What is a Reverse Takeover?

“Taking a company public” (a term used to describe a private company’s first issuance of stock on a public exchange) can be a long, complicated, and expensive process. While going public does greatly widen a company’s access to capital, it requires tedious government oversight, exposes them to fickle investors, and can often pressure them to perform in the short-term at the expense of their long-term goals. Given these difficulties, it’s understandable that the management teams of most startups typically prefer to stay private until they feel their companies have reached maturity.  

In the case of cannabis companies—which often struggle to access private capital—many management teams have chosen to go public at a much earlier stage than would be considered normal for their counterparts in more established industries, and often using much more complicated methods. Instead of the more traditional “initial public offering,” or “IPO,” most cannabis companies choose to go public using a legal mechanism known as a “reverse takeover” or “RTO.”

In an IPO, a company prepares a prospectus and then offers their shares to the public while concurrently obtaining a listing on a public exchange. Simply put, the company looking to go public provides the information potential investors need to accurately value their stock, gets a listing and then opens trading to the public.

On the other hand, an RTO involves a private company buying a majority ownership stake in a company that is already traded on a public exchange—typically some form of shell company that has little or no recent operating activity. The owners of the private company nominally shift their operations under the umbrella of the shell company, essentially creating a proxy for public distribution of their shares. While an RTO also avoids the costs, regulatory requirements and time constraints associated with an IPO, it sometimes bears a stigma among investors and usually dilutes the ownership stake(s) of the original investors in the private company. Further analysis of each method’s many costs and benefits is nicely detailed here in a memorandum prepared by Cassels Brock Lawyers.

To-date, the majority of cannabis companies that have gone public have done so via an RTO of shell mining companies on Canadian stock exchanges, predominantly the Canadian Securities Exchange (CSE) and the TSX Venture Exchange (TSXV), although the TSXV currently refuses to accept any cannabis companies with US operations. There are significant regulatory advantages to being public in Canada versus the United States, given that Canada federally legalized recreational cannabis in October 2018. As a result, CSE listed cannabis issuers raised $3.99bn in 2018, of which US-based cannabis issuers raised $2.65bn (approximately two-thirds of the total).

As more cannabis companies have sought to go public via an RTO, the demand for stock in public shell companies has skyrocketed, giving existing shareholders of those companies substantially increased negotiating power. For example, the rate of dilution private shareholders experience when performing an RTO has increased from approximately 3% to as high as 13%. Despite this, if cannabis remains federally illegal in the US and publicly traded cannabis companies continue to receive robust valuations, we expect demand for RTO activities to remain strong.

While the abundance of publicly traded cannabis companies can be enticing for retail investors looking to access the industry’s growth, we caution them to first understand the risks before making an investment. These securities are typically thinly traded, highly volatile and more susceptible to market manipulation relative to those traded on major exchanges. Before executing on any investment, make sure to conduct detailed due diligence so you understand the merits and risks of the security you’re purchasing.


DISCLAIMERS: This site is not intended to provide any investment, financial, legal, regulatory, accounting, tax or similar advice, and nothing on this site should be construed as a recommendation by Key Investment Partners LLC, its affiliates, or any third party, to acquire or dispose of any investment or security, or to engage in any investment strategy or transaction. An investment in any strategy involves a high degree of risk and there is always the possibility of loss, including the loss of principal. Nothing in this site may be considered as an offer or solicitation to purchase or sell securities or other services.