What is Back Door Listing?

Back door listing is a fancy way for private companies to get on the stock market without doing an IPO. It’s a popular “secret” trick. But maybe it shouldn’t stay secret. Let’s spill the beans on this back door action!

What the Heck is a Back Door Listing?

A back door listing happens when a private company that’s not traded on the stock exchange decides to merge with or get bought by a public company that is already listed.

It lets the private company sneak onto the exchange through the “back door” without going through the normal front door process of an initial public offering (IPO). Sneaky, huh?

Why do companies do this? Going public the regular way with an IPO is a huge pain. Tons of paperwork, getting grilled by the SEC, schmoozing investors on a roadshow, and spending buckets of money on bankers and lawyers. Ugh, who needs that headache?

With a back door listing, you can avoid a lot of that nonsense. Find a shell company already on the exchange, make a deal to combine with them, and boom – you’re public! Way easier.

Reverse Mergers: The Usual Back Door Method

The most common way to do a back door listing is through something called a reverse merger or reverse takeover (RTO). Despite the name, you’re not driving backwards. Here’s how it goes down:

1. The private company finds a public shell company. This is a company that’s listed on the exchange but doesn’t really do much business anymore.
2. The private company buys a controlling stake in the shell company, usually by giving the shell company shareholders a bunch of shares in the private company.
3. Abracadabra, now the private company has magically transformed into a public company by taking over the shell!
4. The private company usually changes the shell company’s name to its own name. Maybe give it a fresh coat of paint and some new executives too.

Alternative Look: Backdoor IPOs

Sometimes you’ll hear back door listings called “backdoor IPOs.” But that’s not exactly right. In an IPO, a company is selling new shares to investors to raise money.

With a back door listing, the private company isn’t raising new capital, it’s just getting its shares listed on the exchange by combining with an already-public shell company. So “backdoor listing” or “reverse merger” is a bit more accurate than “backdoor IPO.”

Why Companies Sneak in the Back Door

Back door listings have gotten super popular in places like Australia, Hong Kong, the UK and Sweden. In the US, not as much lately. But they’re still a thing. Over 200 companies have gone public in the US via back door listings since 2015.

Easier & Cheaper than an IPO

The number one reason companies like back door listings is that they’re usually faster, easier and cheaper than doing a traditional IPO. No need for a lengthy SEC review or pricey investment bankers.

Going public through an IPO can take 6-9 months minimum and cost millions in legal, accounting and underwriting fees. A back door listing can often be done in 2-4 months for a fraction of the cost.

Avoid Market Scrutiny

Some companies may choose a back door listing because their financials aren’t strong enough for the scrutiny of an IPO. With a traditional IPO, you have to share a lot of details about your business in the prospectus for investors.

If a company’s business is still unproven or even kind of sketchy, it’s a lot easier to go public by merging with some defunct shell company than trying to convince the SEC and investors your story in an IPO.

Piggyback on an Existing Listing

Another reason a company might use a back door listing is to get access to a particular stock market that’s hard to IPO on directly. Like if a company really wants to list on the NASDAQ but doesn’t meet the exchange’s criteria.

By merging with a shell company that’s already on the NASDAQ, the private company can piggyback on that existing listing without having to qualify on its own. Crafty!

The Dark Side of Back Door Listings

While back door listings can be totally legit, sometimes they’re favored by companies that may have something to hide. Since there’s less scrutiny vs. an IPO, it can attract shadier businesses.

Loosey-Goosey Financials

In China, back door listings were a popular way for companies to go public without the full financial disclosure required in an IPO. Questionable accounting? Meh, just find a shell company and merge! Regulators caught on and cracked down.

Pump and Dump Schemes

Back door listings have also been used in some stock manipulation schemes. Bad actors take a worthless shell company, spread false hype to pump up the stock price, then quickly sell out, leaving other investors holding the bag.

Not All Unicorns & Rainbows

Even when it’s not a total scam, companies that go public through back door listings tend to underperform vs. IPO companies. One study found that back door listed companies lagged IPO companies on revenue growth, cash flow and stock price returns.

Without the proving ground of an IPO, some companies may not be fully ready for the big leagues of the public markets. Their inexperience often shows in their results.

Should You Invest in Back Door Listings?

If you’re thinking of throwing some money at a company that’s gone public via a back door listing, be very careful. Do extra homework to make sure it’s the real deal.

Some things to watch out for:

• Is it a real business or just an empty shell?
• Do they have a track record of growing revenue and profits or is it all projection and hype?
• Have their executives run public companies before or is this their first rodeo?
• Is the reason for the backdoor listing something innocent like saving on IPO costs or are they trying to avoid disclosure and oversight?

Back door listings aren’t necessarily bad but they do deserve some healthy skepticism. Don’t just assume that because a stock has a ticker symbol that it’s a quality company.