Put It In Reverse

Backward Bonus

Following are some of the primary benefits you can reap with a reverse merger:

  • Imperviousness to market conditions: Conventional IPOs are risky for companies to undertake because the deals depend on market conditions over which you have no control. If the market is off, the underwriter may pull the offering. The market doesn't even need to plunge wholesale. If a company seeking an IPO is in an industry that's making unfavorable headlines, investors may shy away from the deal, causing it to run out of gas on the runway.

But with a reverse merger, the deal rests on whether the shell company likes your company enough to be acquired by it. Market conditions have almost no bearing.

  • Compressed timetable: Regular IPOs can drag on for a year or more from when the idea pops into your head until you actually get a check. Unfortunately, when a company transitions from an entrepreneurial venture to a real public company fit for outside ownership, senior management's time is at its most valuable. Spending it in seemingly endless meetings and drafting sessions can have a disastrous effect on the growth the offering is predicated on and even nullify it. In addition, during the many months it takes to put together an IPO, market conditions can deteriorate, closing the IPO window on a company. By contrast, a reverse merger can be completed in 45 days.
  • Reduced expenses: For a real IPO, it can cost as much as $200,000 just to get a preliminary prospectus on the street. To actually bring the deal to the closing table, the costs increase. A reverse merger, however, can be done for only $50,000 to $100,000.
  • Corporate tax shelter: Many shell companies have what's known as a tax-loss carry forward. This means losses incurred in previous years can be applied to income in future years. When this occurs, future income is sheltered from income taxes. There's a better-than-average chance the shell you meet will offer this opportunity. (As discussed in the next section, however, the shell company's history can rub off on you, which turns out to be one of the biggest drawbacks to reverse mergers.)
  • More ways to raise money: The primary reason to do a reverse merger is the greater number of financing options that become available to companies once they have gone public. These include:

1. The issuance of additional shares in a secondary offering.

2. Exercise of warrants. Warrants are options that give the holder the right to purchase additional shares in a company at a predetermined price. When many shareholders with warrants--which a public company can easily issue--exercise their option to purchase additional shares, the company receives an infusion of capital.

3. Private offerings. Many more investors will step up to the plate for a private offering of shares once they know there's some sort of mechanism in place for them to resell their shares if the company succeeds. Most investors realize that even a successful company may not be able to go public if market conditions are off. But a company that is already public . . . that's a different story. If it succeeds, there's a greater likelihood of developing a market for its common stock that accurately represents the company and lets investors sell their shares.

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This article was originally published in the June 1999 print edition of Entrepreneur with the headline: Put It In Reverse.

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