Professional Documents
Culture Documents
Exclusivity agreement
Also known as lock-out, shut-out or no-shop agreements. Agreements which are
used to try to ensure that the other party to a prospective deal negotiates solely
with the client for a period of time. They aim to give the client some protection
from another party outbidding him.
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Paragraph 1.1(e) provides for the reimbursement of the buyer's costs in the event
that a legally binding sale and purchase agreement is not completed by a
specified date. It is worth noting that in Radiant Shipping Co. Limited v Sea
Containers [1995] CLC 977 an undertaking by a party for good consideration to
reimburse costs is only enforceable if it applies to "reasonable fees". The court's
view was that "the court has to make a common sense judgement upon the
evidence in all the circumstances" as to whether or not the fees incurred were
reasonable.
Information memorandum
Also known as an Info. Memo. This term has a number of meanings depending on
the context in which it is used.
In a syndicated loan, it is a document put together by the arranger who circulates
it to potential lenders to provide information on the borrower and the proposed
loan. The borrower provides much of the information for the document. The
document typically includes:
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companies are run by managers they know rather than the incumbent
management team.
What is 'Earnout'?
Earnout is a contractual provision stating that the seller of a business is to obtain
additional future compensation based on the business achieving certain future
financial goals.
The financial goals are usually stated as a percentage of gross sales or earnings.
Say an entrepreneur selling a business is asking $2,000,000 based on projected
earnings, but the buyer is willing to pay only $1,000,000 based on historical
performance. An earn out provision structures the deal so that the entrepreneur
receives more than the buyer's offer only if the business achieves a certain level
of earnings. The exact numbers would depend upon the business, but in this
example a simplified provision might set the purchase price at $1,000,000 plus
5% of gross sales over the next three years. The earn out thereby helps eliminate
uncertainty for the buyer.
How do private equity and buy-out funds differ from venture capital funds?
Venture capital firms have similar business models as those found in private
equity. However, their focus varies: venture funds largely invest capital in start-
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up and young companies with little or no track record. Private equity and buy-out
funds focus on investing capital in more mature businesses that demonstrate the
potential for growth in value and enhancing their performance over a prolonged
period through structural, strategic management and operational improvements.
How does private equity benefit portfolio companies and the broader economy
and society?
In today's globalised world, private equity investment activity is increasing
substantially. CVC's success in investing in some of the world's most prominent
companies and developing their long-term value has helped to fuel the economy,
create wealth and drive innovation. Empirical evidence shows that private equity
portfolio companies create economic value by operating more efficiently.
Academic studies have shown that private equity investment and leverage has
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an overall positive impact on the financial performance and efficiency of
companies, especially since the transitional capital invested fills a critical gap
when capital markets are fragile.
Ultimately, leveraged buy-outs of portfolio companies generate greater
productivity, promote employment and salary growth, and have a positive effect
on employee relations within the company. Superior returns from private equity
investments strengthen pension funds that provide benefits for millions of
employees. According to research carried out by Preqin, by 2008, the total net
profits distributed to investors worldwide by private equity funds raised
throughout 2007 were over US$1.1 trillion.
What happens when private equity-owned companies reach the end of their
holding period?
At the end of the holding period, an exit from a portfolio company is usually
sought through: an initial public offering (IPO) or flotation of the portfolio
company on the stock market; a 'trade sale' of the company to a strategic
acquirer through a merger or acquisition (M&A); or a 'secondary sale' to another
private equity house.
Mezzanine financing is a hybrid of debt and equity financing that is typically used
to finance the expansion of existing companies. Mezzanine financing is basically
debt capital that gives the lender the rights to convert to an ownership or equity
interest in the company if the loan is not paid back in time and in full. It is
generally subordinated to debt provided by senior lenders such as banks and
venture capital companies.
Since mezzanine financing is usually provided to the borrower very quickly with
little due diligence on the part of the lender and little or no collateral on the part
of the borrower, this type of financing is aggressively priced with the lender
seeking a return in the 20-30% range.
Mezzanine financing is advantageous because it is treated like equity on a
company's balance sheet and may make it easier to obtain standard bank
financing. To attract mezzanine financing, a company usually must demonstrate a
track record in the industry with an established reputation and product, a history
of profitability and a viable expansion plan for the business (e.g. expansions,
acquisitions, IPO).
What is 'Contango'?
A situation where the futures price of a commodity is above the expected future
spot price. Contango refers to a situation where the future spot price is below the
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current price, and people are willing to pay more for a commodity at some point
in the future than the actual expected price of the commodity. This may be due to
people's desire to pay a premium to have the commodity in the future rather
than paying the costs of storage and carry costs of buying the commodity today.
When a market is "in contango" when the delivery price of a particular futures
contract has to converge downward to meet the futures price. If prices did not
converge, it would set up an opportunity for investors to profit from arbitrage.
Contango situations can be costly to investors holding net long positions since
futures prices are falling. For example, assume an investor goes long a futures
contract today at $100. The contract is due in one year. If the expected future
spot price is $70, the market is in contango, and the futures price will have to fall
(unless the future spot price changes) to converge with the expected future spot
price.
The opposite of contango is known as normal backwardation. A market is "in
backwardation" when the futures price is below the expected future spot price for
a particular commodity. This is favourable for investors who have long positions
since they want the futures price to rise.
A contango market is often confused with a normal futures curve; and a normal
backwardation market is confused with an inverted futures curve.
Let's start by getting an understanding of the difference between the two. Start
with a static picture of a futures curve. A static picture of the futures curve plots
futures prices (y-axis) against contract maturities (i.e., terms to maturity). This is
analogous to a plot of the term structure of interest rates: we are looking at
prices for many different maturities as they extend into the horizon. The chart
below plots a normal market in green and an inverted market in red:
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Copyright spot price. In the chart above, the spot price is $60. In the normal
(green line) market, a one-year futures contract is priced at $90. Therefore, if you
take a long position in the one-year contract, you promise to purchase one
contract for $90 in one year. Our long position is not an option in the future - it is
an obligation in the future.
Supply/Demand Determines the Shape
The red line in Figure 1, on the other hand, depicts an inverted market. In an
inverted market, the futures price for faraway deliveries is less than the spot
price. Why would a futures curve invert? Because, in the case of a physical asset,
there may be some benefit to owning the asset (called the convenience yield) or,
in the case of a financial asset, ownership may confer a dividend to the owner.
SEE: Why Dividends Matter
A few fundamental factors (i.e., the cost to carry a physical asset or finance a
financial asset) inform supply/demand for the commodity, which ultimately
determines the shape of the futures curve. If we really want to be precise, we
could say that fundamentals like storage cost, financing cost (cost to carry) and
convenience yield inform supply and demand. Supply meets demand where
market participants are willing to agree about the expected future spot price.
Their consensus view sets the futures price. And that's why a futures price
changes over time: market participants update their views about the future
expected spot price.
The traditional crude oil futures curve, for example, is typically humped: it is
normal in the short-term but gives way to an inverted market for longer
maturities.
Contango and Normal Backwardation: Patterns over Time
We have established that a futures market is normal if futures prices are higher at
longer maturities and inverted if futures prices are lower at distant maturities.
This is where the concept gets a little tricky, so we'll start with two key ideas:
As we approach contract maturity (we might be long or short the futures
contract, it doesn't matter), the futures price must converge toward the spot
price. The difference is called the basis. That's because, on the maturity date, the
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futures price must equal the spot price. If they don't converge on maturity,
anybody could make free money with an easy arbitrage.
The most rational futures price is the expected future spot price. For example, if
you and your counterparty both could foresee that the spot price in crude oil
would be $80 in one year, you would rationally settle on an $80 futures price.
Anything above or below would represent a loss for one of you!
Now we can define contango and normal backwardation. The difference is that
normal/inverted refers to the shape of the curve as we take a snapshot in time.
Contango and normal backwardation refer to the pattern of prices over time.
Specifically, is the price of our contract rising or falling?
Suppose we entered into a December 2012 futures contract, today, for $100.
Now go forward one month. The same December 2012 future contract could still
be $100, but it might also have increased to $110 (this implies normal
backwardation) or it might have decreased to $90 (implies contango). The
definitions are as follows:
Contango is when the futures price is above the expected future spot price.
Because the futures price must converge on the expected future spot price,
contango implies that futures prices are falling over time as new information
brings them into line with the expected future spot price.
Normal backwardation is when the futures price is below the expected future spot
price. This is desirable for speculators who are "net long" in their positions: they
want the futures price to increase. So, normal backwardation is when the futures
prices are increasing.
Consider a futures contract that we purchase today, due in exactly one year.
Assume the expected future spot price is $60 (see the blue flat line in Figure 2
below). If today's cost for the one-year futures contract is $90 (the red line), the
futures price is above the expected future spot price. This is a contango scenario.
Unless the expected future spot price changes, the contract price must drop. If
we go forward in time one month, note that we will be referring to an 11-month
contract; in six months, it will be a six-month contract.
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What is a 'Lock-Up Agreement?'
A
A lock-up agreement is a legally binding contract between the underwriters and
insiders of a company prohibiting these individuals from selling any shares of
stock for a specified period of time. Lock-up periods typically last 180 days (six
months) but can on occasion last for as little as 120 days or as long as 365 days
(one year).
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Debt push-down an acquisition structure leading to a tax effective
interest deduction?
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One of the factors of the success of M&A transactions is an appropriate
acquisition and financing structure. Using maximum leverage in an acquisition, in
which the return on assets exceeds the interest expenses, leads to a substantially
higher return on equity. For this reason, investors (for instance in an LBO or MBO)
wish to obtain maximum debt financing, also considering an increased risk of
insolvency and strategically reduced business opportunities due to lower financial
flexibility.
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2.4 Tax Consequences for the Seller
The tax consequences of the acquisition for the seller can of course not be
neglected in a transaction either. Especially in cases where the seller had held
the shares in the target company in his personal property, an indirect partial
liquidation provision must be observed. A merger of the acquisition company with
the target company within five years after the acquisition of the target company
may trigger income taxes for the seller. This is the reason why share purchase
agreements often limit a debt push-down to cases where it does not lead to an
indirect partial liquidation taxation of the seller.
3. ALTERNATIVE STRUCTURES
It appears that the Swiss Federal Supreme Court has never decided on debt push-
down structures. This can be explained by the long duration of court case
proceedings. Tax advisors have developed several viable alternatives which
depending on the specific starting point allow at least a partial tax deduction of
interest expenses. The most common structural alternatives are the following:
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3.3 Transfer of Assets to the Acquisition Company
Depending on the initial situation, further structuring alternatives may be
considered. It is for example possible to transfer income-generating assets from
the target company to the acquisition company by means of a tax-neutral
intragroup transfer (also called asset push-up). It must be noted, however, that in
certain cases the tax authorities have not only qualified such transaction
structure as tax avoidance but also refused the deduction of interest expenses for
tax purposes.
4. CONCLUSION
These alternative structures are helpful, but usually do not lead to a complete
tax-effective interest deduction. Therefore it is important to determine all non-tax
purposes leading to a debt push-down in a merger of the acquisition company
with the target company. Such determination allows discussions with the tax
authorities to demonstrate that the case at hand does not qualify as a tax
avoidance.
What's the difference between working capital and net working capital?
While both focus on obligations due within a year, thus exclude fixed assets/PP&E
(which together make up total capital) they actually have two almost opposite
meanings and implications.
From a strict accounting standpoint, basic working capital is current assets (cash,
inventory, a/r) minus current liabilities (a/p, short term debt). This essentially
represents a company's liquidity, or ability to meet short term demands. The
higher the working capital, the better / more liquid.
Net working capital is similar but removes the cash and debt consideration and
simplifies the formula to a/r and inventory minus a/p. This represents how much
capital is required run the operations of the business. In this case, the lower the
number the better as that means it takes up less capital (ie money) to run the
daily operations, ie the company is being more efficient. Less capital required =
less shareholders and creditors to pay. This definition has become much more
prominent in the last decade with companies and often when they talk working
capital they are actually referring to this definition, not the former.
For further comparison, in the first example having higher a/r is a good thing as
that means you have more money coming your way in the near term. In the latter
example it's a bad thing as that means your customers are taking too long to pay
you. (Vice versa for a/p) In the former example, higher inventory is good as that
means you're holding onto higher value, in the latter example high inventory is
bad as that means the company is not managing inventory effectively by
purchasing too much, and thus tying up capital in the process.
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Pitchbook
A pitchbook is a sales book created by an investment bank or firm that details the
main attributes of the firm, and it is used by the firm's sales force to help sell
products and services and generate new clients. Pitchbooks are helpful guides for
the sales force to remember important benefits and to provide visual aids when
presenting to clients.
There are two main types of pitchbooks. There is the main pitchbook, which
contains all of the main attributes of the firm, and one that contains details about
a specific deal, such as a company's IPO or investment product.
The main pitchbook provides general overview about the firm. For an investment
bank, it would show information like the number of analysts, its prior IPO success
and the number of deals it completes per year. For an investment firm, it will
show information such as the financial strength of the company, and the many
resources and services available for its clients. If the pitchbook is being used by a
team or individual financial advisor, there could be biographical information as
well. All the details displayed in the pitchbook are points that the sales team
should focus on when selling the benefits of the firm to potential clients.
Product Pitchbook
For an investment bank, this form of pitchbook focuses on all of the benefits of
the issue, helping brokers and investment bankers demonstrate how the firm can
service the specific needs of their potential clients. It would have more detailed
information about how the potential IPO process could play out for the potential
client. It would also show comparable IPOs within the same industry that the
investment bank has had success in the past.
Envy ratio
Envy ratio, in finance, is the ratio of the price paid by investors to that paid by
the management team for their respective shares of the equity. It is used to
consider an opportunity for a management buyout. Managers are often allowed
to invest at a lower valuation to make their ownership possible and to create a
personal financial incentive for them to approve the buyout and to work diligently
towards the success of the investment. The envy ratio is somewhat similar to the
concept of financial leverage; managers can increase returns on their
investments by using other investors' money.
If private equity investors paid $500M for 80% of a company's equity, and a
management team paid $60M for 20%, then ER=(500/80)/(60/20)=2.08x. This
means that the investors paid for a share 2.08 times more than did the
managers. The ratio demonstrates how generous institutional investors are to a
management teamthe higher the ratio is, the better is the deal for
management.[2]
As a rule of thumb, management should be expected to invest anywhere from six
months to one years gross salary to demonstrate commitment and have some
"skin in the game".[3] In any transaction, the envy ratio is affected by how keen
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the investors are to do the deal; the competition they are facing; and economic
factors.[4]
There have been allegations that U.S. rent-to-own businesses bypass certain
consumer protection laws by referring to the purchase contracts as rental
agreements instead as an extension of credit. Rental agreements are exempt
from the Truth in Lending Act that requires the clear disclosure of interest rates
on consumer loan products. This allows rent-to-own businesses to refrain from
explicitly stating the associated interest rate paid based on the product's price
compared to the monthly payment amounts.
Additionally, if a buyer using a hire purchase fails to make the required payments,
the company sponsoring the purchase can repossess the item. Whether a
repossession is voluntary or involuntary, the buyer is generally not eligible to
receive any funds back that have already been placed toward the purchase.
'Shadow Market'
Add-On Acquisition
An add-on acquisition refers to a company that is added by a private equity firm
to one of its platform companies, or by a strategic buyer pursuing a consolidation
investment strategy. Typically, the acquirer will already have the management
capabilities, infrastructure, and systems that allows for organic or acquisitions
growth. The add-on acquisitions can provide complimentary services, technology,
or expansion into the existing geographic footprint that can be quickly integrated
into the existing infrastructure. A larger add-on target might also bring some
diversification of products, geographies, and customers which would further
extend the reach of the buyer.
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Similar to a bolt-on or tuck-in, an add-on acquisition can refer to acquisitions of
smaller companies with very little financial and administrative infrastructure.
Given the lack of infrastructure, acquirers will usually pay lower end valuation
multiples for add-on acquisitions.
Unlike a bolt-on or a tuck-in, an add-on acquisition can also refer to the
acquisition of a larger company that provides diversification to an existing
business. The add-on business could have strong infrastructure and management
teams, and in some instances might be seen as a synergistic purchase by an
acquirer. In this case, an add-on acquisition could fetch a premium valuation in
the marketplace.
Bolt-on Acquisition
A bolt-on acquisition refers to a company that is added by a private equity (PE)
firm to one of its platform companies. Typically, a PE firm will partner with a
larger company that has a position in a particular market. This larger company
becomes a platform to expand into the market because it has the management
capabilities, infrastructure and systems that allows for organic or acquisition
growth.
The platform company will look for bolt-on acquisitions that provide
complementary services, technology or geographic footprint diversification and
can be quickly integrated into the existing management infrastructure.
Bolt-on acquisitions are usually smaller companies with very little financial and
administrative infrastructure. They are typically operated by the company owner
and have hit a tipping point where they can't grow anymore due to lack of
capital, scale or management expertise. They may have unsophisticated financial
systems, IT and internal controls, but are usually excellent operating companies
with good customer relationships.
The owners of bolt-on acquisitions are usually looking to move the administration
and corporate management so they can focus on operations and customers. This
is why private equity-backed platform companies or corporate buyers with the
infrastructure in place can be a perfect fit. Given the lack of infrastructure at
these companies, buyers will usually pay a lower valuation multiple for a bolt-on
acquisition than they would for a platform company.
Hostile Takeover
A hostile takeover is the acquisition of one company (called the target company)
by another (called the acquirer) that is accomplished by going directly to the
company's shareholders or fighting to replace management to get the acquisition
approved. A hostile takeover can be accomplished through either a tender offer
or a proxy fight.
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The key characteristic of a hostile takeover is that the target company's
management does not want the deal to go through. Sometimes a company's
management will defend against unwanted hostile takeovers by using several
controversial strategies, such as the poison pill, the crown-jewel defense, a
golden parachute or the Pac-Man defense.
A company can establish stocks with differential voting rights (DVR); a stock with
less voting rights pays a higher dividend. This makes it an attractive investment
but it becomes harder to generate the votes needed for a hostile takeover.
Another defense is to establish an employee stock ownership program (ESOP),
which is a tax-qualified plan in which employees own substantial interest in the
company. They are more likely to vote with management, which is why this can
be a successful defense. In a crown jewel defense, a provision of the company's
bylaws requires the sale of the most valuable assets if there is a hostile takeover.
Reactive Defenses
Officially known as a shareholder rights plan , a poison pill defense allows existing
shareholders to buy newly issued stock at a discount if one shareholder has
bought more than a stipulated percentage of the stock; the buyer who triggered
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the defense is excluded from the discount. The term is often used broadly to
include a range of defenses, including issuing both additional debt to make the
target less attractive and stock options to employees that vest upon a merger. A
people pill provides for the resignation of key personnel in the case of a hostile
takeover, while the Pac-Man defense has the target company aggressively buy
stock in the company attempting the takeover.
Poison Pill
In regard to mergers and acquisitions, poison pills were initially constructed in the
early 1980s. They were devised as a way to stop bidding takeover companies
from directly negotiating a price for the sale of shares with shareholders and
instead force bidders to negotiate with the board of directors.
Shareholder rights plans are typically issued by the board of directors in the form
of a warrant or an option attached to existing shares. These plans, or poison pills,
can only be revoked by the board. Since their inception, poison pills have
formulated into two types with the flip-in variety being the most common.
An Example
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Flip-in poison pills may hold an attached option that permits shareholders to buy
additional discounted shares if any one shareholder buys more than a certain
percentage, or more, of the companys shares. For example, a flip-in poison pill
plan is triggered when a shareholder buys 25% of the companys shares. When it
is triggered, every shareholder, minus the holder who purchased 25%, is entitled
to buy a new issue of shares at a discounted rate. The greater the number of
shareholders who buy additional shares, the more diluted the bidders interest
becomes and the higher the cost of the bid. If a bidder is aware such a plan could
be activated, it may be inclined not to pursue a takeover without board approval.
Golden Parachute
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Some examples of golden parachutes that have been reported in the press
include:
Meg Whitman, chief executive officer (CEO) of Hewlett-Packard Enterprise,
stands to receive almost $9 million if there is a change of control at the company
and more than $51 million if she is terminated.
Until a federal court blocked it in May 2016, Staples Inc. and Office Depot Inc.
were looking to merge. If they had done so, the CEO of Office Depot would have
collected $39 million under his golden parachute.
Dell Inc. is in the process of merging with storage giant EMC Corporation. By
virtue of his golden parachute, EMC's CEO will receive compensation worth $27
million.
War Chest
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A companys war chest is the buffer of cash kept aside for uncertain adverse
events, such as taking over a company. A war chest is typically invested in liquid
assets such as Treasury bills and bank deposits that are available on demand.
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Transitional service agreements can be extremely difficult to manage if they are
not properly defined. Usually, poorly drafted TSA's result in disputes between the
buyer and the seller centred on the scope of services to be provided.
TSA's should ensure the following key points are fully defined:
The fee for the general scope of services and additional charges for services
beyond the scope;
The term of the agreement and any available renewal terms;
The dispute resolution mechanism to deal with discrepancies between the buyer
and seller; and
How the TSA will be transitioned once the buyer is able to assume the
administrative responsibilities
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The representations and warranties need to be fully scrutinized to ensure there is
no statement that is believed to be untrue. There is usually recourse and
potential legal action if it is later found out that the representations and
warranties provided were untrue. Even post-transaction, this may result in a
purchase price adjustment where the seller is required by the legal courts to
reimburse the buyer for any misrepresentations.
A reverse takeover (RTO) is a type of merger that private companies use become
publicly traded without resorting to an initial public offering (IPO). Initially, the
private company buys enough shares to control a publicly traded company. The
private company's shareholder then uses its shares in the private company to
exchange for shares in the public company. At this point, the private company
has effectively become a publicly traded company. An RTO is also known as a
reverse merger or a reverse IPO.
With this type of merger, the private company does not need to pay the
expensive fees associated with arranging an IPO. However, the company does not
acquire any additional funds through the merger, and it must have enough funds
to complete the transaction on its own.
While not a requirement of an RTO, the name of the publicly traded company
involved is often changed as part of the process. Additionally, the corporate
restructuring of one or both of the merging companies are adjusted to meet the
new business design.
It is not uncommon for the publicly traded company to have had little, if any,
recent activity, existing as more of a shell corporation. This allows the private
company to shift its operations into the shell of the public entity with relative
ease, all while avoiding the costs, regulatory requirements and time constraints
associated with an IPO. While a traditional IPO may require months or years to
complete, an RTO may be complete within weeks.
Using a Reverse Takeover to Access U.S. Markets
A foreign company may use an RTO as a mechanism to gain entry into the U.S.
marketplace. If a business with operations based outside of the U.S. purchases
enough shares to become a controlling interest in the U.S. company, it can move
to merge the foreign-based business with the U.S.-based one, giving access to a
new market without the costs traditionally involved.
To complete the process, the final resulting company must be able to meet all
Securities Exchange Commission (SEC) reporting requirements and other
regulatory standards, including the filing of an SEC Form 8-K to disclose the
transaction.
Alternate Definition
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A reverse takeover can also refer to an instance where a smaller company takes
over a larger one. It is so named due to the fact that it is the lesser expected
arrangement of the traditional takeover of a smaller business by a larger one.
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