory filings, but instead, buying out shares in an existing company.